Social screens and systematic boycott risk

Abstract

We consider the pricing implications of screens imposed by Socially Responsible Investing funds. The model extends standard risk-based asset pricing models by deriving as an additional systematic risk factor a portfolio of stocks shunned by a subgroup of institutional investors. We reconcile the empirically observed risk-adjusted sin-stock abnormal return with a "boycott risk premium" which has a substantial financial impact that is, however, not limited to the targeted firms. The boycott effect cannot readily be explained by litigation risk, a neglect effect, or liquidity considerations. The boycott factor is extremely useful in explaining cross-sectional differences in mean returns across industries. Valuation Insight: Luo and Balvers establish the existence of an investor boycott risk premium which implies that firms producing socially undesirable products are valued less in the market. This effect spills over to the valuation of firms with revenue streams that are merely positively correlated with those of boycotted firms.