A Theory of Socially Responsible Investment

Abstract

We characterize conditions under which socially responsible investors can impact firm behavior. Impact requires a sufficient relaxation of financing constraints for clean production, which can only occur if socially responsible investors internalize social costs irrespective of whether they are investors in a given firm. Socially responsible and financial investors are complementary: jointly they can achieve higher welfare than either investor type alone. Scarce socially responsible capital should be allocated based on a social profitability index (SPI) that captures not only on a firm’s social status quo but also the counterfactual social costs produced in the absence of socially responsible investors.

Keywords: Socially responsible investing, ESG, SPI, capital allocation, sustainable investment, social ratings

JEL Classification: G31, G23