Derwall, Koedijk, and terHorst (2010)

Derwall, Jeroen, Kees Koedijk, and Jenke Ter Horst.  “A Tale of Values-Driven and Profit-Seeking Social Investors.”  Working paper (Tilburg University, Maastricht University), June 25, 2010.

From the authors' abstract:  "A segmentation of the socially responsible investing (SRI) movement by values-versus-profit orientation solves the puzzling evidence that both socially responsible and controversial stocks produce superior returns. We derive that the segment of values-driven investors, who are willing to sacrifice financial return to derive non-pecuniary utility, is primarily served by “negative” screens that avoid controversial stocks. Consistent with values affecting stock prices, controversial stocks produce anomalously positive returns. The profit-driven segment is best served by specific “positive” screens involving environmental and social issues, which also have produced superior returns. The finding that each segment is served by a different form of SRI explains why the average SRI mutual fund, which adopts a mixture of screens, neither outperforms nor underperforms conventional peers."


LK comment:  The authors make the important point that boycott effects are likely to persist, but information effects (e.g., outperformance due to good employment practices) are likely to be arbitraged away over time.  This is a really important point from the standpoint of financial theory.  I would put it this way:

  • Angel and Rivoli (1997) explain the relevant theory for stock boycotts (informed by Merton).  The key issue is that a boycotted stock may be mispriced, but faced with a large boycott in a world of rational diversifiers it may be that no one can afford to accept the large tracking error needed to arbitrage away the mispricing. 
  • But anomalies based on intangible information are a different story.  Here the mispricing arises because the market simply doesn't (yet) understand the importance of the factor.  So as information becomes available, astute profit motivated investors have a big incentive to trade on the information, eventually arbitraging away the observed effects.  Bebchuk, Cohen, and Wang (2013) offer a real-world example, showing that markets have become more sophisticated about corporate governance over time, apparently diminishing the profitability of trading strategies based on governance ratings such as the one used by Gompers, Ishii, and Metrick (2001).