Institutional Investors and ESG Preferences

• Published date: 01 November 2024
• Author: Florencio Lopez‐de‐Silanes,Joseph A. McCahery,Paul C. Pudschedl
• Date: 01 November 2024
• DOI: http://doi.org/10.1111/corg.12583

Corporate Governance: An International Review, 2024; 32:1060–1086

https://doi.org/10.1111/corg.12583

Corporate Governanc e: An International Review

SPECIAL ISSUE ARTICLE

Institutional Investors and ESG Preferences

F l o r e n c i o  L o p e z - d e - S i l a n e s 1,2 | JosephA.McCahery3,4,5 | PaulC .Pudschedl4,6

1SKEMA Bu siness School, University C ote d'Azur, Valbonne, France | 2U S National Bureau of Economic Rese arch, Cambridge, MA , USA | 3Tilburg L aw

School, Tilburg Univ ersity, Tilburg, The Netherlands | 4TILEC , Tilburg University, Tilburg , The Netherlands | 5ECGI, B russels, Belgium | 6Department

of Finance and Applie d Economics, University of Appl ied Sciences Wiener Neustadt, Wiener Neust adt, Austria

Correspondence: Florenc io Lopez- de- Silanes (florencio. lopezdesila nes@skema.edu)

Received: 9 October 2022 | Revised: 12 Februar y 2024 | Acc epted: 5 March 202 4

Funding: The authors received no speci fic funding for thi s work.

Keywords: disclosure | E SG | financial perfor mance | institutional inve stors | sustainable fi nance

ABS TRACT

Research Q uestion/Issue: We examine t he effect of multiple environmental, social, and governance (ESG) scores on inst itu-

tional i nvestor owner ship of firm s and investor p ortfolio weig htings. We are a lso the fir st to analyze the three ind ividual compo -

nents of ESG ranking s to estimate the relative preferences of institutional investors.

Research Findings/Insig hts: Using a unique panel dataset covering US companies and institutional i nvestor portfolios over

the 2010–2019 per iod, we find that while investors are driven to add hig h- quality ES G companies to their p ortfolios, there is a

negative relationship with ESG when it comes to tak ing large ownership stakes. Fur thermore, ESG scores are negatively related

to the portfolio weighting s of institutional investors, which raises concerns of g reenwashing. Our analysis of individual ESG

scores points to significantly larger effects of G scores in terms of holdings, and G is the only sc ore with no negative impact on

portfolio weight ings. Finally, in support of s ystematic stewardship the ory, top institutional investor s allocate higher proport ions

of the ir por tfolio s to fi rms wit h high - ES G ratin gs. Ou r resu lts are robust to the use of a diff erenc e- in - di ffer ences analy sis add ress -

ing endogeneity c oncerns.

Theoretica l/Academic Implic ations: The findings in this paper offer important policy implications for institutional inve s-

tors, managers, and policymakers. Given the ongoing debate on ESG scores, this paper shows the importance of examin ing

greenwashing for investors who have a concern regarding the extent to which the valuation of assets might be influenced by

unsupported sustaina bility claims. In addition, our study adds to the debate regardi ng ESG investing and stewardship theor y.

1 | Introduction

The last decade has s een an explosion in institutional inves-

tor demand for environmental, social, and governance (ESG)

investments. According to Morningst ar (2023), the amount

of net inf lows into the global universe of sustain able or ESG

funds exceeded USD 63 bil lion in 2023. Data from the Global

Sustainable Investment Alliance (2023) indicate t hat total sus-

tainable investment assets in Europe increased from USD 12

trillion at the start of 2020 to USD 14 tril lion at the start of 2022,

and the amount of global sust ainable assets under management

exceeded USD 30 trillion in 2022 . Moreover, the number of UN

Principles for Responsible Investment (UN PRI) signatories rose

by 26% in 2 022, reachin g a tota l of 49 02 investors with an es-

timated total assets under mana gement of USD 121.3 tr illion

(PRI 2022). Given researchers' and polic y makers' increasi ng

interest in ESG investing, we examine investor ESG preferences

and investment deci sions, as reflecte d in ownership holdings

and portfolio weights.

The nascent literature has offered two contrasting v iews on in-

vestors' preferences for ESG investment (Ceccarelli et al.2021;

© 2024 John Wi ley & Sons Ltd.

1060

Drobetz et al. 2023; Fr iede, Bus ch, and Bassen 201 5; Gillan,

Koch, and Sta rks 2021; Hong and S hore 2023; Hornuf and

Yüksel 2023; I. Ki m eta l.2019; Velte2023). Sta rks(2023) de-

scribes the central difference of these two views in terms of

its con nection to pecun iary and nonpec uniary mot ivations.

The first v iew holds that there is a relationship between E SG

and corporate fina ncial performance and therefore “value.”

Early studies provide considerable evidence on the impact of

ESG on returns (Friede, Busch, and Bassen 2015). More recent

studies, howe ver, have found mixed results (Gillan, Koch, and

Starks2021; Whelan, Atz, and C lark2021). Our a nalysis of in-

vestor preferences, proxied by ownership holdings a nd portfolio

weightings, c ontrols for firm financial performa nce in order to

consider this motivation.

