Sustainability membership and stock price: an empirical study using
the Morningstar-SRI Index
Miwa Nakai a, Keiko Yamaguchi b and Kenji Takeuchi a*aGraduate School of Economics, Kobe University, 657-8501 Kobe, Japan
Graduate School of Humanities and Social Sciences, Okayama University,
700-8530 Okayama, Japan*
Corresponding author. E-mail: takeuchi@econ.kobe-u.ac.jpbRunning Title: Sustainability membership and stock price
Abstract:
This paper investigates how investors evaluate a membership ofsustainability index. By using the data on the Morningstar Socially
Responsible Investment Index from 2003 to 2010, we estimate the impact
of inclusion on and exclusion from the Index on the stock price. Resultshows that the inclusion on the Index was evaluated significantly positively,
while the removal from the Index did not lead to a significant drop in shareprices. We also found that the average cumulative abnormal returns were
negative in the earlier years but positive in later years. This could be due tochange in appreciation of the concept of corporate social responsibility by
investors throughout the years.
Keywords: sustainability
Morningstar-SRI Index

membership;

JEL Classification: A13; G14; M14

1

stock

price;

event

study;

I. Introduction

A great deal of attention has been paid to Corporate Social Responsibility (CSR) in
developed countries as well as in emerging countries. CSR usually refers to voluntary
behaviour by a firm that integrates social issues such as environmental problems into
the firm’s business operations without blindly sacrificing profits.
Firms in Japan have actively worked on CSR since the concept was imported andadopted by Japanese corporate bodies in the late 1990s. Japan has the largest number offirms issuing CSR reports in the world, an indication of the great efforts by such bodies
to be socially responsible (KPMG, 2008). Another reflection of the attention paid byJapanese firms is the fact that they rank second in the world in acquiring ISO 14001
certifications (ISO, 2010). Firms would like to know, however, whether or not theirinvestment in CSR will yield a profit. If investors in the share market appreciate CSR
activity on the part of firms, the share prices of such firms will increase, and this would
provide further incentive to firms to increase their CSR efforts. This beneficial
interaction between investors and firms would lead to improvements in social welfare

2without government intervention. Investors have a significant role to play, therefore, inwhether or not CSR becomes established in Japan. Hence, it is important to analyse howmuch value investors in Japan place on the efforts of firms in regard to CSR.
This study aims, by using the Morningstar Socially Responsible Investment(MS-SRI) Index as a proxy for the highest standard of CSR, to examine whether or not
Japanese investors value firms that have adopted CSR. We assume that the market
appreciates inclusion on the MS-SRI Index because it means that a firm is thus
perceived to be one of the highest socially responsible firms. On the other hand, if a
firm were removed from the MS-SRI Index, it would be penalised for its lower level of
CSR activity. Consequently, we adopt the following hypothesis to carry out our study:
the announcement of inclusion on the MS-SRI Index has a positive effect on the shareprice, whereas removal from the Index negatively affects the share price.
We employ an event study methodology and a dummy regression analysis in ourstudy. An event study is a widely used approach to analyse the effect of an
unanticipated event on a share price. We adopt this methodology because we would liketo know investors’ immediate response to the announcement of inclusion on or removal

3

from the MS-SRI Index. In addition, studying the effect on share prices every year from2003 to 2010 can identify any time-series change in the trend of investors’ views
regarding CSR. Since CSR developed rapidly in Japan during these years, such ananalysis would be appropriate. On the other hand, a dummy regression analysis will
reveal the average effect on the share price of such announcements for the whole
research period. Using these two approaches enables us to investigate changes ininvestors’ attitudes towards CSR through time as well as the average effect over eight
years.
The contribution of our study is threefold. First, we use a more appropriate proxy for
CSR—the MS-SRI Index—since SRI indexes used in previous studies, especially the
FTSE4Good UK Index, limited inclusion on those indexes to economically strong firms.
As a result, changes in share prices could be due to investors’ appreciation of firms’
economic strength. The MS-SRI Index, however, does not restrict inclusion on the
Index to big firms, so it can better reflect in share prices investor response to CSR.
Second, to the best of our knowledge this is the first paper to analyse how Japanese
investors respond to CSR-related announcements. Earlier studies examined markets

4where CSR has a much longer history than it has in Japan, and so reactions toannouncements in such markets could differ from what happens in Japan. Finally, we
study a longer period than was done in previous studies, and this gives a better grasp of
the shift in investors’ attitudes towards CSR over time.
Our study will proceed as follows. In Section 2 we review previous studies thatexamined the share price reaction to levels of CSR in the US and Europe. Then in
Section 3 we describe our data and explain our event study methodology and dummy
regression analysis. Section 4 will present our empirical results, and the implications of
those results are discussed in Section 5. We then briefly summarise our findings in
Section 6.

