Hec center for impact finance research

Can a self-proclaimed Socially Responsible Fund (SRF) whose objective is to maximize assets under management improve social welfare? We study this question in a general equilibrium two-sector model incorporating financial intermediation, negative externalities due to firms’ emissions, and investors' social preferences, which are of two kinds: (a) private benefits from investing in low-emission footprint equities (``value alignment''), and (b) utility from causing improvement in social welfare (``impact''). We analyze the equilibrium size and strategies of the SRF. When investors with value-alignment preferences are in large proportion in the population we show that the SRF invests in the low-emission sector, while requiring invested companies to use low-emission suppliers. This ``Scope 3 strategy'' attracts both types of investors and indirectly induces lower emissions by acting on the supply-chain. In some other scenarios, the SRF adopts a dual-fund strategy that separates the two types of investors: One fund, focussed on the clean sector, caters to investors with value-alignment preferences, while another, which invests in the higher-emission sector, appeals to impact investors by imposing reduced direct emissions to invested companies.

By Augustin Landier and Stefano Lovo

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To the extent that firms don't internalise the negative externalities of their CO2 emissions, government intervention is needed to curb global warming. We study the equilibrium interaction between firms, which can invest in green technologies, and government, which can impose\emission caps but has limited commitment power. Two types of equilibria can arise: If firms anticipate caps, they invest in green technologies. These investments have positive spillover effects, lowering the aggregate cost of emission reductions for all firms, thus making the government willing to cap emissions. If firms anticipate no caps, they don't invest in green technologies, and the government finds it too costly to cap emissions. A large fund, engaging with firms' management to foster investment in green technologies, can tilt equilibrium towards emission caps.

By Bruno Biais and Augustin Landier

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Work in progess By Philipp Koenig, Vincent Maurin, and David Pothier

Work in progress By Bruno Biais, Johan Hombert, Daniel Schmidt

We study the conditions under which debt securities that make the cost of debt contingent on the issuer's carbon emissions, similar to sustainability-linked loans and bonds, can be equivalent to a carbon tax. We propose a model in which standard and environmentally-oriented agents can adopt polluting and non-polluting technologies, with the latter being less profitable than the former. A carbon tax can correct the laissez-faire economy in which the polluting technology is adopted by standard agents, but requires sufficient political support. Carbon-contingent securities provide an alternative price incentive for standard agents to adopt the non-polluting technology, but require sufficient funds to fully substitute the regulatory tool. Absent political support for the tax, carbon-contingent securities can only improve welfare, but the same is not true when some support for a carbon tax exists. Understanding the conditions under which the regulatory and capital market tool are substitutes or complements within one economy is an important stepping stone in thinking about carbon pricing globally. It sheds light, for instance, on how developed economies can deploy finance to curb carbon emissions in developing economies where support for a carbon tax does not exist.

By Franklin Allen, Adelina Barbalau & Federica Zeni

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We develop a theory of optimal security design for financing green investments in the presence of greenwashing. Green outcomes are uncertain and can be obtained through the implementation of tangible projects and/or intangible effort-based strategies. When manipulation is not possible, the optimal contract takes the form of an outcome-based security design, similar to a sustainability-linked bond (SLB), with a payoff that is contingent on green outcomes. When manipulation is costless, the optimal contract takes the form of a project-based security design, similar to a green bond (GB), with a payoff that depends on the implementation of green projects. When green outcomes can be manipulated at some cost, the optimal contract is a hybrid which incorporates both an outcome-contingency (like an SLBs) and a project-contingency (like a GB). The model rationalizes several empirical facts. 

By Adelina Barbalau & Federica Zeni

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We provide the first analysis of the risk exposure and risk-adjusted performance of impact investing funds, private market funds with dual financial and social goals. We introduce a dataset of impact fund cash flows and exploit distortions in VC performance measures to characterize risk profiles. Impact funds have a lower market β than comparable private market strategies. Accounting for β, impact funds underperform the public market, though not necessarily more so than comparable strategies. We consider alternative pricing models, accounting for sustainability and emerging markets risk. We show investors’ wealth portfolios and taste change the perceived financial merit of impact investing.

By Jessica Jeffers,  Kelly Posenau and Tianshu Lyu.

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We investigate the expected consequences of negative ESG news on firms' future profits. After learning about negative ESG news, analysts significantly downgrade their forecasts at short and longer horizons. Negative ESG news affect forecasts more strongly at longer horizons than other types of negative corporate news. The negative revisions of earnings forecasts following negative ESG news reflect expectations of lower future sales (rather than higher future costs). Quantitatively, forecast revisions can explain most of the negative impacts of ESG news on firm value. Analysts are correct to revise forecasts downward following negative ESG news.

By François Derrien, Philipp Krueger, Augustin Landier and Tianhao Yao.

