How Effective are Portfolio Mandates?

42 Pages Posted: 2 Oct 2023 Last revised: 27 Nov 2023

See all articles by Jack Y Favilukis

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Lorenzo Garlappi

University of British Columbia (UBC) - Sauder School of Business

Raman Uppal

EDHEC Business School; Centre for Economic Policy Research (CEPR)

Date Written: September 15, 2023

Abstract

We evaluate the effectiveness of portfolio mandates on equilibrium capital allocation. We show that the impact of mandates crucially depends on firms' demand elasticity of capital. In a production economy with constant returns to scale, firms' demand for capital is infinitely elastic, and mandates can significantly impact the allocation of capital across sectors despite having a negligible impact on the cost of capital. This is in sharp contrast to an endowment economy where inelastic demand for capital implies equilibrium price reactions to mandates, which significantly reduce their effectiveness. Within a canonical real-business-cycle model calibrated to match key asset-pricing and macroeconomic moments, we estimate that a significant portion of the mandate remains effective in shaping equilibrium capital allocation, even when there is little disparity in the cost of capital across sectors. Our analysis challenges the common practice of judging the effectiveness of portfolio mandates by their impact on firms' cost of capital.

Keywords: ESG, cost of capital, capital allocation

JEL Classification: D53, G11, G12

Suggested Citation

Favilukis, Jack Y and Garlappi, Lorenzo and Uppal, Raman, How Effective are Portfolio Mandates? (September 15, 2023). Available at SSRN: https://ssrn.com/abstract=4572588 or http://dx.doi.org/10.2139/ssrn.4572588

Jack Y Favilukis (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Lorenzo Garlappi

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Raman Uppal

EDHEC Business School ( email )

58 rue du Port
Lille, 59046
France

Centre for Economic Policy Research (CEPR)

90-98 Goswell Road
London, EC1V 7RR
United Kingdom

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