This leads to some questions, among them, what made greener investments outperform? And when do they deliver better returns than the alternative? Chicago Booth’s Lubos Pastor and his coauthors have developed a model to explain what going green could mean for investors.
Lubos Pastor: Well, we started with a natural assumption, that investors prefer holding shares of green firms—and by green firms, I mean firms that are widely considered as more socially responsible, whereas by brown firms, I mean firms that are widely considered as socially irresponsible.
Narrator: In the researchers’ model, if investors want to hold green assets they bid up the prices for those stocks.
This has to do with sudden climate shocks, events like a giant iceberg splitting from an Antarctic ice shelf.
Lubos Pastor: So brown firms end up performing poorly in bad states of the world when the climate shock hits.
Further, when investors are willing to pay more for green investments and accept a lower rate of return, green companies are able to invest more in their own operations.
We consider Friedman-like managers who simply maximize market value, and yet, we show that ESG investing has a positive social impact, why? Because when a manager makes her firm greener, she is making it more valuable, because remember, in our setting, investors are willing to pay more for green firms. So they will appreciate it when managers make their firm green.
For example, if you wanna save, save our planet, you know? If you wanna solve the climate-change problem, the most efficient solution by far is for the government to impose a carbon tax, OK? Yes, we can fiddle around the edges with ESG investing and maybe make a little bit of impact here and there, but it’s much more natural for the government to take the lead on these big externality problems. In addition, if you think about social issues, as opposed to environmental issues, in today’s polarized society, it makes a lot of sense for the government, a democratically elected government, to make decisions about, you know, what should be and what should not be done.