II. Previous Studies

There are a few studies that examine how share prices react in the market to theannouncement of a firm’s inclusion on an SRI index. For example, Curran and Moran(2007) used an event study to analyse the effect of the FTSE4Good UK Index on the5prices of shares in the UK market. They investigated five announcements of inclusion
on or removal from that index in 2001 and 2002. It was found that only one of the five
events had any statistically significant effect, although in general the announcement of
inclusion on the index brought in positive changes in the share price, while theannouncement of removal led to negative changes. Therefore they concluded that the
UK market did not appreciate CSR activities, nor did it punish the shares of firms thatdropped down from a high-standard certification of CSR. However, because of thecriteria for inclusion on that index, companies must belong to the top 50 largest in
market capitalisation after the social screening. Hence, their study could not control achange in share price that was possibly due to investors placing value on those firms’
economic strength.
Consolandi et al. (2009) also used an event study methodology to investigate theeffect on share prices of firms added to or removed from the Dow Jones Sustainability
Stoxx Index (DJSSI), which covers European companies. As in Curran and Moran(2007), Consolandi et al. found that investors regarded inclusion on the DJSSI as goodnews and removal from it as bad news. In addition, they found that the market penalised6

an unexpected removal from the SRI index to a greater extent than it appreciatedinclusion on the index. One of the possible reasons for this market reaction is that shareprices might already have reflected all the available information, including the CSRlevel, and so the announcement of inclusion did not have a large impact on the shareprice. On the other hand, an unexpected removal from the index would result insignificant negative responses by investors.
Robinson et al. (2011) explored not only the short-term impact but also theintermediary impact on North American firms that were included on or removed fromthe Dow Jones Sustainability World Index (DJSI) using data from 2003 to 2007. It was
revealed that inclusion on the DJSI led to intermediary positive effects on share price,
while no immediate impact was observed. On the other hand, removal from the DJSI
did not cause a significant fall in the immediate and intermediary share prices of firms.
Contrary to the findings of Consolandi et al. (2009), they found that the response toinclusion on DJSI was greater than to removal from it.
In this study we take a different approach from earlier studies in several ways. First,
the MS-SRI Index is more appropriate than indexes used in other studies for the purpose7

of seeing more clearly the effects of CSR on share prices, because inclusion on thoseindexes was based not only on a firm’s high standard of CSR but also on its economic
strength. In such a situation it becomes possible for investors to react to the criterion of
economic valuation rather than to the social responsibility criterion. In the case of the
MS-SRI Index, however, firms are selected by social screening from a universe of 3,600
listed companies that includes relatively small corporate bodies. A more detailed
comparison between SRI indexes is shown in Table 1 below. Second, previous studies
analysed the markets of Europe and North America, where interest in CSR has a long
history among investors. Although large numbers of firms in Japan are now
implementing CSR actively, the concept of CSR is something relatively new toJapanese investors. For this reason this study can examine the impact on a firm’s shareprice resulting from that firm’s sustainability ranking in Japan, an impact that might bedifferent from that in markets in Europe and North America. Japanese investors, forexample, would react strongly to a firm’s inclusion on the MS-SRI Index because of thefact that CSR is still a novel practice for them.

8

Table 1. A comparison of SRI Indexes
MS-SRI Index

FTSE4Good UK

DJSSI

DJSI World Index

Number of firms

150

50

Variable

Variable

Universe

3,600 listed firms

The FTSE

DJ Stoxx 600

Largest 2,500

All-Share Index

Index

firms in the DJ
Global Total Stock
Market Index

Screening-Social Standard-Environmental,-The 20% most-The 10% most-Liquidity

social andsustainable firms

sustainable firms

Standard

stakeholder, andof each sectorof each sector-No negative

human rights

screen-Negative screen-Negative screen-Top 50 firms bymarketcapitalisation
MarketJapan

United Kingdom

EuropeWorldwide

Year established

2003

2001

2001

1999

III. Data and Methodology

We analysed the share prices of firms included on or removed from the MS-SRI
Index. Launched in 2003, the MS-SRI Index is the first Japanese index of socially
responsible investment.
of 3,600 firms.

