This study examines the effect of institutional shareholders on corporate social responsibility (CSR). Specifically, the study seeks to understand how institutional investors use ownership and monitoring attention to influence the CSR policies of their portfolio firms. To address the difficulties in identifying a causal effect of institutional investors on CSR, the researchers developed two experiments to draw “causal inferences” and further general understanding of whether and how institutional shareholders affect sustainability in their portfolio firms.

The researchers hypothesize that institutional shareholders generate improvements in the social impact outcomes of their portfolio firms because of the unprecedented client demand, fund flow benefits, and risk reduction arising from compliance with sustainable goals. They further postulate that if the main incentive is to reduce portfolio risk from negative corporate externalities, the increase in overall CSR ratings is driven by the reduction in negative social activities, which would constitute CSR concerns.

The study confirms that institutional shareholders do affect social impact outcomes and that sustainable goals are not merely an attempt to capitalise on investor demand. The study contributes to the literature on institutional shareholders and sustainability issues, providing comprehensive evidence that institutional investors use both their large stakes and concentrated attention to improve social benefits.

Main findings:

• A higher level of institutional ownership leads to better CSR ratings.
• The effect of institutional ownership is stronger in CSR categories that are financially material to firm values.
• Higher ownership specifically reduces certain negative CSR issues that might lead to lawsuits or regulatory penalties due to gender discrimination, unsafe workplaces, non-compliance with environmental regulations, or improper marketing. Consequently, institutions with market portfolios and long-term investment horizons are the main force to drive CSR improvements.
• Firms tend to have lower CSR ratings (due to a decrease in socially responsible activities) when shareholders are distracted due to exogenous shocks.
• Institutional shareholders tend to influence CSR through socially responsible investment (SRI) proposals in order to increase their influence of investee companies. Findings show that there is an increased number and probability of SRI shareholder proposals in firms at the top of the Russell 2000 Index and for firms with less shareholder attention distraction.

This study is among the first to focus on the impact of investors on CSR rather than how more socially responsible firms might attract new investors. It informs our understanding of the motivations behind change by looking at the factors that affect corporate policies on social goodness and it informs our understanding of how investors can influence corporate decision-making.

1. Higher institutional ownership and more concentrated shareholder attention encourage corporate managers to adopt more socially responsible policies.
2. Exogenous increases in institutional ownership lead to better CSR ratings.
3. Increased CSR ratings are mainly the result of a reduction in CSR concerns, indicating that higher institutional ownership generally focuses on controlling negative corporate externalities to reduce portfolio risk rather than on increasing positive social activities.
4. An increase of one point in a firm’s CSR score is significantly associated with a 6.1% increase in selling, general, and administrative spending.
5. There is a weak negative relation between increased ownership and charitable giving issues, suggesting that institutional shareholders do not encourage corporate investment in these initiatives.
6. Firms with more institutional holdings invest more in CSR activities.
7. Institutional shareholders mainly drive improvement in CSR issues that are financially material to firm values.
8. Shareholders use socially responsible investment (SRI) proposals to increase their influence on CSR investments.