Investment Strategy based on Social Responsibility and Bubbles

Guenster Nadja

Abstract
In contrast to the classical efficient market theory, the behavioral Finance literature acknowledges that people are neither rational utility maximizers nor able to process all available information. Instead, people tend to focus on the most salient aspects of their environment and neglect other information. This dissertation studies this phenomenon through six studies on investment strategies related to investors' attention failures. In the first four chapters, I analyze whether information on companies' environmental, social and governance (ESG) practices is valuable and efficiently incorporated in prices. If the ESG practices of a firm relate positively to its current and future earnings but a large proportion of investors is inattentive to them, rational attentive investors should be able to exploit this information. Results show that a strategy of shorting the least eco-efficient firms and investing in the most eco-efficient firms earns significantly positive abnormal returns. Initially, eco-efficient firms did not trade at a higher value but the valuation premium increased over time. On the social dimension, some aspects of human capital management (HCM) are value-relevant and priced by financial markets. However, there is no conclusive evidence that HCM is associated with positive abnormal returns. As for corporate governance, I provide evidence that investors could have exploited this information to earn positive abnormal returns. I find that well-governed firms have a significantly higher valuation than weakly governed firms implying that investors pay attention to corporate governance. The final two chapters deal with a rational investor's optimal response to asset price bubbles, a phenomenon associated with overattention. My results show that investors face a tradeoff: they can earn positive abnormal returns by investing in the asset bubble but also face the risk of very large negative returns: crashes. I evaluate this tradeoff for downside risk-averse investors and find that riding bubbles is optimal for short-term as well as long-term investors.

Keywords
behavioral finance; bubble; corporate governance; corporate social responsibility; environment; human resource; investment strategy