Once a year it publishes a list of 150 firms chosen from a baseIf in the course of the year any of those 150 firms does something that9

negatively affects society, it would be removed from that index (as happened, forexample, when the Tokyo Electric Power Company operating the Fukushima Nuclear
Power Plants was removed on 6 April 2011).

There are two criteria for inclusion in

the Index: the social standard and the liquidity standard.

The former consists of fiveprinciples: governance and accountability, market, employment, social contribution, andenvironment.

In selecting the candidate companies the MS-SRI Index does not

employ a negative screening approach. While some other SRI indexes, such as theFTSE4Good UK Index, use screening of financial performance in addition to the social
criteria, in the MS-SRI Index the 150 companies that best meet the social criteria are
eligible for inclusion.

This allows greater opportunity for relatively smaller companies

to be included in the MS-SRI Index.
Morningstar provided us a list of the 150 companies selected from 2003 to 2010. For
our analysis, we excluded the dead fund from our sample. We employed two methodsof investigating the effects of inclusion on or removal from the MS-SRI Index: an event
study and a dummy regression analysis.

Our event study examines the relationshipbetween a particular unanticipated event and changes in share prices.

10

Since a publicannouncement of inclusion or removal is made once every year, there were eight eventsin our sample period from 2003 to 2010. For our sample, firms had to survive during thewhole of the research periods shown in Table 2.

Table 3 gives sample numbers forincluded firms and Table 4 gives sample numbers for removed firms.

It is important tonote that a firm must be included in the Index at least once before it can become aremoved firm, and so the year 2003 is not the subject of our investigation for removal
analysis.
The dummy regression analysis investigates the average effect resulting from
inclusion on or removal from the Index throughout the whole of a research period.
While the annual data sets in the event study only contain share price data for the
analysed year, in our dummy regression analysis we use all of the share price data aslong as firms are included in the Index at least once.

Consequently, our sample

consists of the share prices of 239 included firms and those of 124 removed firms. Sincesome firms have included or removed more than once, the numbers of firms above aresmaller than the aggregated numbers of inclusion or exclusion in tables 3 and 4.

11

Table 2. Research periods of event study analysis
Year

Announcement dayth

Estimation windowth

Event window
th

2003

30 May16 October (2002) – 28 May

29th May – 2nd June

2004

1st September

26th January – 30th August

31st August – 2nd September

2005

1st September

24th January – 30th August

31st August – 2nd September

2006

1st September

26th January – 30th August

31st August – 4th September

2007

1st September

25th January – 30th August

31st August – 4th September

2008

1st September

24th January – 28th August

29th August – 2nd September

2009

1st September

22nd January – 28th August

31st August – 2nd September

2010

1st September

22nd January – 30th August

31st August – 2nd September

Table 3. Sample numbers of firms included on MS-SRI Index, by year
Year
2003
2004
2005
2006
2007
2008
2009
2010

Number of Firms
122
130
132
136
137
140
142
148

Table 4. Sample numbers of firms removed from MS-SRI Index, by year
Year
2004
2005
2006
2007
2008
2009
2010

Number of Firms
32
20
30
18
15
9
9

12

For the purpose of our event study we defined the three-day event windows shown in
the last column of Table 2.

Each event window is the period examined for any

changes in the share prices of the firms involved.

In addition, we determined that ourestimation windows would be 150 transaction days before the event windows.

First ofall, we calculated the return of a share from its price:

ri,t = log(Pi,t / Pt −1 ),where ri,t is the share return and Pi,t is the share price on day t for firm i .

(1)

Next, weestimated the counterfactual return, that is, the return if the event does not occur, using
data from the estimation windows.

In order to calculate the counterfactual return, we

estimated the market model, under the assumption that the return of the market index
and the return of each share have the following linear relationship:

ri,t = α i + βi rm,t + ε i,t ,

13

(2)

where rm,t is the return of market proxy (TOPIX in our study) and α i and βi areunknown parameters.

The residual has a zero mean and the variance is σ i2 .

Withthe estimated parameters, we can calculate the abnormal return (AR): the returnobtained by subtracting the counterfactual return from the realised return.

ARi,t = ri,t − (α̂ i + β̂i rm,t ).

(3)

Although AR is calculated for each day of the three-day event window, we would liketo obtain the total effect of the whole event window.

Therefore, we needed to

calculate the cumulative abnormal return (CAR) by adding the ARs of firm i for eachday of the event window.

T1

CARi (T−1 ,T1 ) = ∑ ARi,t .

