Every investor has their own goals, strengths, weaknesses and investing style. Some investors will have no trouble taking large risks, while others will shy away. Other investors may prefer to stay away from unethical investments, or “sin stocks” as they’re known. Of course, how you decide to invest, or not invest, is up to you but it’s always useful to observe market trends, even if you don’t agree with them. You never know where you will find your next trade idea.

I’ve recently covered the relative outperformance of some sin stockscompared to more ethical investments but the data does not stop there. A study published within the 2009 Journal of Financial Economics, written by H. Hong and M. Kacperczyk and entitled, The price of sin: The effects of social norms on markets, provides evidence that the stocks of publicly traded companies involved in producing alcohol, tobacco, and gaming have long acted differently to the rest of the market.

The Boycott effect

Not only do Hong and Kacperczyk study the performance of sin stocks but the paper also looks into the effect that socially responsible investing has on corporations. Simply put, the paper tries to ask the question; is socially responsible investing actually justifiable and having an effect on companies?

On this topic the paper cites the work of Teoh, Welch, and Wazzan (1999), who set out to examine the effect of the shareholder boycott of South Africa’s apartheid regime. They found that there was little discernible effect on either the valuations of South African corporations, or on the South African financial markets following the boycott. However, it should be said that these results were impacted by the fact that South Africa was not a desirable place to invest before the boycott, so there was little in the way of liquid international investment that could be easily withdrawn.

Nevertheless, Hong and Kacperczyk found that sin companies, on average, have a higher cost of capital than non-sin companies. They conclude that a higher cost of capital is a result of ethical investing trends.

What’s more, they found that because many institutional investors avoid sin companies, these companies find it hard to raise capital on equity markets. As a result, sin stocks tend to rely more on the debt markets than equity markets to finance their development plans. The paper found that the average sin company has a 19.3% higher leverage ratio…

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