Heterogeneous Institutional Investor Response to Firm Environmental Regulatory Risk

This paper investigates whether institutional investors incorporate firm-level environmental regulatory risk into their portfolio decisions. We document substantial heterogeneity across investor types in their responses to changes in firm-level environmental regulatory risk. Long-horizon investors, such as banks, insurance companies, and pension funds, tend to tilt their portfolios toward stocks with higher environmental regulatory risk. In contrast, short-horizon investors, including investment advisors and mutual funds, reduce their holdings of these firms. These opposing portfolio adjustments offset each other, attenuating the aggregate impact on stock returns. We further find that these risk-induced demand shifts vary systematically around federal elections. Following Democratic victories, the resolution of regulatory uncertainty induces long-horizon investors to decrease their exposure to environmentally risky firms, while short-horizon investors increase their holdings. By comparison, portfolio adjustments are substantially less pronounced after Republican victories. Overall, our findings highlight the role of investment horizons and heterogeneous environmental preferences in driving institutional portfolio allocation.