Socially Responsible Investing - Research Paper Example

Socially Responsible Investing, Behavioral Factors in Framing Date: Introduction Economics is a broad subject that studies how individual, organizations and the state allocates resources, which are said to be unlimited in nature to several competing wants. It explains how individuals are confronted with the economics question of how, when and where should resources be allocated in an effort to satisfy the never ending human wants. With its many branches, economics tries to present different models and strategies that people use to make decisions concerning resource allocation and utility maximization. Behavioral economics, a branch of the wider economic field together with behavioral finance plays an important role in studying the effects of psychological, social, cognitive as well as emotional factors regarding individuals and institutional decision-making process and its related consequences as far as market prices, returns and resource allocation are concerned (Nava et al 2005). It is important to note that behavioral models typically integrate insights ranging from psychology to micro-economic theory. The study of behavioral economics, a branch of economics comprises of how individuals, organizations, private and public institutions influence and make market decisions as well as mechanisms that drive such choice. It also gives insight into how people come up with decisions about investments and the effect of such investment patterns not only on their financial status but also on the environment as a whole (Mill 2006), something that has given rise to the concept of Socially Responsible Investment (SRI). Socially Responsible Investment People, organizations and institutions make different kinds of investments that are influenced by motives that are different from each other. In the same way, the types and sizes of their investments is also influenced by financial resources available alongside other influencing factors. In general, an investment can be said to be socially responsible due to the type and nature of business that is being undertaken in the process. However, there are some common themes associated with socially responsible investments, some of which include shunning away from investing in companies that deal in addictive substances like alcohol, tobacco and such actions like gambling. Instead, socially responsible investment should seek investment in companies that engage in environmental sustainability initiatives as well as alternative energy and clean technology efforts. Empirical research that has been conducted by different people has shown that in selecting a portfolio, potential investors not only consider statistical measures like risk and return, but also psychological factors such as sentiment, overconfidence and overreaction. In short, it is a general observation that heuristic-driven bias, frame dependence, and market inefficiency plays a crucial role in shaping the kind of portfolios that investors make preference to, the type of securities they find attractive, as well as the biases to which they are considered subject to. For a long period, the process of socially responsible investing has been the subject of significant attention in practitioner and academic literature. The process has so far attracted research process that have been geared towards examining and discussing the financial advantages associated with the process, its effects on social change, pertinent issues and challenges associated with SRI logistics as well as the motives and inspiration that drive investors. While it may be easy to know and comprehend some of the demographic makeup, associated with socially responsible investors, what distinguishes them from non-socially responsible investors as well as what their motives and inspirations are. Our understanding of the decision process behind SRI is still limited; this is influenced by the fact that only a few studies have tested hypotheses about investor behavior in the context of socially responsible investing. Influencers of investor behavior Many individuals have a desire to invest in a business activity that gives them utility and value of their resources invested. In different countries, many people are advised to make investments in different sectors so that their financial status can improve, besides that of the state, for this reason, the government does all it can to create an environment that is conducive for investment. In establishing this environment, the government compiles information investment statistics including financial and other requirements. It is important to note that one of the common themes existing in explanatory studies of investor behavior is the influence of attitudinal and personality variables on investment choices, rather than demographic differences or financial considerations. According to preceding investigation verdicts by McLachlan & Gardner (2004), an investor with a higher perception of moral intensity and placed due regard for quality and high standards in other decision situations was more likely to be a socially responsible investor. At the same time, William (2007) discovered that those investors who considered social responsibility as an integral and vital component of corporate responsibilities and expressed this care in their purchasing decisions were more likely to include social considerations in their investment selection as well. It therefore goes without mention that these studies are essential in giving the much-needed insight into factors influencing particular decisions by investors, especially on the influence of an individual’s expectations as far as corporate conduct is concerned. For this reason, it is important that a manifested preference for products of responsible companies should get preference for the stock of a particular responsible company. Nevertheless, previous studies have been elaborate in showing that even non-socially responsible investors seem to have concern for corporate social behavior, as if they are ignorant on acting on these particular concerns in their investment choices (McLachlan & Gardner 2004). This understanding provides a clear inconsistency in particular factors that play a part in an investors decision making process over sectors to make investments in. for this reason, one possible underlying explanation that can be provided for this inconsistency is that investing means different things to different people. For instance, there are clear distinctions that exist among investors in the way they approach this issue of investing. McLachlan & Gardner (2004) explains that an investor that can be termed as socially responsible tends to view investing as something that is more than just income generation. The influence of a difference in how investing is perceived by different investors has been indicated in previous experimental studies that comprehensively examined the effecting of framing on investment choice as brought out by the different investors used in the study. Glac (2008) has been instrumental in