The Price of Sin: The Effects of Social Norms on Markets
Abstract (Via CFA)
We provide evidence for the effects of social norms on markets by studying “sin” stocks—publicly-traded companies involved in producing alcohol, tobacco, and gaming. We hypothesize that there is a societal norm to not fund operations that promote vice and that some investors, particularly institutions subject to norms, pay a financial cost in abstaining from these stocks. Consistent with this hypothesis, sin stocks are less held by certain institutions, such as pension plans (but not by mutual funds who are natural arbitrageurs), and less followed by analysts than other stocks. Consistent with them facing greater litigation risk and/or being neglected because of social norms, they outperform the market even after accounting for wellknown return predictors. Corporate financing decisions and time-variation in norms for tobacco also indicate that norms affect stock prices. Finally, we gauge the relative importance of litigation risk versus neglect for returns. Sin stock returns are not systematically related to various proxies for litigation risk, but are weakly correlated with the demand for socially responsible investing, consistent with them being neglected.
Introduction (Via CFA)
Many social scientists believe that social norms are important in shaping economic behavior and market outcomes, overriding at times even the profit motive.1 An early articulation of this issue in economics is Becker (1957)’s model of discrimination. In his model, agents (e.g., employers) with discriminatory tastes (likely norms enforced by their community) pay for those tastes in that they are willing to pay a financial cost to not interact with a particular class of people. Arrow (1972) points out that a complete theory must also explain why entrepreneurs without those discriminatory tastes and who could make profits by hiring labor cheaply from the discriminated-against group fail to do so. Subsequent theories of social norms (e.g., Akerlof (1980), Romer (1984)) provide sufficient conditions under which social customs that are disadvantageous to the individual may nevertheless persist if individuals are sanctioned by loss of reputation for disobedience of the custom.
Empirical work in economics on the effects of social norms on markets centers on measuring the extent of discrimination in the labor market. However, measuring discrimination is difficult for a variety of reasons such as biases in self-reported data. More generally, empirical tests have a difficult time distinguishing between taste- or norm-based versus information-based models of discrimination, where economic actors have no animus, but discriminatory outcomes arise nonetheless because of incomplete information and signaling. There is a large literature on this issue with many papers developing clever techniques to identify the extent of racial discrimination. The evidence supporting taste-based discrimination is mixed