Pricing Investor Impact

Abstract

This paper presents a novel asset pricing model that allows for investor impact, defined as the change in social and environmental outcomes generated by an investor's actions. Price elasticities of supply and demand determine contribution multipliers for each asset, capturing the degree to which shifts in investor demand lead to shifts in supply, and hence, investor impact. Heterogeneity in the price elasticities implies considerable cross-sectional variation in the contribution multipliers and covariance with expected financial returns. If the potential for investor impact is correctly reflected in asset prices, investors with impact preferences should not be able to shift their demand in a way that improves their utility. Using this principle, a theoretical valuation formula for investor impact is derived along with the associated optimal portfolios. An empirical calibration finds a 3% contribution multiplier for the average large- and medium-sized U.S. stock, suggesting potential for significant investor impact even in these liquid assets, but making it challenging to reconcile observed ESG-driven demand shifts with impact preferences. Nevertheless, divestment may be coherent with impact preferences in select cases. Ideal impact investments are large, positive allocations to profitable, socially productive assets with elastic supply and inelastic demand. These findings have implications for how the pursuit of investor impact is managed, researched and regulated.

Keywords: Impact investment, supply and demand curves, Investor impact, Investor contribution, Enterprise impact, ESG, Greenhouse gas emissions

JEL Classification: C3, G11, G12, G30, H41