Becoming Virtuous? Mutual Funds’ Reactions to ESG Scandals

Abstract

We study how mutual funds respond to ESG scandals of portfolio companies. We find that, after experiencing an ESG scandal in their portfolio, active mutual fund managers (but not passive ones) are more likely to vote in favor of ESG proposals compared to other funds voting on the same proposal, and are more likely to reduce their stakes (and hence their voting power) in high-ESG risk stocks compared to other funds holding the same stock at the same time. Both results are pronounced (a) when the stake in the scandal stock is large, (b) when the scandal is less expected, and (c) when the scandal is accompanied by more negative stock returns. Our results suggest that scandal-shocked funds manage ESG risks in their portfolios, but fail to have much impact as exit undermines their engagement efforts precisely for those firms that have the biggest need for reform.

Keywords: ESG, Mutual Fund Voting

JEL Classification: G11, G12, G14, G15