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We study how mutual funds respond to ESG scandals of portfolio companies. We find that, after experiencing an ESG scandal in their portfolio, active mutual fund managers (but not passive ones) are more likely to vote in favor of ESG proposals compared to other funds voting on the same proposal, and are more likely to reduce their stakes (and hence their voting power) in high-ESG risk stocks compared to other funds holding the same stock at the same time. Both results are pronounced (a) when the stake in the scandal stock is large, (b) when the scandal is less expected, and (c) when the scandal is accompanied by more negative stock returns. Our results suggest that scandal-shocked funds manage ESG risks in their portfolios, but fail to have much impact as exit undermines their engagement efforts precisely for those firms that have the biggest need for reform.

By Bastian von Beschwitz, Fatima Zahra Filali Adib, and Daniel Schmidt.

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We exploit the release of Type 2 EEO-1 forms by the Department of Labor for over 11,000 public and private U.S. contractors to estimate gender and race/ethnicity pay gaps. These forms contain standardized detailed demographic breakdowns of companies' workforces by ten job categories. Using EEOC pay data alongside these forms, we estimate that public firms save, on average, over $49 million a year by including women and minorities in their workforce. Private firms, which generally are smaller, save almost $6 million a year. In relative terms, private firms have larger pay gaps than public firms, and for all firms, the pay gap increases with firm size. Pay gaps vary dramatically across industries, and they are associated in ways consistent with labor economics theory. We further exploit the public release of EEO-1 forms by examining the market reaction to this release, conditional on the size of the firm's pay gap. Pay gaps lower labor costs, thus increasing net income and potentially firm value. On the other hand, systematic pay inequities can lower employee satisfaction, potentially hurting firm value. We present strong and consistent evidence that investors view pay gaps as net value-enhancing. Our results hold after controlling for workplace diversity, the IO structure of the firm, state, industry and other effects. Our findings should inform stakeholders about the size, determinants, and perceived value of pay gaps. They also suggest that capital markets may not be the appropriate avenue to address systematic pay inequities in the U.S.

by Ferdinand Bratek, April Klein and Crystal Yanting Shi

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We characterize investors’ moral preferences in a parsimonious experimental setting, where we auction stocks with various ethical features. We find strong evidence that investors seek to align their investments with their social values (“value alignment”), and find no evidence of behavior driven by the social impact of investment decisions (“impact-seeking preferences”). First, the willingness to pay for a stock is a linear function of corporate externalities, and is symmetric for positive or negative externalities. Second, whether charity transfers are contingent or independent on investors buying the auctioned stock does not affect their WTP. Our results are thus compatible with a utility model where non-pecuniary benefits of firms’ externalities only accrue through stock ownership, not through the actual impact of investment decisions. Finally, non-pecuniary preferences are linear and additive: willingness to pay for social externalities is proportional to the expected sum of charity transfers made by firms (even if some of these donations are negative).

By Jean-Francois Bonnefon, Augustin Landier, Parinitha Sastry and David Thesmar.

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How can we encourage the adoption of low carbon footprint (CF) consumption habits? In a large-scale field experiment at a university canteen, we find that adjusting dish prices to positively correlate with their carbon footprint is the most effective policy, leading to a 26.8% reduction in CF. This approach outperforms policies such as banning high-CF dishes once a week (10% CF reduction) or merely informing consumers of dishes' CF (non-significant reductions). In a follow-up survey, when asked to choose between taking no action and these three policies, only 3.5% of respondents preferred no action, while 60% supported the price adjustment policy.

By Yurii Handziuk and Stefano Lovo

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Using unique data on French firm-sponsored savings plans, we establish that there exists a significant negative relationship between firms’ ESG incidents and their employees’ investments in the company’s stock. Incidents in the “Social” category, especially those related to employee working conditions, exert the most substantial influence on these investment decisions. Conversely, incidents in the “Environment” and “Governance” categories exhibit no discernible impact. Pecuniary motives do not explain these findings. Overall, our results point to employees exhibiting parochial altruism, caring about their own interests and the interests of their colleagues within the company when making investment decisions in their company’s stock.

By Maxime Bonelli, Marie Briere and François Derrien.

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Work in progress By Michael Brown, Shawn Cole, Jessica Jeffers, Katherine Klein

We study climate-risk related engagements by one of the world's largest investors. Climate risk engagements represent a growing fraction of ESG engagements and are more frequent in high carbon emissions industries. We find that firms with greater carbon footprint and greater exposure to climate transition risk are more likely to be targeted. Following a climate risk engagement, targeted firms are more likely to commit to adopt a science-based climate target and to disclose climate-related information. Targeted firms also experience a reduction in their carbon emissions. However this reduction is limited to scope 1 and 2 emissions and its magnitude is inconsistent with net-zero targets. We also find that climate risk engagements are associated with greater voting support for management. Overall, our results suggest that shareholder engagement on climate issues can be an important tool in the fight against climate change.

