Theory of Socially Responsible Investment: A Review

Abstract

Socially responsible investment (SRI), where individuals look beyond financial payoffs to integrate environmental, social and governance (ESG) factors into their investment decisions, is not fully explained by standard models of preferences. Consequently, within the theoretical literature, economists have sought to enrich preferences by incorporating additional motivations for socially responsible behaviours. We first survey the investment literature, which introduces a ‘warm glow’ benefit derived from the act of investing responsibly. However, within the investment literature, the mechanisms underlying this warm glow benefit have been overlooked. Therefore, we draw on literature on public good provision and green consumerism to investigate the underlying social and moral mechanisms. We highlight the importance of incorporating elements of our shared humanity in order to understand economic behaviours in situations where the market mechanism is imperfect and incomplete. Subsequently, we propose an agenda for future research based on the two key questions dominating this literature. Firstly, would non-standard preferences which incorporate morally enriched warm glow payoffs enable an efficient equilibrium to be achieved whereby externalities from production are internalised? Secondly, if government intervention is needed, what is the nature of this intervention under these non-standard preferences? Answering these questions would guide the efficient design of policy to catalyse SRI.