Socially Responsible Investing and Expected Stock Returns

Abstract

Using implied cost of capital derived from analysts' earnings estimates, I find that investors demand significantly higher expected returns on stocks excluded by environmental screens (such as hazardous chemical, substantial emissions and climate change concerns) widely used by socially responsible investors as compared to firms without these environmental concerns. I also document that firms with these environmental concerns have lower institutional ownership and are held by fewer institutional investors than firms without similar environmental concerns. These results suggest that exclusionary socially responsible investing and the consequent increase in the cost of capital is one channel through which environmental externalities can be internalized by the firm.