Taste, Information, and Asset Prices: Implications for the Valuation of CSR

Abstract

Firms often undertake activities that do not necessarily increase cash flows (e.g., costly investments in corporate social responsibility or CSR), and some investors value these non cash activities (i.e., they have a "taste" for these activities). We develop a model to capture this phenomenon and focus on the asset-pricing implications of differences in investors' tastes for firms' activities and outputs. Our model shows that, first, investor taste differences provide a basis for investor clientele effects that are endogenously determined by the shares demanded by different types of investors. Second, because the market must clear at one price, investors' demands are influenced by all dimensions of firm output even if their preferences are only over some dimensions. Third, information releases cause trading volume, even when all investors have the same information. Fourth, investor taste provides a rationale for corporate spin-offs that help firms better target their shareholder bases. Finally, individual social responsibility can lead to corporate social responsibility when managers care about stock price because price reacts to investments in CSR activities. AbstractFirms often undertake activities that do not necessarily increase cash ‡ows (e.g., costly investments in corporate social responsibility, or CSR), and some investors value these noncash activities (i.e., they have a "taste"for these activities). We develop a model to capture this phenomenon and focus on the asset-pricing implications of di¤erences in investors'tastes for …rms' activities and outputs. Our model shows that, …rst, investor taste di¤erences provide a basis for investor clientele e¤ects that are endogenously determined by the shares demanded by di¤erent types of investors. Second, because the market must clear at one price, investors'demands are in ‡uenced by all dimensions of …rm output even if their preferences are only over some dimensions. Third, information releases cause trading volume, even when all investors have the same information. Fourth, investor taste provides a rationale for corporate spin-o¤s that help …rms better target their shareholder bases. Finally, individual social responsibility can lead to corporate social responsibility when managers care about stock price because price reacts to investments in CSR activities.

Does social performance influence breadth of ownership?

“…Their model predicts that, when there is a non-trivial fraction of investors who value CSR, a firm's shareholder base is a result of its CSR performance. Although the theoretical arguments of Fama and French (2007), Heinkel et al (2001) and Friedman and Heinle (2016) are different from each other, they all suggest that more investors are attracted to firms with better CSR performance. Similarly, El reason that high CSR firms tend to have a larger investor base, which is a channel through which CSR performance is related to cost of equity capital.…”

“…Although the theoretical arguments of Fama and French (), Heinkel et al. () and Friedman and Heinle () are different from each other, they all suggest that more investors are attracted to firms with better CSR performance. Similarly, El Ghoul et al.…”

“…The first strand of argument is based on three theoretical models (Fama & French, ; Friedman & Heinle, ; Heinkel et al., ). Heinkel et al.…”

“…() reason that high CSR firms tend to have a larger investor base, which is a channel through which CSR performance is related to cost of equity capital. In addition, as suggested by Friedman and Heinle (), more and more investors (with trillions of dollars to invest) are tilting their portfolios in favour of firms that act in socially responsible ways, especially in more recent years. One can therefore expect that better CSR firms have higher breadth of ownership than poor CSR firms.…”

“…The first strand of argument is based on three theoretical models (Fama & French, 2007;Friedman & Heinle, 2016;Heinkel et al, 2001). Heinkel et al (2001) demonstrate that in a risk-averse equilibrium setting, exclusionary social investment strategies lead to green investors eschewing stocks of poor CSR (or polluting) firms.…”