Institutional investors have in recent years become the largest equity holders in the U.S., owning about 80 percent of the market value of S&P 500 index stocks and more than 70 percent of the shares of the 10 largest U.S. firms (Mcgrath, 2017). As a result, institutional investors’ power and influence on corporate decision-making have grown, increasing concerns about whether they actively monitor firms and exercise stewardship to enhance firms’ long-term sustainable value.
Do institutional investors act in short-sited ways, interested mainly in boosting short-term share prices, or do they encourage management to invest for the long-term? The answer, and institutional investors’ incentives, are complex. Institutional investors differ greatly in their investment incentives, trading styles, clients, and regulatory restrictions, and these differences are likely to affect their roles in corporate governance and their abilities to gather and process information (Gillan and Starks, 2000; Yan and Zhang, 2009). In particular, institutional investors’ different investment horizons affect monitoring incentives that, in turn, affect various corporate practices and decisions (e.g., Bushee, 1998; Chen, Harford, and Li, 2007; Attig, Cleary, El Ghoul and Guedhami, 2013).
Corporate social responsibility (CSR) has also received greater attention from finance practitioners and academics over the last decade. Many firms devote a significant portion of their annual reports to describing their CSR activities, and several issue annual CSR reports on how they benefit consumers, employees, and society. In addition, many business schools now incorporate CSR and sustainability in their curricula. This has prompted growing demand for CSR research. Given that institutional investment horizons can be an important factor in influencing corporate policies, we examine the effect of those horizons on its CSR activities.
Institutional investors include pension funds, banks, hedge funds, mutual funds, ETFs, and insurance companies. These investors are subject to different regulatory schemes, and they aim at differing levels of activism to affect corporate governance (Gillan and Starks, 2000).Institutional shareholders that focus on the long-term can benefit from monitoring their firms and so have a strong incentive to do so (Gaspar, Massa, and Matos, 2005). These efforts can dissuade managers from taking risks that could harm the firm’s reputation. Long-term investors can also persuade managers to pursue agendas that enhance long-run value maximization (Kim, Park, and Song, 2019). In contrast, short-term oriented institutional investors have less incentive to monitor managers. Instead, they seek short-term profits by exploiting informational advantages and boosting managerial short-termism (Yan and Zhang, 2009).
As for CSR, studies have argued that justifying a commitment to it requires a long-term perspective (Mahapatra, 1984; Graves and Waddock, 1994; Johnson and Greening, 1999). CSR can improve firm value in two ways. First, it can mitigate a firm’s risks, such as lawsuits over a lack of product safety or penalties resulting from socially irresponsible activities (e.g., Shane and Spicer, 1983; Waddock and Graves, 1997; Heal, 2005). For example, firms involved in “sin” businesses, such as alcohol, tobacco, or gambling, experience substantial litigation risks (Hong and Kacperczyk, 2009). In contrast, firms with proactive environmental policies can significantly reduce the risk of social or environmental crises (Feldman, Soyka, and Ameer, 1997; Sharfman and Fernando, 2008).
Second, CSR can build a favorable reputation that leads to greater firm valuation in the long run (e.g., Titman, 1984; Cornell and Shapiro, 1987; Hill and Jones, 1992). According to this stakeholder-value maximization view, a firm devoted to CSR builds the loyalty of customers, employees, suppliers, creditors, and the community as a whole. In return, these stakeholders exert greater commitment to fulfilling explicit and implicit long-term contracts between themselves and the firm (Cornell and Shapiro, 1987). This greater alignment between the firm and its stakeholders contributes to the firm’s long-term profitability and efficiency (e.g., Jensen, 2001; Freeman, Wicks and Parmar, 2004).
Based on these two major views on CSR, we test whether firms whose investors have longer horizons promote CSR activities more than do firms whose investors have shorter horizons. Using data on U.S. firms’ CSR ratings from 1995 to 2012, we find that long-term institutional ownership positively affects CSR activities. Further, by splitting long-term institutional investors into active investors (investment companies and advisers) and passive investors (banks, insurance companies, and pension funds), we show that active long-term institutions increase CSR whereas passive long-term institutions have no significant effect. Our results suggest that investors with long-term horizons have more incentives to monitor their firms, which leads managers to engage in more vigorous CSR activities.
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This post comes to us from Professor Hyun-Dong Kim at Sogang University’s Graduate School of International Studies, Taeyeon Kim, a PhD candidate at Korea Advanced Institute of Science and Technology (KAIST)’s College of Business, Professor Yura Kim at the University of Seoul’s College of Business Administration, and Professor Kwangwoo Park at KAIST’s College of Business. It is based on their recent paper, “Do Long-term Institutional Investors Promote Corporate Social Responsibility Activities?,” available here.