Corporate social responsibility in a general equilibrium stock market model: Solving the financial performance puzzle

We analyze corporate social responsibility (CSR) in a general equilibrium stock market model with uncertainty in production. Production generates non-market costs and consumers take this into account when they construct their portfolio. We deduce empirically testable hypotheses and analyze how CSR affects various financial performance indicators. We show that our model offers an excellent explanation of the seemingly contradictory findings in the existing empirical literature. We stress that our findings are not a result of assumptions on the operational level of the firm. We conclude that there is a clear and direct association between CSR and different measures of corporate financial performance.

Towards a theory of responsible investing : on the economic foundations of corporate social responsibility

Studies that link corporate social and financial performance usually find a positive association between the two. However, the literature does not establish a significant impact of socially responsible investing on stock market returns. We develop a coherent economic framework of responsible investing to address this paradox. The framework offers theoretical underpinnings for all research on responsible investment as it provides the theoretical underpinnings for the actual behavior of market participants. We associate corporate social performance with key financial accounting ratios like the market-to-book ratio (market value of the firm in relation to accounting value), return on assets, and stock market return. We conclude that there is a strong theoretical foundation for a positive relationship between corporate social responsibility and financial performance, though the relation is conditional on which financial performance measure is considered. We illustrate that the empirical literature about responsible investing is well in line with our model's propositions.PostprintPeer reviewe

The Environmental and Macroeconomic Effects of Socially Responsible Investment

We analyze the effects of socially responsible investment and public abatement on environmental quality and the economy in a continuous-time dynamic growth model featuring optimizing households and firms. Environmental quality is modelled as a renewable resource. Consumers can invest in government bonds or firm equity. Since investors feel partly responsible for environmental pollution when holding firm equity, they require a premium on the return to equity. We show that socially responsible investment behaviour by households partially offsets the positive effects on environmental quality of public abatement policies.socially responsible investment, economic growth, environmental economics, resource dynamics, stock market

The overnight return puzzle and the "T+1" trading rule in Chinese stock markets

Overnight returns in Chinese stock markets are on average negative. This overnight return puzzle appears to be unique to Chinese markets. We hypothesize that a particular arrangement in Chinese stock markets explains the puzzle: the “T+1” trading rule. T+1 trading prohibits traders from selling the shares they bought on the same day. This restriction leads to a discount on daily opening prices. We find empirical support that the T+1 induced discount explains the overnight return puzzle and estimate the average T+1 discount at 14 bps. In addition, we establish that the T+1 discount contributes significantly to overnight risk

Bank bailouts, interventions, and moral hazard

To test if safety nets create moral hazard in the banking industry, we develop a simultaneous structural two-equations model that specifies the probability of a bailout and banks' risk taking.We identify the effect of expected bailout probabilities on risk taking using exclusion restrictions based on regional political, supervisor, and banking market traits. The sample includes all observed capital preservation measures and distressed exits in the German banking industry during 1995-2006. The marginal effect of risk with respect to bailout expectations is 7.2 basis points. A change of bailout expectations by two standard deviations increases the probability of official distress from 6.2% to 9.9%. Only interventions directly targeting bank management and, to a lesser extent, penalties mitigate moral hazard. Weak interventions, such as warnings, do not reduce moral hazard. --Banking,supervision,moral hazard,intervention,bailouts

Corporate financing policies, financial leverage, and stock returns

We examine the interaction between equity returns and firms’ financing policies in a stochastic Ramsey model with heterogeneous firms. Motivated by empirical evidence, firms maintain stationary financial leverage ratios by issuing debt. We present a novel closed-form solution to this class of models and, subsequently, use this solution to show that restricting firms’ financing policies can explain various stylized facts of both the dynamic as well as the cross-sectional behavior of equity returns. Our restrictions induce persistent and countercyclical heteroskedasticity in returns, predictability by dividend–price ratios, a security market line that is “too flat”, and mean-reverting CAPM betas that correlate with leverage. Our model explains both established as well as recent empirical evidence, but challenges recent theoretical macro-finance explanations of the link between capital structure and equity returns