The sec ond view holds that investor demand for E SG invest-

ments is driven by factors other than the connection between

ESG and firm performance, wh at Starks (2023) would group

under the t erm “value s.” A first ver sion of this v iew holds that

a subs et of inv estors with a no npecun iary compone nt of util ity

are w illing to accept lower potential returns in exchange for

holding firms w ith high- ESG quality (Fam a and French2007;

Oehmke and Opp2023; Pastor, Sta mbaugh, and Taylor20 21;

Pedersen, Fitzgibbons, and Pomorski2021). This may explain

the empirical evidence of the underperformance of ESG mu-

tua l fund s and th e flow of fund s into a nd out of E SG fun ds as a

function of ESG performance (Hartzma rk and Sussman2019;

Renneboog, Ter Horst, and Zhang2008a, 2008b). A nother ver-

sion on this v iew suggests that some funds cater to a clientele

with nonpecun iary preferences for ESG. Th is view is similar

to Allen, Bernardo, a nd Welch's (2002) argument for high

dividend- yield stocks. Such as set manager s are incentivized

to adopt ESG investment strategies because they can increase

their management fees as they attract this clientele a nd grow

assets under management.1

A final version on the nonpecuniar y benefits view applies

to large a sset managers' preferences for ESG invest ments.

Albuquerque et al.(2020) argue that ESG can be used to di-

versify systemic risk. Following Gordon (2022), since inves-

tors want to maximize risk- adjusted returns , it is in the asset

manager's interest to support ESG as it re duces systemic risk.

In th is sense, “s ystemic stewardship” ends up ser ving inves-

tor and social welf are. In support of this arg uments, Fichtner,

Heemskerk, and Garcia- Bernardo (2017) repor t that la rge

asset managers are much less exposed to systemic risks and

are, therefore, motiv ated to reduce the systemic risks i n their

portfolios that are associated with E SG factors (e.g., climate

risk). Similarly, there is also research sug gesting that im-

provement s in ESG met rics are a ssociate d with decr eased ri sk

(Bialkowski and Starks 2016 ; Hanson et al. 2017; Hoe pner

etal.2019; Shafer a nd Szado2019).

We draw on arg uments based on cl ientele effect s and systemati c

stewardship theory to exa mine the effect of multiple ESG scores

on institutional investor ownership of firms and investors' port-

folio weightin gs. More specifically, we investigate the connec-

tion bet ween these metrics and the ES G quality of companies

and its i ndividual ESG c omponent scores. We also contrast the

results using the Bloomberg disclosure- based scores and the

subjective Sustainaly tics ratings.

We put together a rich panel data set containing data on 853

US fir ms over the 2010–2019 period, w ith a total of 6407 f irm-

year obser vations, to study how ESG preferences influence the

portfolio holding s and weightings of institutional investors. To

estimate investor preferences, we calculate several measures of

institutional investor owner ship for each fir m: the total num-

ber of institutional investors in each f irm; the tot al percentage

of a f irm's outstandi ng share s held by institutional investors;

the mean ownership percenta ge of institutional investors in

the fi rm; and the shareholder concentr ation of instit utional

investors (using t he HHI measurement). To complement these

measures, we look i nto each institutional investor portfolio and

calculate the average portfolio weighting of each individual firm

investment. This number provides us with an altern ative way

of looking at the inve stors' relative commitment to ESG in their

portfolio s.

Our first set of finding s shows that, controlling for f irm p er-

formance, institutional i nvestors show significant preference

for firms with high- ES G ra nkings. These results are statisti-

cally si gnificant for the ESG r atings from both Bloomberg and

Sustainalyt ics, but the d isclosure- based Bloomberg ESG score s

are more strongly correlated than the subjective Sustainaly tics

ratings. One potential reason for t his is the dif ferent methodol-

ogies and data used b y the rating agencies, a finding that is con-

sistent with recent work on rati ngs (Berg, Kölbel, and Rigobon

2022; Billio etal. 2021). Our results suggest that ESG disclosure-

based mea sures play a more important role than quality- based

measures in determining institutional investor ESG preferences.

We continue our analysis examinin g the individual compo-

nents of ESG ranking s to estimate the relative preferences of

institutional investors among the th ree ESG dimensions. This

issue relates to the deeper debate about what is behi nd ESG

(Pollman2022; Starks20 23). Although the term ESG has the

benefit of appealing to a large set of populations, it also masks

its true underlining drivers. A central component of ESG is still

deeply rooted in the original gov ernance factors that the early

literature li nked to higher valuations and retu rns. Governance

could therefore be a central factor attracti ng investors.

Our results show that the Governance (G) dimension is the

most i mportant factor in investors' choice of por tfolio compa-

nies. Specifica lly, these results also suggest that G is responsible

for most of the statistical a nd economic significa nce of ESG ef-

fects on institutional ownership. I n fact, G is the only dimen-

sion with a nonnegat ive effect on investor por tfolio weightings:

Institutional investors have lower weights on high E and S

stocks but keep tho se with high G. The d isaggregate d results for

Bloomb erg and Sus taina lytics m imic the ov erall ES G score fi nd-

ings described above. A striking finding is that the coefficient on

the Bloomberg gov ernance rating is more than si x times larger

than that of the Bloomberg env ironmental rating and three

times larger than that of the so cial rating.

In contrast to the prev ious findings, our second set of results re -

veal that high- ESG scores are associated w ith lower concentra-

tions of ownership stakes by institutional investors. The lower

ownership concentration of institutional investors on high- ESG

companies is the outcome of a greater number of institutional

investors and a nonsignificant overall percentage ow nership of

1061