(4)

t =T−1

In order to evaluate the average effect that the announcement of inclusion or removal
had on a firm, we needed to calculate the averaged cumulative abnormal return (ACAR),

14

as follows:N

ACAR(T−1 ,T1 ) = ∑ CARi (T−1 ,T1 ) / N.

(5)

i =1

The variance of ACAR can be obtained by using the following equation:

VAR[ACAR(T−1 ,T1 )] =1 N 2
∑ σ̂ (T−1,T1 ).
N 2 i =1

(6)

Finally, we needed to test the null hypothesis that the event does not affect the shareprice, before assessing how the event does affect the share price, by estimating ACAR
with the following J-statistics:

J=

ACAR(T−1 ,T1 )
1 N 2∑ σ (T−1,T1 )N 2 i =1

~ N(0,1).

(7)

While our event study methodology employs three-day event windows, our dummy
regression analysis uses only a one-day event window, namely, the day of the15

announcement.

The market model of dummy regression is as follows:

ri,t = ci + φi rm,t + di Di,t + υ i,t ,(8)where Di is the dummy variable taking one if the firm is added to or removed fromthe index; ri,t and rm,t are the returns of the share i and the market proxy in period t ,respectively; ci , φi , di are unknown parameters; E[υ i,t ] = 0 and Var[υ i,t ] = σ i2 .

Since

the event occurs annually, the maximum frequency of ranking is eight for inclusion
analysis and seven for removal analysis.

IV. Empirical Results

Results of event study
Table 5 shows the ACARs of shares of firms included on the MS-SRI Index and the
J-statistics to represent the statistical significance by each year.

While the ACARs are

significantly negative in 2003, 2004, and 2008, they are significantly positive in 2006
and 2007.

16

Table 5. ACARs of included-firms
Year

ACAR

J-statistics

2003-0.005-2.695***2004-0.004-2.246**

2005

0.001

0.988

2006

0.004

3.522***

2007

0.005

3.753***

2008-0.005-3.030***

2009

0.003

1.547

2010

0.000

0.316

The empirical results of the effect on shares induced by removal of a firm from theIndex are shown in Table 6.

While more than half the ACARs in Table 5 aresignificant, Table 6 shows that only the ACAR of 2004 is significant.

It reveals thatshare prices were not affected by an announcement of removal from the MS-SRI Index
except in 2004.

17

Table 6. ACARs of removed-firms
Year

ACAR

J-statistics

2004-0.007-2.082**

2005

0.005

1.673

2006

0.004

1.586

2007

0.003

0.836

2008

-0.007-1.324

2009

0.003

0.397

2010

0.005

1.228

Results of dummy regression analysis
We used Equation 8 to estimate the impact on share prices of both inclusion on andremoval from the Index.
affects share price.

First of all, let us look at how inclusion on the MS-SRI Index

We found that 13 out of 239 firms showed a statisticallysignificant effect, as shown in Table 7.

Of these 13 firms, nine exhibited a positiveeffect and four showed a negative effect.

On the other hand, in line with the results ofour event study, an announcement of removal from the MS-SRI Index did not affect theshare price.

Only 2 out of 124 firms showed a significant negative impact on theirshare prices, as we see in Table 8.

In addition, these tables also break down the resultson the basis of the frequency with which firms are included or removed.

18

They showthat the frequency of ranking in or out of the MS-SRI Index did not affect the directionof the result.

Table 7. Impact on share price of inclusion, by frequency
Frequency of

1

2

3

4

5

6

7

8

Total

45

25

26

24

24

14

33

48

239

(18%)

(10%)

(10%)

(10%)

(10%)

(5%)

(13%)

(20%)

(100%)

3

1

2

1

2

2

0

2

13

Significance

(23%)

(7%)

(14%)

(7%)

(14%)

(14%)

(0%)

(14%)

(100%)

Positive

1

1

2

1

1

2

0

1

9

(11%)

(11%)

(22%)

(11%)

(11%)

(22%)

(0%)

(11%)

(100%)

2

0

0

0

1

0

0

1

4

(50%)

(0%)

(0%)

(0%)

(25%)

(0%)

(0%)

(25%)

(100%)

Ranking
Numberof

Firms
NumberofNegative

Table 8. Impact on share price of removal, by frequency
Frequency of Deletion

1

2

3

4

Total

Number of Firms

115

9

0

0

124

(93%)

(7%)

(0%)

(0%)

(100%)

2

0

0

0

2

(100%)

(0%)

(0%)

(0%)

(100%)

0

0

0

0

0

(0%)

(0%)

(0%)

(0%)

(100%)

2

0

0

0

2

(100%)

(0%)

(0%)

(0%)

(100%)

Number of Significance
Positive
Negative19

V. Discussion

At this point we can discuss the key estimated results of our study: asymmetric
reaction, different reactions from investors in Europe, and changes in investor behaviour
towards CSR through time.

