Externalities of Responsible Investments

Abstract

We develop a framework to explore the equilibrium implications of socially responsible investments (SRI). Investors acquire positions in ex-ante identical firms, and firms compete in selling products to consumers. A fraction of investors and consumers are socially responsible in that they value corporate social responsibility (CSR). They shape CSR policies through shareholder engagement and consumption choices, respectively. Responsible investors prefer to invest in stocks with a large proportion of like-minded investors, which leads to a concentration of responsible capital in a small subset of firms. In equilibrium, these firms' CSR investments crowd out those of the excluded firms, generating differentiation across firms and market power. If this crowding-out dominates, aggregate CSR investments and welfare are higher without SRI.

Keywords: Socially responsible investment, divestment, engagement, externalities, governance

JEL Classification: D62, G34, M14