Institutional investors and corporate environmental and financial performance

• Published date: 01 September 2023
• Author: Steve M. Miller,Bin Qiu,Bin Wang,Tina Yang
• Date: 01 September 2023
• DOI: http://doi.org/10.1111/eufm.12392

DOI: 10.1111/eufm.12392

ORIGINAL ARTICLE

Institutional investors and corporate

environmental and financial performance

Steve M. Miller

1

|Bin Qiu

2

|Bin Wang

3

|Tina Yang

4

1

Baldwin Risk Partners School of Risk

Management and Insurance, Muma

College of Business, University of South

Florida, Sarasota, Florida, USA

2

Craig School of Business, Missouri

Western State University, St. Joseph,

Missouri, USA

3

Department of Finance, College of

Business Administration, Marquette

University, Milwaukee, Wisconsin, USA

4

Kate Tiedemann School of Business &

Finance, Muma College of Business,

University of South Florida, St.

Petersburg, Florida, USA

Correspondence

Tina Yang, Muma College of Business,

University of South Florida, 140 7th Ave

S, LPH 426, St. Petersburg, FL, USA.

Email: ty@usf.edu

Abstract

We propose a conceptual framework to illustrate that

when three conditions hold, institutional investors

moderate a positive relation between corporate financial

performance andcorporate environmental performance.

We explore heterogeneities across institution types to

demonstrate the importance of each condition. The

moderating effect works through the channels of expert

consulting and effective monitoring. Our results have

important policy and practical implications given the

global trend of ownership concentration in institutional

investors and the projection that by 2025, one out of

three dollars under professional management will be

invested in corporate social responsibility assets.

KEYWORDS

corporate environmental performance; delegated philanthropy

theory; environmental, social and governance; institutional

investors; shareholder theory; stakeholder theory

JEL CLASSIFICATION

D22, G34, M14

1|INTRODUCTION

This article investigates whether institutional investors moderate a positive relation between

corporate environmental performance (CEP) and corporate financial performance (CFP).

Our inquiry is motivated by two needs in academia and practice. First, although the research on

Eur Financ Manag. 2023;29:1218–1262.wileyonlinelibrary.com/journal/eufm1218

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We have benefited from comments by the editor (John A. Doukas), an anonymous referee, Kiyoung Chang, Guoli

Chen, Vishal Gupta and participants at the 2019 Southern Finance Association Annual Meeting.

the relation between CFP and corporate social responsibility (CSR) dates to 1972 and despite

voluminous work on the topic, the evidence remains inconclusive, especially regarding the

CEP–CFP relation.

1

Because the environment is a public good, firms do not incur the loss in

aggregate productivity or societal wellbeing caused by environmental degradation (Aghion

et al., 2016). However, firms incur all the costs of investing in environmentally friendly

practices while the greatest benefits accrue to the public. Consistent with this environmental

externality argument, although empirical evidence has found an overall positive but weak

CSR–CFP relation (Grewatsch & Kleindienst, 2017; Margolis et al., 2009), researchers have

found a negative CEP–CFP relation (Fisher‐Vanden & Thorburn, 2011; Filbeck et al., 2019).

Also consistent with this environmental externality argument, Andriosopoulos et al. (2022) find

that while the stock market reacts positively to the announcement of new patents in general,

the market reacts negatively to environmental innovation.

Our second motivation stems from the striking gaps between a lack of CSR

engagement by firms and the vast literature on why firms should engage in CSR along

with an increasing desire expressed by managers to pursue CSR. More specifically, over

the years, the literature on stakeholder theory (Donaldson & Preston, 1995; Freeman,

1984;Quinn&Jones,1995) and the literature on responsible management (Cullen, 2020;

Montiel et al., 2020) have made great strides in advancing arguments for why firms should

engage in CSR and how to promote managerial practices that integrate sustainability,

responsibility and ethics. In recent years, managers have also increasingly expressed a

desire to take a more stakeholder‐oriented approach to run businesses. For example, in

2019, the Business Roundtable—anon‐profit association whose members are exclusively

the Chief Executive Officers (CEOs) of major US companies—abandoned the principle of

shareholder primacy that it had endorsed since 1997 to adopt a modernized standard for

corporate responsibility that meets the needs of all stakeholders.

