Socially Responsible Finance: How to Optimize Impact?

Abstract

socially responsible finance: how to optimize impact? augustin landier∗ stefano lovo † may 31, 2021 abstract we consider a general equilibrium productive economy with negative externalities. entrepreneurs maximize profits, and investors seek to maximize their pecuniary and nonpecuniary returns. we analyze how in equilibrium, the size and investment policy of a socially responsible fund (srf) vary with investors’ preferences, production technologies and capital market frictions. if investors care about impact, the srf should prioritize investments in companies with acute negative externalities and facing strong capital market friction. the srf can amplify its impact by imposing restrictions on the suppliers used by the firms it finances. this lowers emissions even in industries that are not directly financed by the srf. the nonpecuniary benefits of investors improve welfare when they take the form of sensitivity to impact but can deteriorate welfare when take the form of value alignment. jel:g11, g23, m14, o44, q51 keywords: impact investing, esg funds, emission externalities, carbon footprint. ∗hec paris †hec paris 1 introduction negative externalities generated by corporations, such as pollution, are a central theme in current policy debates. the traditional economic prescription to solve such externalities is regulation; through the use of pigouvian taxes or tradable pollution permits (“cap-and-trade”), governments could in theory influence the decisions of firms, thereby forcing …

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