Interested Investors and Intermediaries: When do ESG Concerns Lead to ESG Performance?

Abstract

Interested investors and intermediaries (asset managers) are concerned about corporate managers' actions above and beyond the effects of those actions on cash flows. These interests could relate to environmental, social, or governance performance, payout policy, etc. We examine the implications of such interests, combined with the potential for owners to influence managers, on corporate actions, stock prices, and portfolio decisions. When investors are small and invest directly, free-riding causes their non-monetary interests to have no effect. An intermediary can overcome the free-rider problem that prevents small investors from exerting influence activities. However, the free-rider problem persists as investors optimally choose not to delegate to the intermediary, absent frictions. We show that, due to free riding, intermediaries benefit from mechanisms that allow them to economize on costly influence efforts, such as having interests aligned with managers, negative externalities across portfolio firms, and co-investing with similarly-interested insiders. Our findings have implications for research and policy-making related to asset management, investor activism, and corporate social responsibility.

Keywords: Asset management, investor preferences, asset pricing, corporate social responsibility, impact investing

JEL Classification: G11, G23, G34, M14, M40