By Derrien François, Garel Alexandre, Romec Arthur and Zhou, Feng

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Due to the opaque labor market and heavy reliance on professional headhunters’ private networks, significant information frictions exist in the sourcing of independent directors for US public companies’ boards. Drawing on information cost and network effect theories, this study examines the impact of LinkedIn, an online professional information intermediary, on alleviating these information frictions and improving the sourcing process for independent directors. Using LinkedIn’s staggered global expansion, we document an average 19.7% increase in appointments of Foreign Independent Directors (FIDs) to US public company boards from countries where LinkedIn recently expanded into over the three years post LinkedIn’s entry relative to three years before. These increases are mainly observed among foreign candidates who had not served on any US boards before, and in firms with higher demands of foreign independent directors. We identify two key mechanisms through which LinkedIn’s expansion influences FID sourcing—increased local usership and enhanced visibility of LinkedIn account holders. Our findings highlight the critical role of network access in sourcing independent directors and illustrate how professional information intermediaries like LinkedIn can influence board composition by expanding the talent pool and reducing recruitment costs. In doing so, LinkedIn enhances the efficiency of the independent director labor market.

By Luc Paugam, Chrystal Yanting Shi and Yujie Yao

In credit markets, screening algorithms aim to discriminate between good-type and bad-type borrowers. However, when doing so, they can also discriminate between individuals sharing a protected attribute (e.g. gender, age, racial origin) and the rest of the population. This can be unintentional and originate from the training dataset or from the model itself. We show how to formally test the algorithmic fairness of scoring models and how to identify the variables responsible for any lack of fairness. We then use these variables to optimize the fairness-performance trade-off. Our framework provides guidance on how algorithmic fairness can be monitored by lenders, controlled by their regulators, improved for the benefit of protected groups, while still maintaining a high level of forecasting accuracy.

By C. Hurlin, C. Pérignon and S. Saurin.

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We model how a profit-maximizing agency decides whether to sell ESG ratings to issuers or investors. For firms in sufficiently green sectors or when the proportion of socially responsible investors is large enough, ESG ratings increase expected stock prices and the “issuer pays” business model is more profitable than “investors pay”. When all investors are socially responsible, the model coincides with a model of credit ratings, explaining why credit ratings are sold to issuers while most ESG ratings are sold to investors. Ratings boost equilibrium investment in ESG but their impact on welfare is ambiguous, even for socially responsible investors.

By Stefano Lovo and Jacques Olivier

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This paper examines the integration of ESG performance metrics into executive compensation using a detailed panel dataset of European executives. Despite becoming more widespread, most ESG metrics are largely discretionary, carry immaterial weights in payout calculations, and contribute little to executive pay risk. Such ESG metrics with arguably weak incentive power are common in financial firms and large companies, particularly for their most visible executives, which seems consistent with greenwashing. In contrast, binding ESG metrics with significant weights, which have potential to influence incentives, are only found in sectors with a large environmental footprint.

by Matthias Efing, Stefanie Ehmann, Patrick Kampkötter, Raphael Moritz

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High-quality independent directors are vital for effective corporate governance, particularly in emerging markets characterized by low transparency and weak protections for minority shareholders. This paper examines the impact of integrating certification and transparency mandates through a 2008 policy change by the Shenzhen Stock Exchange (SZSE). Our results show that the enforcement of director certification and the establishment of an “Independent Director Database” significantly mitigate adverse selection, enhance director quality, and improve engagement. Following the implementation, independent directors receive higher compensation, attend more board meetings, and hold fewer excessive board positions, reflecting improved labor market outcomes. These changes lead to stronger firm performance, evidenced by higher ROA. Additionally, while SZSE firms initially have lower Tobin’s Q than firms in Shanghai Stock Exchange (SSE)—reflecting investor concerns about poorer governance and higher risks—Tobin’s Q for SZSE firms converges to SSE levels postenforcement period, signaling increased investor confidence. These findings highlight that combining certification with transparency effectively addresses information asymmetry, elevates director quality, and enhances corporate governance.

by Vedran Capkun, Crystal Yanting Shi and Yujie Yao

We present novel evidence on how environmental and social (E&S) incidents affect the
capital-raising ability of Private Equity (PE) firms. PE firms with E&S incidents in portfolio
companies are less likely to fundraise and raise smaller subsequent funds. The decrease in
capital commitment does not seem related to fund performance; instead, it is driven by E&S
concerns of relationship limited partners (LPs). LPs trade off E&S concerns with financial
cost of breaking relationships, implying a weaker impact on large, top-performing PE firms.
The threat of “exit” by E&S-concerned investors incentivizes PE firms to exert “voice” and
mitigate negative E&S externalities.

By Teodor Duevski, Chhavi Rastogi and Tianhao Yao

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