showing how a different description of an investment scenario can have an effect on the probability that an individual will choose socially responsible or non-socially responsible investment options. Mental Frames It is evident that as far as decisions making over various facets of life are concerned, mental frames play an important role (Tenbrunsel & Smith 2008). When individuals are confronted with situations that require them to make certain decisions, they are likely to impose a mental template or frame on the particular information environment. This way, individuals are able to make subsequent interpretation and actions; this implies that mental frames are essential in creating an understanding of particular situations as well as the type of decisions that individuals are being confronted with. A substantial body of research has made a comprehensive and elaborate research, and documented the link between mental frames and behavior in a wide range of empirical studies. According to Glac (2008), the effects of framing are very prevalent in the investment environment. On one hand, the experimental study has indicated that individuals become highly sensitive when it comes to created frames, however, it does not clearly explain whether investors actually have different mental frames of investing and whether they affect investment choices. At the same time, it fails to provide clear explanation on how particular investors are able to retain the mental frames that they hold in their investment plans. The impact of mental frames on investment behavior It is important to point out that the particular themes reflected in socially responsible investment literature points to several ways in which socially responsible and non-socially responsible investors might frame an investing situation. In this regard, there are those investors who view investing as some kind of an enjoyable game or hobby; similarly, there are those who view it as a form of charity or way to assuage a guilty conscience. In general, many individuals are known to perceive investment as a kind of decision that can be described as highly functional in nature and mainly contains special elements of financial knowledge. Following this argument and reasoning, and the large public relations campaign that was facilitated by the New York Stock Exchange, this kind of frame is regarded as ‘normal.’ This ‘normal’ mental frame was geared towards creating and increasing the public’s knowledge on equity markets on the stock exchange. Knowledge element for investors refers to the types and levels of risks that are associated with various investments, their prevailing relationship between return and risk as well as non-systematic process of risk reduction through diversification. Another frame that is relevant and severally mentioned in socially responsible investment literature is the ‘integrative frame.’ This frame is known for categorizing investment as a type of decision that is reflective in nature and extends the investor’s values, principles and social beliefs into the investment choice, for instance, an investment is part of its owner and therefore it should be in tandem with his principles during the time of its existence. The integrative frame is similar to that described in the ethical consumerism and symbolic consumption literature, however, there is a profound and explicit parallel that has been drawn between Socially Responsible investing and consumer movement, in fact, William (2007) seems to confirm the idea that for some individuals, purchasing patterns find expression in investing. This is because; this decision frame effectively integrates an investor’s values and principles into the investment domain that is characterized by various investors. Some investors have the perception that investment is a kind of decision that is able to integrate the identity of the investor and the social beliefs into the investment domain. This application of social criteria to portfolio selection and management therefore plays a role in the fulfillment of important identity enhancing and preserving functions of investors. In the end, the particular investors have the option of choosing to avoid the negative symbolic associations that could arise from supporting unethical firms or seeking out the positive associations that could come from supporting unethical firms or seek out the positive associations that are associated with engagement in socially responsible investment. It is important to understand that the application of social criteria to portfolio selection and management might thus fulfill important functions in making investment decisions for the investor. In addition, those individuals that are able to effectively let their decision frames allow for the expression values and beliefs will apply social criteria to their portfolio selection to a larger extent than individuals whose decision frames do not. On the contrary, the application of non-financial criteria to the process of portfolio selection can be regarded as being in contrast to standard portfolio theory; this is in accordance to observations made by different authors and research findings (Brealy, Stewart & Allen 2006). It is general observations that most investors develop their idea of the criteria relevant for investing from sources that draw on these fundamental theories, one can therefore expect that they will be familiar with the basic objections to the use of nonfinancial criteria in portfolio selection. In addition, the financial arguments against socially responsible investing draw on the basic concepts of investing, for instance, the risk-return relationship and diversification, which are part of every investor’s basic knowledge set. In this regard, it is clear that the more investors see investing as a functional decision that is focused on the financial aspects of income production, the more they will consider the standard objections against socially responsible investing and apply social screens to their portfolio selection to a lesser extent. References Brealy, R. A., Stewart C. M. & Allen F. (2006). Principles of Corporate Finance. New York, NY: McGraw-Hill/Irwin. Glac, K. (2008). “Understanding Socially Responsible Investing: The Effect of Decision Frames and Trade-Off Options.” Journal of Business Ethics, 52(2), 11–35. McLachlan, J & Gardner, J.(2004) “A Comparison of Socially Responsible and Conventional Investors.” Journal of Business Ethics, 52(5), 11–25. Mill, G. A. (2006). “The Financial Performance of a Socially Responsible Investment over Time and a Possible Link with Corporate Social Responsibility.” Journal of Business Ethics, 63(1), 131–148 Nava A, et al. (2005). "Adam Smith, Behavioral Economist," Journal of Economic Perspectives, 19(3), 142-145. Tenbrunsel, A. E & Smith C.C. (2008). “Ethical Decision Making: Where we’ve been and Where We’re Going.” Academy of Management Annals. 2(1), 545–607. Williams, G. (2007). “Some Determinants of the Socially Responsible Investment Decision: A Cross-Country Study.” Journal of Behavioral Finance. 8(1), 43–57. Read More