Social Screens and Systematic Boycott Risk

Author(s): Hao (Arthur) Luo and Ronald J. Balvers
Web Index: 2014-04
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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.
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