A Theory of Socially Responsible Investment
46 Pages Posted: 21 Oct 2019 Last revised: 20 Mar 2020
Date Written: March 18, 2020
We characterize necessary conditions for socially responsible investors to impact firm behavior in a setting in which firm production generates social costs and is subject to financing constraints. Impact requires a broad mandate, in that socially responsible investors need to internalize social costs irrespective of whether they are investors in a given firm. Impact is optimally achieved by enabling a scale increase for clean production. Socially responsible and financial investors are complementary: jointly they can achieve higher welfare than either investor type alone. When socially responsible capital is scarce, it should be allocated based on a social profitability index (SPI). This micro-founded ESG metric captures not only 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
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