Alpha's Tale: The Economic Value of CSR

Abstract

Numerous studies report empirical evidence that trading strategies based on CSR information – often going ‘long’ the CSR ‘leaders’, and ‘short the ‘laggards’ – produced risk-adjusted investment profits (CSR Alpha). The claim of CSR Alpha is often used by SRI proponents and investment managers to convince mainstream investors that they can do well by doing good, potentially offsetting opportunity costs incurred by ethics/values-based screening.

Although the thesis is attractive, claiming the presence of CSR Alpha begs an important question: Did the high (low) social responsibility standards of companies cause the strong (weak) stock returns – or – were these returns caused by risk or other underlying – perhaps time-period-specific – factors that happen(ed) to be correlated with CSR performance? SRI proponents would like to claim causality between CSR and returns, but such a causality relationship implies that CSR Alpha was the product of stock market inefficiencies; investors would have misevaluated the importance of CSR performance for future operating cash flows.

Our findings suggest that CSR Alpha arose because investors have historically overlooked the full value relevance of CSR information, thus being surprised at the earnings performance of CSR leaders and re-evaluating their assessment of companies‘ prospects upon earnings announcements. Using market-based measures such as earnings announcement surprises, analyst forecast errors and Tobin's q, the paper lends credence to the claim that CSR caused stock returns. However, proposing that recent institutional pressures to incorporate ESG factors have improved investors' attention to and hence treatment of CSR information (eg. UN PRI), I find evidence suggesting that the stock market now more fully reflects the value relevance of CSR information, laying doubt on the view that best-in-class strategies will continue to outperform.

These findings shed light on the future viability of responsible investment strategies, implying that focus will move away from security selection and towards new approaches to strategic asset allocation, impact investing, and shareholder engagement. These latter strategies will be increasingly recognized for their potential to generate economic value. As the paper suggests, CSR creates shareholder value. Disputing the anti-thesis of reverse causality that relies on slack resources theory, it brings clarity to a 40 year-old debate that questioned the economic value of CSR.

I discuss the implications of CSR's suggested economic role, the capital market's appreciation of this role, and explore how institutions can affect more economically efficient and sustainable behaviour at the level of capital markets and strategic management. Findings yield substantial support for the work of institutional players like the UN PRI for helping improve capital market efficiency and thus affecting more economically efficient and sustainable corporate behaviour. The tale of CSR's Alpha borrows from a rich assortment of over 500 scholarly articles for its foundation. Applied to actual developments in the investment industry, it yields significant findings for academics and practitioners alike in the fields of sustainability, management, capital markets, investment, finance, political science, law, ethics and institutionalism.

Keywords: socially responsible investing (SRI), corporate social responsibility (CSR), market efficiency, externalities, behavioural finance, asset pricing, learning, attention, institutional theory, isomorphism, UN PRI, Wages of Social Responsibility (WSR)

JEL Classification: A14, G10, G11, G12, G14, G18, M14, N20