Faculty of law blogs / UNIVERSITY OF OXFORD

Corporate Social Responsibility and Sustainable Finance: A Literature Review


Hao Liang
Associate Professor of Finance, Lee Kong Chian School of Business, Singapore Management University
Luc Renneboog
Professor of Corporate Finance, Tilburg University, and a research member of the European Corporate Governance Institute (ECGI)


Time to read

3 Minutes

Corporate social responsibility (CSR) has increasingly become a mainstream business activity, ranging from voluntarily engaging in environmental protection to increasing workforce diversity and employee welfare. The term ‘CSR’ is often used interchangeably with ‘ESG’, which refers to the incorporation of Environmental, Social, and Governance considerations into corporate management and investors’ portfolio decisions.

In our recent paper, entitled Corporate Social Responsibility and Sustainable Finance, we aim to comprehensively review the literature in finance and economics on these topics. The literature has offered three views on CSR with regard to its motivation and consequence. The first view considers CSR as a ‘win-win’ situation for both the company’s shareholders, the other stakeholders and the society at large. This is commonly referred as ‘doing well by doing good’, namely, when a firm acts like a good corporate citizen, it can also become more profitable. The ‘win-win’ view essentially suggests that CSR can be viewed as a long-term investment leading to long-run value maximization, even though it may come at a cost in the short run. The second view considers CSR as a ‘delegated philanthropy’. That is, CSR emerges as a response to societal demands for corporations to deal with market and distributive failures, and is a delegated exercise of prosocial behavior on behalf of stakeholders. Some stakeholders, including investors but also customers and employees, are often willing to sacrifice money (return/yield, purchasing power and wages, respectively), so as to further social goals. The third view considers CSR as an insider-initiated corporate philanthropy. That is, CSR can be a manifestation of agency problems and raises a corporate governance issue.

CSR is usually measured by ESG ratings provided by various ESG data vendors. However, a major problem in CSR research consists of biases in ESG ratings driven by: (1) size (larger companies may receive better ESG reviews because they can dedicate more resources to prepare ESG disclosures and control reputational risk); (2) geography (higher ESG assessments may be given to companies domiciled in regions with higher reporting requirements); and (3) industry (normalizing ESG ratings by industry can lead to oversimplifications). Another issue is that ESG ratings may be backward-looking and not capture how a company may be making an honest effort to improve its sustainability record. Furthermore, the providers of ESG scores use different methodologies (with an average correlation of merely 0.3 between different ratings), which casts doubt on the ratings’ validity. An important academic research task hence comprises the comprehension of why ESG ratings differ and what the optimal methodology is to construct ESG ratings.

The reliability of ESG ratings has significant implications for any research on CSR or SRI (Socially Responsible Investments). For instance, ESG performance affects asset prices and portfolio returns. When ESG criteria are used to delineate the investment universe, differences in firm ESG scores across ESG rating agencies yield different optimal portfolios for SRI funds, even when applying the same optimization technology. Currently, there is still no consensus about whether ESG-based investing helps or hurts performance. ESG considerations may lower expected returns because high ESG may lower risk, which leads to lower expected returns while others state that ‘the outperformance of ESG strategies is beyond doubt’.

A recent phenomenon is impact investing made by private-equity investors who seek both financial returns and a positive social and environmental impact. Although venture capital impact funds earn lower returns than traditional funds, the reason that investors are still investing in impact funds is that they derive nonpecuniary utility from such dual-objective funds. This is especially the case in Europe, which dominates the demand for impact funds.

A new financial market that has grown fast since 2013 is the market for green bonds and loans, which beckons the question about their pricing efficiency. Environmental commitment in the supply (the issuers) and demand (retail and institutional investors) can justify green bond issues, as investors are willing to forgo part of the yield relative to that of conventional bond issues, which lowers the cost of capital of green bond issuing firms.

Besides green bonds, some recent studies also investigate how climate change affects financial markets more generally. Investing in firms with a high carbon exhaust yields a higher return because such investments are considered riskier by investors, such that a higher return is required to compensate for the higher risk. Also, if such stocks are ignored by part of the investor base, these stocks may become more illiquid and may be temporarily under-priced. This carbon premium is not only related to a firm’s direct exhaust but also to the carbon emissions by firms in its supply chain. It is not only the stock market that is affected by global warming, but also the real estate market. Research has shown that real estate valuations reflect the differential beliefs among the general population on its occurrence (risk of future inundation); houses that are projected to be underwater in neighbourhoods of people who believe it tend to sell at a discount.

Despite its relatively late advent, the literature on CSR and sustainable finance has been growing exponentially and evolving towards various topics. We believe more research is needed in this area to further our understanding on the role of CSR and sustainable investment in driving firm value, investor returns, and social welfare. We hope our paper will sprout further discussions and debates on these important issues.

Hao Liang is an Associate Professor of Finance at Lee Kong Chian School of Business, Singapore Management University

Luc Renneboog is a Professor of Finance at Tilburg University


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