Why Sin Stocks Have Abnormal Returns? An Experimental Investigation on the Effect of Corporate Social Responsibility on Investor's Investment Behaviour and Firm's Choice of Production Methods

Abstract

In classical finance theory, social preference is assumed to play no role in investor’s portfolio choice, as the optimal portfolio is formed by considering return and risk of the stocks. While it has been known that sin stocks have abnormal returns, the causality (i.e., whether it is caused by investor’s social preference) of the phenomenon remains to be investigated. This paper first uses a data set on portfolio of 78,000 retail investors to investigate the relationship between investment in sin stocks and religiosity. We find that investors underweight sin stocks, and the degree of underweighting is positively correlated with the degree of religiosity of the region where investors reside. This is the first result reported in the literature for the correlation between investors’ moral concern and holding of sin stocks. The result is robust after we control for holding in familiar stocks, lottery stocks, and demographics. Then, we conduct laboratory experiments to cleanly identify the casual relationship between concern for corporate social responsibility (CSR) and investment. The first experiment shows that investors avoid holding sin stocks despite its return dominates the non-sin stocks. The second experiment shows that the concern for CSR induces firms to adapt clean production or to outsource production process with pollution. Overall, our paper provides the first causal evidence in the literature that investor’s concern for social responsibility leads them to underweight sin stocks. Our result highlights the importance of social preference in the financial market, and its implications for asset pricing theories.