When public companies focus on social responsibility, institutional investors can help — or hurt.
In a paper entitled, “Institutional Ownership Stability and Corporate Social Performance,” Kun Tracy Wang and Aonan Sun from Australian National University’s school of accounting found a positive relationship between some kinds of institutional ownership and corporate social responsibility.
“Some people would argue that institutional investors typically tend to prefer or pursue short-term profits and [to] put pressure on managers about short-term earnings,” Wang said in an interview. “Others would argue that institutional investors — given the growing pressure on social investing — may have an interest in investing in social activities.”
Wang and Sun’s research systematically categorized institutional investors based on their volatility, which they measured by the types of strategies that they employed. Investors that made frequent trades were classified as highly volatile, for example, with those that tended to buy and hold shares described as low-volatility.
With these parameters, mutual funds and investment advisers were considered highly volatile investors as their investment mandates are more sensitive to the current financial performance of their portfolio companies. Conversely, institutional investors like banks, insurance companies, and pension funds often take a more prudent investment approach, investing in safer stocks for the long-term. They are therefore less sensitive to the shorter-term performance of portfolio companies, the authors wrote. As such, they are considered stable — or non-volatile — investors.
For volatile investors — mutual funds and investment advisers — the competitive pressures they face to hold portfolio companies with strong earnings reports means that they are less likely to oversee the companies’ social responsibility practices, the authors wrote, as they prioritize financial returns.
Pension plans and insurance companies, however, have the opposite effect on companies with social responsibility goals. The authors found that these more stable institutional owners strengthened most aspects of corporate social performance for companies, including the environment, community, diversity, employee relations, and products. A company’s human rights record was one notable exception.
“...The relation between institutional ownership stability and CSP is only present for prudent institutional investors who are subject to less pressure on short term financial performance, which is consistent with our expectation that stable institutional investors tend to place greater emphasis on firms’ CSP,” Wang and Sun wrote.
This generally positive relationship, the authors wrote, is likely due to the fact that stable institutional investors, or those that avoid short-term trading, tend to have a longer-term interest in the corporation. What’s more, majority shareholders also had the ability to challenge and influence the corporation’s decisions and corporate social responsibility record.
“Additional analysis shows that the positive [relationship] is driven by prudent institutional investors who are subject to less pressure [when it comes to] short-term financial performance (e.g., banks and insurance companies) and by CSP dimensions [that are] directly pertinent to specific, primary stakeholder groups,” Wang and Sun wrote.
On the other hand, “volatile” institutional investors are more likely to participate in frequent trading — churning through companies — and seeking quick profits by putting more pressure on quarterly earnings goals. That naturally translates into companies prioritizing profits today over longer term goals or what the authors call “managerial myopia.”
“Institutional investors can be a force that [can] drive companies to pursue long-term oriented goals, such as CSR activities,” Wang said.