A Theory of Socially Responsible Investment

54 Pages Posted: 21 Oct 2019 Last revised: 23 Mar 2023

See all articles by Martin Oehmke

Martin Oehmke

London School of Economics & Political Science (LSE) - Department of Finance; Centre for Economic Policy Research (CEPR)

Marcus M. Opp

Stockholm School of Economics - Department of Finance; Swedish House of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 22, 2023

Abstract

We characterize the conditions under which a socially responsible (SR) fund induces firms to reduce externalities, even when profit-seeking capital is in perfectly elastic supply. Such impact requires that the SR fund's mandate permits the fund to trade off reduced financial performance against reductions in social costs - relative to the counterfactual in which the fund does not invest in a given firm. Based on such an impact mandate, we derive a micro-founded investment criterion, the social profitability index (SPI), which characterizes the optimal ranking of impact investments when SR capital is scarce. If firms face binding financial constraints, the optimal way to achieve impact is by enabling a scale increase for clean production. In this case, SR and profit-seeking capital are complementary: Surplus is higher when both investor types are present.

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

JEL Classification: G31, G23

Suggested Citation

Oehmke, Martin and Opp, Marcus M., A Theory of Socially Responsible Investment (March 22, 2023). Swedish House of Finance Research Paper No. 20-2, Available at SSRN: https://ssrn.com/abstract=3467644 or http://dx.doi.org/10.2139/ssrn.3467644

Martin Oehmke

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Marcus M. Opp (Contact Author)

Stockholm School of Economics - Department of Finance ( email )

SE-113 83 Stockholm
Sweden

Swedish House of Finance

Drottninggatan 98
111 60 Stockholm
Sweden

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