Investing Ethical: Harder Than You Think

Abstract

After the financial crisis, the public perception of capital markets changed from means of an efficient capital allocation to being an irresponsible institution that endangers the stability of the economy. Seemingly, only the state can prevent such negative outcomes through increasing regulation of financial markets. With the threats from climate change, politicians and regulators used their newfound legitimacy for state interventions to widen the perspective of the required ethical behavior on financial markets towards green and ethical investments. In this paper, we discuss the role that private financial markets can play in this context. Individual ethical investments work in line with investors’ intentions if they reduce the price of capital for such investment and thus set positive incentives for an increase in the amount of ethical investments. Consequently, we scrutinize the existing literature on whether ethical investments outperform similar conventional investments. The results of the numerous studies are diverse, but they mainly find no or only very modest premia. Seemingly, capital markets show a sufficient degree of perfection to prevent or limit such distortions. A direct positive effect of ethical investments can only be expected through direct investments or through the employment of specialized intermediaries.

Keywords: Green Finance, Ethical Investing, Socially Responsible Investing, Capital Merket Theory, Efficient Market Hypothesis

JEL Classification: G11, G14, G38, M14, Q2