2

However, despite the

persistent efforts in academia and the growing desire expressed by managers to engage in

CSR, mainstream managers have yet to integrate CSR principles into their daily

management practices (Montiel et al., 2020). As Bruce Van Saun, the Chairperson and

CEO of Citizens Financial Group, explained during an interview in December 2019,

‘shareholders are the ones that [managers] have to please first and foremost’as they are

agents of shareholders and if better CSR performance comes at the expense of poor CFP,

shareholders will fire the managers.

3

(Citizens has endorsed the modernized standard for

corporate responsibility of the Business Roundtable.) Institutional investors are the most

influential shareholder group because of their large equity holdings (Gillan & Starks,

2007). Hence, it is vital to understand whether and how institutional investors impact the

CSR–CFP relation.

However, our knowledge concerning the role of institutional investors in CSR, especially

the role played by different types of institutional investors, is incomplete. There is an urgent

need to fill this literature gap because, in recent years, institutional investors have received

tremendous capital inflows oriented toward CSR. According to the US Social Investment

Forum, assets under management with CSR strategies in the United States grew from $639

1

For simplicity, this article interchangeably uses sustainability, CSR, ethical investing and environmental, social and

governance (ESG) (see, e.g., Kim et al., 2019; U.S. Social Investment Forum, https://www.ussif.org/).

2

https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-

economy-that-serves-all-americans

3

https://www.bloomberg.com/news/audio/2019-12-27/bruce-van-saun-shares-banking-industry-insights-podcast

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billion in 1995 to $17 trillion in 2020.

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Characterizing this growth from another perspective, it is

projected that by 2025, one out of three dollars under professional management will be invested

in CSR assets (Bloomberg, 2021).

We fill the above‐mentioned lacunas by integrating shareholder theory, stakeholder theory

and delegated philanthropy theory and proposing a novel conceptual framework. We

hypothesize that institutional investors moderate a positive CEP–CFP relation when three

conditions hold: (1) they internalize the cost of poor CEP, (2) they have a stakeholder

orientation and (3) they focus on maximizing long‐term CFP. For greater insights from

empirical tests on the framework, we use US data because the US features a shareholder model

and institutional investors own 70% of US firms (Patel, 2018). For a more stringent test of the

three conditions, we focus on CEP—but not CSR—because as discussed at the start of the

Introduction, the theoretical arguments and the empirical evidence are much weaker for

corporate engagement in environmental activities than in CSR. To mitigate endogeneity

concerns, we follow Kim et al. (2019) in using facility‐level data and calculating the abnormal

amount of toxic release to proxy for CEP.

We find that local institutional investors (LIIs), rather than their distant peers, moderate a

positive CEP–CFP relation, consistent with the conjecture that dueto their proximity to polluting

facilities, LIIs internalize to a greater extent the cost of poor CEP. The moderating effect works

through the channels of expert consulting and effective monitoring. Specifically, when they hold

a larger number of firms within the same industry, LIIs exert a larger positive moderating role,

consistent with the notion that through crossholding, LIIs learn the best environmental practices

of the industry and are therefore more capable of helping firms identify the environmental

initiative that has the most potential to simultaneously enhance CEP and CFP. We also find that

LIIs play a more positive moderating role in firms with a higher level of free cash flows, which

supports the argument that LIIs mitigate the agency costsin CSR activities. Our results arerobust

to endogeneity checks and using either market or accounting measures of CFP.

Admittedly, it is not obvious why less toxic release contributes to better CFP, especially

when considering the environmental externality argument. Therefore, to provide additional

evidence for our framework, we explore the heterogeneities across institution types to test each

of the three conditions that we argue, when they hold, enable LIIs to facilitate a positive

CEP–CFP relation. More specifically, whereas the finding that LIIs—but not distant ones—

moderate a positive CEP–CFP relation underscores the importance of the first condition, for

additional corroboration, we show that institutional investors in aggregate, measured as total

institutional ownership, do not moderate a positive CEP–CFP relation. This finding offers

additional support for the first condition because an average institutional investor does not

internalize the negative externalities caused by the facility to the same extent as an LII located

close to that facility. We find that local hedge funds do not, but local socially responsible

investing (SRI) funds do, have a positive moderating effect on the CEP–CFP relation. This

finding supports the importance of the second condition because hedge funds are shareholder‐

centric and SRI funds are stakeholder oriented. Lastly, we find that transient LIIs do not, but

dedicated LIIs do, moderate a positive CEP–CFP relation. This finding supports the importance

of the third condition because transient institutional investors are known to sacrifice long‐run

performance for short‐term trading profits. In contrast, dedicated institutional investors focus

on maximizing long‐term CFP.

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https://www.ussif.org/

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MILLER ET AL.