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Is There a Gold Social Seal? The Financial Effects of Additions to and Deletions from Social Stock Indices

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Abstract

This study investigates the financial effects of additions to and deletions from the most well-known social stock index: the MSCI KLD 400. Our study makes use of the unique setting that index reconstitution provides and allows us to bypass possible issues of endogeneity that commonly plague empirical studies of the link between corporate social and financial performance. By examining not only short-term returns but also trading activity, earnings per share, and long-term performance of stocks that are involved in these events, we bring forward evidence of a ‘social index effect’ where unethical transgressions are penalized more heavily than responsibility is rewarded. We find that the addition of a stock to the index does not lead to material changes in its market price, whereas deletions are accompanied by negative cumulative abnormal returns. Trading volumes for deleted stocks are significantly increased on the event date, while the operational performances of the respective firms deteriorate after their deletion from the social index.

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Notes

  1. Broadly defined as a process whereby fund managers incorporate environmental, social and corporate governance considerations in the security selection process, in an effort to maximize portfolio performance while respecting the social concerns of investors.

  2. The data mentioned in this discussion are based on the 2010 Report on Socially Responsible Investing Trends in the United States, created by the US Social Investment Forum, last accessed May, 16th 2012 at ussif.org.

  3. Schröder (2007) provides the details of 29 different SRI stock indices. At the time of writing, MSCI has more than 80 different ESG (environmental, social, governance) indices while the family of Dow Jones Sustainability Indices numbers 19 members; these are just two ESG index providers.

  4. In the United States, “twenty-six exchange traded funds (ETFs) with $4.0 billion in total assets were identified as incorporating ESG criteria. Although ETFs accounted for only 1 % of the total assets of all ESG investment vehicles, their assets have grown 225 % since 2007, the fastest of all registered investment vehicles”(Report on Socially Responsible Investing Trends in the United States, 2010, US Social Investment Forum, p. 9).

  5. Lackmann et al. (2012) also examine these issues, but as possible determinants of the magnitude of investor reactions to index reconstitutions and not as focal points of the empirical analysis—as is the case in this study.

  6. Assuming that they have no impact on the discounted sum of the expected future firm profits accruing to shareholders.

  7. A more detailed discussion of the various CSP metrics that have been used is provided by Margolis et al. (2009).

  8. There is also the possibility that due to leakage of information or the market’s ability to forecast the decision of the committee, the effects of the reconstitution of the index are gradually incorporated to the prices of the stocks prior to the respective announcement.

  9. For further information about the index’s inclusion and deletion criteria, the reader is directed to MSCI KLD 400 Social Index Methodology manual, May 2011. A brief overview of the criteria is placed in the appendix of the paper.

  10. It is worth mentioning that in its earlier days of the (then) KLD 400, exits from and entries to the index would most usually coincide, would take place outside of periodic reviews and with announcements and recompositions occurring simultaneously.

  11. Numbers taken from http://us.ishares.com/product_info/fund/overview/DSI.htm. Last accessed June 25, 2012.

  12. We have checked the frequency of such events in our final deletion sample. It is very limited and does not influence the conclusions we draw. We would like to thank an anonymous referee for pointing this out.

  13. For our observation period, this criterion leads to a reduction of the overall additions sample by 0.15 % and the deletions sample by 0.8 %. Thus, we believe that applying this filter to remove the effect of extreme outliers does not severely influence the representativeness of the final samples we utilize for our analyses.

  14. http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l. Last accessed June, 5th 2012.

  15. In order to account for biases resulting from simultaneous changes in the broader earning performance of US corporates, we perform a similar analysis by examining Earnings Ratios expressed by each company’s total earnings as a percentage of the concurrent total earnings of the S&P 500 index. The results are not reported here for the sake of parsimony but are qualitatively identical to those coming from unadjusted earnings.

  16. Although these numbers look small, the average scores of aggregated strengths for the entire KLD panel dataset consisting of circa 38,000 firm-year observations is 0.049 (for aggregated concerns it is 0.073). Thus, the changes are of significant magnitude.

  17. The reader is directed to Table 1 for an overview of the characteristics that are compatible with each theory that tries to explain the index effect.

Abbreviations

AAR:

Average abnormal return

CAAR:

Cumulative average abnormal return

CFP:

Corporate financial performance

CSP:

Corporate social performance

CSR:

Corporate social responsibility

ETF:

Exchange traded fund

ESG:

Environmental, social, governmental

SRI:

Socially responsible investment

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  1. ICMA Centre, Henley Business School, University of Reading, Whiteknights, PO Box 242, Reading, RG6 6BA, UK

    Konstantina Kappou & Ioannis Oikonomou

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  1. Konstantina Kappou
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Correspondence to Ioannis Oikonomou.

Appendix: ESG Criteria for the MSCI KLD 400

Appendix: ESG Criteria for the MSCI KLD 400

MSCI’s ESG research framework generates an analysis and rating of each company’s management of its environmental, social and governance performance. The rating criteria address a company’s ESG performance in the context of five categories, covering key corporate stakeholders.

  • Environment —rates a company’s management of its environmental challenges, including its effort to reduce or offset the impacts of its products and operations.

  • Community and Society —measures how well a company manages its impact on the communities where it operates, including its treatment of local population, its handling of human rights issues and its commitment to philanthropic activities.

  • Employees and Supply Chain —assesses a company’s record of managing employees, contractors and suppliers. Issues of particular interest include labour–management relations, anti-discrimination policies and practices, employee safety, and the labour rights of workers throughout the company’s supply chain.

  • Customers —measures the quality and safety record of a company’s products, its marketing practices, and any involvement in regulatory or anti-competitive controversies.

  • Governance and Ethics —addresses a company’s investor relations and management practices, including company sustainability reporting, board accountability and business ethics policies and practices.

MSCI applies its proprietary ESG rating framework to each company by selecting the ESG rating criteria most relevant to each firm. To evaluate a company, analysts review more than 500 data points and score more than 100 indicators. MSCI expresses a company’s ESG performance as a numerical score and on a letter-based rating scale. The ratings fall on a nine-point scale from AAA to C. Scores and ratings are not normalized across individual industries or the overall company universe. This means that one industry may have no companies that receive any “A” ratings, while another industry may have no companies with “C” ratings. In addition, the index excludes companies with significant business activities involving alcohol, tobacco, firearms, gambling, nuclear power or military weapons.

For additional information on the MSCI KLD 400 Social Index Methodology, the interested reader is directed to: http://www.msci.com/products/indexes/esg/methodology.html.

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Kappou, K., Oikonomou, I. Is There a Gold Social Seal? The Financial Effects of Additions to and Deletions from Social Stock Indices. J Bus Ethics 133, 533–552 (2016). https://doi.org/10.1007/s10551-014-2409-z

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