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Socially Responsible Finance and Investing: Financial Institutions, Corporations, Investors, and Activists by John R. Nofsinger, H. Kent Baker

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CHAPTER 11

Externalities in Financial Decision Making

JANIS SARRA

Professor of Law, University of British Columbia

INTRODUCTION

Any shift towards socially responsible investing (SRI) should take into account the externalities created by the choice of investment. Those externalities can be positive, in that sophisticated and well-resourced investors who want to support socially and environmentally sustainable activities can signal to others in the market the soundness of their particular investment choices. Equally, however, the externalities created by supporting particular products and services can be negative, imposing substantial costs on both individuals and society at large. This chapter illustrates how financial markets, as currently structured, cause negative externalities. In particular, it examines three types of financial strategies that produce negative externalities: derivatives, securitization, and syndication. This chapter also explores the social and economic harm generated when investors fail to appreciate that the speculative returns generated through investment in these products can work against broader goals of sustainable businesses.

In most instances relating to the 2008–2009 global financial crisis, the externalities were highly negative, imposing substantial losses on broad numbers of people who did not bargain for these outcomes. Further, the individuals who engaged in activities that caused the negative outcomes did not bear the costs. Within the financial ...

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