How Financial Misconduct by Institutional Investors Affects Corporate Social Responsibility

In recent years, institutional investors have publicly voiced their support for firms’ corporate social responsibility (CSR) activities. Most notably, Larry Fink, the CEO of BlackRock— the largest institutional investor in the world, with over $7 trillion in assets under management—sent a letter to the CEOs of investee firms and encouraged them to act in a more socially responsible manner and report such activities.[1] Acts like these raise questions about the role of institutional investors in shaping the socially responsible behavior of corporations in which they hold equity positions. Of course, not all institutions have the same (financial or social) incentives. In our study, we investigate the effect of institutional investors’ disciplinary history on the CSR activities of investee firms. Specifically, we focus on CSR activities related to community, diversity, employee relations, the environment, and human rights.

We predict that institutional investors with histories of financial misconduct constrain socially responsible behavior in investee firms because these investors are less concerned about socially responsible behavior in general. Institutional investors with a history of disciplinary problems have already exhibited disregard for social norms by violating laws, rules, or regulations established by the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA) or other governmental agencies, self-regulatory agencies, or legislatures. As a result, these institutions are more likely to be motivated by private returns than the broader social returns. Therefore, we conjecture that institutional investors with disciplinary histories are more likely to discourage socially responsible behavior.

To address our research question, we first classify institutional investors in two broad categories: institutions with disciplinary history (IDH) and others. We use required SEC forms to identify institutional investors that are reprimanded or disciplined by regulators or courts as a direct approach to detect and capture institutional investors’ financial misconduct.[2]

After identifying institutional investors with and without disciplinary problems, we identify the portfolios of all institutional investors using SEC Form 13-F, which captures the holdings of institutional investors with at least $100 million. Using the information on holdings, we analyze the impact of each institutional investor type on the CSR activities of investee firms. Our main results suggest that institutional investors with disciplinary history discourage CSR activities in investee firms.  We also break CSR activities into five categories and find that IDH constrain CSR activities related to community, diversity, the environment, and employee treatment.

Beyond our baseline analysis, we investigate the mechanisms through which IDH constrain the CSR activities of investee firms. Our results suggest that firms with higher IDH are less likely to have CSR-related proposals during shareholders’ meetings and, when CSR-related proposals do exist, they are less likely to be approved and more likely to be withdrawn if a firm has higher IDH ownership.

The results in our study are relevant for practitioners as they show that ethical behavior is contagious and has far-reaching consequences for society. Fink’s letter demonstrates the power of institutional investors and how they can shape social norms by pushing changes in the behavior of investee firms. Institutional investors should have the ethical vision to push for positive changes. Prior unethical behavior is a predictor of future unethical behavior, and individuals or companies engaging in one form of unethical behavior are more likely to engage in other forms. Although constraining CSR activities is not necessarily unethical in a strictly legal sense, it imposes significant negative externalities on society by deemphasizing corporate endeavors that have broader social benefits rather than only private ones.


[1] Larry Fink’s letter can be found here.

[2] Registered investment advisers (RIAs) are required to file with the SEC Form ADV to provide information about business operations, assets under management, and disciplinary events that involve the RIA and its key personnel. RIAs are institutional investors, typically classified as investment advisers, hedge funds, mutual funds, or pension funds. In the interest of full disclosure and to protect investors’ interests, the SEC requires RIAs to disclose in Form ADV any felony or misdemeanor charges, convictions, or violations of regulations in connection with an investment-related business that occurred in the last 10 years.

This post comes to us from professors Samuel B. Bonsall at Pennsylvania State University and Babak Mammadov and Blerina Bela Zykaj at Clemson University. It is based on their recent paper, “The Importance of Financial Misconduct of Institutional Investors on Corporate Social Responsibility,” available here.

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