By Yuxia Zou, CERF Research Associate, Cambridge Judge Business School, University of Cambridge
Public commitments to sustainability by investment companies have been widely criticised as greenwashing practices (Fletcher and Oliver 2022). By adopting a public sustainability commitment, such as by becoming a signatory to the United Nations-supported Principles for Responsible Investment (PRI), investment companies can attract substantial capital, regardless of their ability to deliver promised financial or sustainability outcomes (Brandon et al. 2022; Liang, Sun, and Teo 2022; Kim and Yoon 2022). However, from 2009 to 2021, PRI lost over 1,100 signatories collectively managing assets of US$10 trillion. In 2022, the closure of ESG funds rose disproportionately compared to conventional funds, and leading investment companies such as Blackrock voted against climate-related shareholder proposals (Chen 2022; Masters 2022). Why and when would an investment company abandon its public commitment to sustainability?
In a recent study, I address this question by analysing the circumstances under which companies delist themselves from PRI, for reasons other than merger, acquisition, or liquidation. The PRI setting is ideal for answering this question because the PRI signatory status is the most internationally recognised signal for an institutional investor to “publicly demonstrate its commitment to including environmental, social and governance (ESG) factors in investment decision making and ownership” (PRI 2022). Established in 2006, PRI is the world’s largest institutional network of sustainable investors, with almost 4,000 signatories managing combined assets of over US$120 trillion at the end of 2021.
Why and when do companies delist?
This study is based on a dataset covering 1,280 unique mutual fund investment companies from 55 countries during 2006-2021, including 125 delisted companies and 1,155 companies that have remained PRI signatories since joining. The United States has the largest number of signatories and the highest delisting frequency, while Brazil, Mexico, and South Africa have the highest delisting rates among countries with at least five signatories covered in the sample.
Companies tend to delist from PRI when they cannot realise the expected benefits, mainly improving risk-adjusted returns, portfolio-level ESG performance, and fund flows. However, fund flow attraction only becomes a significant factor recently. These companies often have fewer internal resources and weaker external support for sustainable investment, such as managing fewer assets, receiving less support from PRI, and operating in countries with worse environmental performance or less progressive social norms.
These results suggest a non-negligible cost for publicly committing to sustainable investment. Only companies that derive sufficient benefits to cover the cost afford to maintain this commitment. Therefore, a long-term public commitment to sustainable investment can be a signal for companies that are capable of “doing well by doing good”.
Costs and benefits of mandatory sustainability disclosure standards
So, what are the costs of publicly committing to sustainable investment? One major cost can be due to PRI’s standardised sustainability disclosure mandate, which signatories commonly claim as a primary delisting reason.
This study finds that the frequency of delisting spiked when PRI released the first mandatory disclosure standards for public consultation between September and October 2011, when approximately ten additional investment companies delisted per month. About three more investment companies left every month when PRI extensively consulted signatories to finalise the disclosure standards between September 2012 and September 2013. As companies have been mandated to provide standardised sustainability disclosures since October 2013, their delisting decisions have become more sensitive to realised benefits, suggesting that companies demand more benefits in improving financial and sustainability performance to maintain their PRI signatory status.
These results document the real effects of mandatory sustainability reporting standards, particularly reporting companies’ usage of market exit as a strategy to avoid regulation (Christensen, Hail, and Leuz 2021). Such behaviours resemble companies’ strategic avoidance actions in going dark or private ahead of the 2002 Sarbanes–Oxley Act (Engel, Hayes, and Wang 2007; Leuz, Triantis, and Wang 2008; DeFond and Lennox 2011). Therefore, mandating standardised sustainability disclosures may act as a catalyst to filter out companies more capable of pursuing dual objectives in financial and sustainability performance, hence policing the sustainable investment industry.
Informational value of mandatory standardised sustainability disclosures
Given the significant effect of mandating standardised sustainability disclosures, a natural question to ask next is: Does the standardised information provided by signatories predict future delisting decisions?
The answer is ex-ante unclear because, on the one hand, the disclosures mandated for PRI signatories focus on management control systems, which theoretically play an important role in achieving dual objectives in sustainability and profits (e.g., Henri and Journeault 2010; Eccles, Ioannou, and Serafeim 2014; Flammer, Hong, and Minor 2019). Moreover, standardised disclosures can benefit stakeholders by improving transparency and enabling differentiation across companies, even if the standards do not increase the quantity or quality of information (Brochet, Jagolinzer, and Riedl 2013; De George, Li, and Shivakumar 2016). On the other hand, PRI signatories are not required to audit their reports and may have incentives to misreport because PRI grades their reports and provides the grading scheme along with the disclosure standards (Cho et al. 2015; Pinnuck et al. 2021). Surprisingly, results show that reported management control practices effectively predict future delisting. Companies are most unlikely to delist if they provide internal training on sustainable investment, internally assure their sustainability disclosures, and assign individual accountability for sustainable investment performance to a specialised department head.
Hence, despite the freedom and incentives to misreport, companies subject to mandatory disclosure standards provide valuable information that can effectively predict the duration of their sustainability commitment.
What happens after delisting?
If companies prefer not to bear the costs of publicly committing to sustainable investment, would they become better off after abandoning the commitment, or would the market punish them?
In the short term, delisted companies continue to receive similar fund flows as before, but experience improved net returns one year after delisting. In the second and third years after delisting, these companies see a statistically significant 1% increase in fund flows. Hence, delisted companies become economically better off. Changes in portfolio composition can explain the improvement in returns. Delisted companies become “browner” as they allocate more assets towards sin industries and stocks with more ESG controversies. Specifically, the percentage of sin stocks held by delisted signatories surges from about ten months before delisting and is twice as much as that held by the matched stayed signatories during the delisting month. Therefore, delisting from PRI is not merely ditching a label but reflects real changes in investment decisions.
Collectively, this study highlights the cost of public sustainability commitments. This cost includes compliance costs such as mandatory reporting and opportunity costs for imposing a constraint on companies’ investment activities in maximising financial performance. As a result, only firms with internal resources and external environment to “do well by doing good” can afford to maintain a public sustainability commitment in the long term. Mandating standardised sustainability disclosures increases commitment costs, providing valuable information to stakeholders and helping screen out companies more capable of pursuing dual objectives in financial and sustainability performance. These findings shed light on the potential consequences of standardised sustainability disclosure mandate in the financial sector on a national or international level, such as the Sustainable Finance Disclosure Regulation (SFDR) by the European Commission and ESG Investment Product Disclosure by the US SEC (European Commission 2022; US SEC 2022).
What are the effects of favouritism on employee incentives and behaviour more generally? Do well-connected mutual fund managers exert less effort in managing their funds? Why do mutual fund companies tolerate favouritism? These are some of the questions explored by Elias Ohneberg, who is a research associate at the Cambridge Endowment for Research in Finance.
CERF Fellow Oğuzhan Karakaş, and research collaborators Pedro Saffi (a former CERF fellow) and Mehrshad Motahari (a former CERF Research Associate), analyse whether the short sellers can anticipate negative ESG incidences of firms, and make money from the negative price reactions to the news announcement of such incidences.
How sensitive are green firms to monetary policy? Alba Patozi, PhD student at the University of Cambridge (Faculty of Economics) explores this question in a recent paper that won the 2023 CERF/Cambridge Finance Best Student Paper Award.