First of all, as discussed in the previous section, the resultsof the event study suggest that investors significantly reacted to the event of a firm’s
inclusion on the MS-SRI Index.

On the other hand, announcement of a firm’s removalfrom the Index did not effect a change in its share price.
with the dummy regression analysis.

We found a similar result

Of the 239 firms that were added to the Index at

least once, 13 showed a significant effect on share prices, while only 2 of the 124 firms
removed from the Index experienced a significant change in their share prices.

From

this we can conclude that investors in the Japanese market in large part reacted to theannouncement of a good assessment of CSR on the part of a firm, while they did notseem to consider removal from the Index a factor leading to a negative reaction.
In regard to asymmetric reaction, we found that investors in Japan and Europe react
differently to the inclusion on, or removal from, an SRI index.

20

As we saw in Section

II, investors in Europe punished removal from such an index more than they rewarded
inclusion on it (Curran and Moran, 2007; Consolandi et al., 2009).

Our results,

however, show that Japanese investors reacted positively to inclusion on the MS-SRI
Index, whereas announcement of removal from the Index did not significantly affect afirm’s share price.

This suggests to us that investors in Japan might not expect firms

to implement socially responsible activities as much as investors in Europe do, therefore,
they greatly appreciate the social contribution of firms. For exactly the same reason,
they did not penalise firms that were removed from the MS-SRI Index.

The view

obtained from our estimation reveals that investors in Japan have yet to consider CSR to
be as indispensable an investment factor as investors in Europe do.

Robinson et al.

(2011) also found an asymmetric stronger response to inclusion on an SRI index in the
US market, which shows that investors in the US evaluate CSR in a manner similar to
Japanese investors.
Finally, we can observe from the empirical results shown in Table 5 that investors inJapan have changed their attitudes towards CSR through time.

In the first two years,

2003 and 2004, investors did not seem to understand fully what CSR was and how it

21

affected the management of a firm.

They did not properly appreciate the fact that

implementing CSR adds to a firm’s costs and involves some sacrifice..

However,

ACAR turned positive the following year and has remained positive except for 2008.
It can be argued that in earlier years investors valued CSR negatively because ofignorance regarding how CSR affects a firm’s operations, but that they gradually began
to appreciate the socially friendly approaches of firms.

VI. Conclusion

This study examined, by using an event study and a dummy regression analysis, theimpact on the share prices of Japanese firms of inclusion on, or removal from, theMS-SRI Index.

While most results from inclusion on the Index were significantly

positive, the announcement of removal from the Index did not lead to a significant dropin share prices.

This suggests that investors in the Japanese market greatly appreciate

the highest CSR standard of firms, while they did not react to removal from the Index
when making their investment decisions.

This result contrasts with what was found in22

a previous study using data from European countries (Consolandi et al., 2009) andsuggests a difference of appreciation of CSR between investors in Japan and Europe.
The results of our event study also indicated that the ACARs were negative in theearlier years but positive in later years.

This could be due to less appreciation of theconcept of CSR by investors when it was introduced into Japanese society.

In lateryears, as the benefits of CSR became better appreciated, however, investors began toevaluate inclusion on an SRI index positively.
Previous studies revealed that inclusion on an SRI index has positive impacts on theshare prices of firms in the European and US markets (Curran and Moran, 2007;
Consolandi et al., 2009; and Robinson et al., 2011).

Our study also showed that being

sustainability leaders has been evaluated positively by investors.

The result suggeststhat CSR activities are not merely altruistic activities for the benefit of society, but they
could also contribute to the ultimate objective of corporate bodies, that of maximizing
their own value. This could persuade firms to enhance CSR activities in Japan.
Although inclusion on the MS-SRI Index was negatively evaluated in the beginning, it
can be seen in a positive light after some years of trial.

23

Such a result will proveimportant for countries that are going to introduce CSR activities from now on.

Acknowledgements
The earlier versions of this paper have been presented at seminars held at the Universityof Kitakyushu and Kogakuin University. Helpful comments from seminar participants
are gratefully acknowledged. We also thank Morningstar Japan K.K. for providing us
the data used in the analysis.

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