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Journal of Business Ethics

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16.09.2020 | Original Paper

The Role of Mutual Funds in Corporate Social Responsibility

verfasst von: Zhichuan Frank Li, Saurin Patel, Srikanth Ramani

Erschienen in: Journal of Business Ethics | Ausgabe 3/2021

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Abstract

This paper examines the role of mutual funds in corporate social responsibility (CSR). Using a fund-level, holdings-based CSR score, we find that CSR-friendly mutual funds improve firms’ CSR standings. This effect is more pronounced for firms with higher mutual fund ownership and stronger corporate governance. We further show that while CSR-friendly mutual funds have influence on almost all CSR categories, they focus on increasing CSR strengths rather than reducing CSR concerns. We also discover that CSR-friendly funds are more likely to vote in favor of CSR proposals, and that firms owned by CSR-friendly funds are more likely to link their CEO compensation to CSR outcomes. These results suggest that actively managed mutual funds, which were previously thought to be indifferent (or even detrimental) to social and ethical issues, play a significant role in corporate social outcomes of the firms they invest in.

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GSI Alliance, “2018 Global Sustainable Investment Review,” accessed March 10, 2020, (https://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf).

For example, Fidelity Investments introduced two new index funds in 2017 to provide investors with a wider array of options for their ESG investments. Fidelity, “Fidelity Launches First Two Sustainability-Focused Index Funds,” accessed on August 12, 2018, (https://www.fidelity.com/about-fidelity/institutional-investment-management/first-two-sustainability-focused-index-funds).

Financial Times, “Asset managers accused of climate change hypocrisy,” accessed on November 2, 2018, (https://www.ft.com/content/1833bc1e-800d-11e6-8e50-8ec15fb462f4).

Available at https://www.ussif.org/sribasics.

Existing literature argues that institutional investors’ long investment horizon allows them to focus on the long-term benefits of CSR (Starks et al. 2017; Gibson and Kruger 2018; Gloßner 2019; Kim et al. 2019; Gibson et al. 2020; Ilhan et al. 2020).

Available at https://www.unpri.org/signatories/reporting-for-signatories.

Additionally, unlike index funds, actively managed mutual funds focus on active stock selection and have the ability to influence CSR policies by threat of ‘exit’ or ‘voting with their feet’ (Parrino et al. 2013).

We also employ an alternative measure of mutual fund social preference following Hong and Kostovetsky (2012) who find that Democratic-leaning managers are more likely to hold high-CSR firms. Our results remain robust in Table 9.

In untabulated results, we find similar results using exogenous fund mergers within or across fund families. Note that while mergers of mutual funds are exogenous (McLemore 2018), retaining or dropping stocks after the mergers can be endogenous for reasons related to CSR. We do find CSR-friendly mutual funds gradually drop low-CSR firms after mergers.

It is, however, well studied that institutional owners can provide better corporate governance and ultimately improve firm financial performance (Del Guercio and Hawkins, 1999; Hartzell and Starks, 2003; McCahery et al. 2016).

Many studies also explore the link between responsible investing and fund performance, including Bauer et al. (2007), Climent and Soriano (2011), Barnett and Salomon (2012), Hong and Kacperczyk (2009), Borgers et al. (2015) and Ibikunle and Steffen (2017). Morgan et al. (2011) find that mutual funds vote less in favor of social proposals, but it is not the focus of their paper.

Hartzmark and Sussman (2019) provide strong causal link between fund flows and high sustainability rating. They also show mutual funds with low sustainability scores did not face any significant outflows before Morningstar published their sustainability ratings in March 2016. Thus, we do not expect fund flows to be weak for mutual funds with low CSR scores in our sample, which ends in 2013. Nonetheless, this could be a reason that mutual funds would want to improve a firm’s CSR.

KLD also evaluates firms on corporate governance. As the focus of this paper is strictly on the role of mutual funds on CSR, the study follows the literature to exclude the corporate governance measure when calculating the CSR score.

Following Matvos and Ostrovsky (2010), we match the ISS data with the EDGAR data based on fund and family name and then match the voting data to Morningstar through fund tickers.

In robustness checks, the raw, unscaled CSR score generates qualitatively similar results.

The data show that the Annual Fund CSR of some funds vary considerably from one year to the next. To smooth out the noise, we construct Fund CSR as the three-year average of the Annual Fund CSR. However, all the results remain qualitatively similar if Annual Fund CSR is used.

We include Industry CSR in all our main specifications to control for industry-specific CSR trends over time.

To control for the overall effect of institutional holders, we include institutional ownership (excluding all mutual fund ownership) in our main regressions. The results remain robust as shown in Appendix Table 2.

We use firm fixed effects to control for unobservable time-invariant firm characteristics and to study within-firm variations of CSR scores. We also try industry fixed effects, in Appendix Table 3, which allow us to examine the cross-sectional variations and remove potential measurement errors. The results suggest that mutual fund CSR can explain the cross-sectional variations in firm CSR.

We thank Harrison Hong for sharing the data on his website.

Note that investment horizon and CSR friendliness are two related but distinct preferences. First, although funds with higher Fund CSR score have longer investment horizons, the difference in the investment horizon is 1.15 years, quite small in economical terms, between the CSR-friendly and CSR-unfriendly funds. The correlation between Fund CSR and Investment horizon (as measured by Duration) is only 0.15. Second, Table 10 shows that the interaction term of CSR-unfriendly ownership and longer investment horizons has a negative effect on a firm’s future CSR. That is, CSR-unfriendly funds with a long-term view are more likely to decrease CSR. Finally, all our results are robust after controlling for investment horizon.

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Titel: The Role of Mutual Funds in Corporate Social Responsibility
verfasst von: Zhichuan Frank Li
Saurin Patel
Srikanth Ramani
Publikationsdatum: 16.09.2020
Verlag: Springer Netherlands
Erschienen in: Journal of Business Ethics / Ausgabe 3/2021
Print ISSN: 0167-4544
Elektronische ISSN: 1573-0697
DOI: https://doi.org/10.1007/s10551-020-04618-x

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