March

The article at a glance: Marwin Mönkemeyer, Research Associate at Cambridge Centre for Finance (CCFin) and Cambridge Endowment for Research in Finance (CERF), blogs about the capacity of institutional investors to address biodiversity risks through their investment practices.

Are institutional investors effective in mitigating biodiversity risks?

By Marwin Mönkemeyer, CERF/CCFin Research Associate, Cambridge Judge Business School, University of Cambridge

Why should we care about biodiversity (finance)?

Over the past decade, academic researchers have increasingly focused on the complex relationships between the modern economy and the degradation of nature. While climate finance has received considerable attention (Hong et al., 2020; Krüger et al., 2020; Giglio et al., 2021; Stroebel & Wurgler, 2021), it is only one dimension of the negative impact economic activities have on the health of our planet. Another critical dimension is the economic and financial risk resulting from biodiversity loss—the dramatic deterioration in the variety of living organisms across all habitats, largely originating from human activity (Heal, 2004; Giglio et al., 2024; Flammer et al., 2025).

The accelerating loss of biodiversity constitutes one of the most urgent challenges of the 21st century. Biodiversity is vanishing at an alarming rate, posing severe risks to both economic stability and human well-being. The World Wide Fund for Nature issued a “code red” warning for humanity, documenting a 73% decline in studied wildlife populations over the 1970–2020 period (WWF, 2024). Biodiversity underpins critical ecosystem services such as clean water, healthy soils, and raw materials. With more than half of the world’s GDP directly dependent on nature and ecosystem services (UN, 2022), the loss of biodiversity represents an existential threat to the global economy. Preserving biodiversity is not only a moral and ecological imperative but also essential to sustainable economic development (Ali et al., 2024; Giglio et al., 2024). Biodiversity finance—the use of private capital to finance biodiversity conservation and restoration—may be one potential solution to the biodiversity crisis (Flammer et al., 2025). However, academic research on this topic remains nearly nonexistent (Karolyi & Tobin-de la Puente, 2023; Starks, 2023).

Institutional investors as biodiversity stewards

To the extent that capital markets can assess and price exposure to biodiversity risks, they can help mitigate threats to economic prosperity and to cultural and genetic heritage. In my job market paper, I argue that institutional investors possess both (1) the incentives and (2) the power and sophistication to address this great challenge.

Institutional investors are already expressing concern about biodiversity risks (Giglio et al., 2023). They are affected directly through their asset portfolios and indirectly via liability exposures. Biodiversity risks include both physical risks, such as supply chain disruptions, and transition risks arising from evolving policy and consumer preferences (OECD, 2019; IFC, 2019), such as client pressure for biodiversity-positive investment strategies.

They have superior monitoring capabilities compared to retail investors (Dasgupta et al., 2021) and control more than 60% of equity holdings in public markets (Medina et al., 2022). Through coordination with other institutions, collective ownership often grants them majority stakes, enabling effective stewardship action (Dimson et al., 2015). Empirical studies already document their influence in reducing climate risks and environmental costs (Stroebel & Wurgler, 2021; Dimson et al., 2015, 2023; Pedersen et al., 2021; Pastor et al., 2023).

The right measure of biodiversity risks

Traditional ESG rating providers base their assessments, to varying degrees, on publicly available data found in the sustainability sections of firms’ annual reports or sustainability reports. This practice raises concerns about reporting biases and the influence of firms on their ESG scores through greenwashing, that is, overstating their ESG activities in self-reported disclosures (Montgomery et al., 2024). There is also criticism about the divergence of ESG ratings across prominent ESG rating agencies (Berg et al., 2022).

To address these limitations, I employ a more objective measure of ESG risk from RepRisk, a Zurich-based ESG data provider. RepRisk uses textual analysis to monitor over 80,000 media sources and NGO reports, providing a more difficult to-manipulate measure of ESG incidents. For the purposes of my analysis, I only use incident data within the category “impacts on landscapes, ecosystems, and biodiversity,” reflecting the fact that changes in land use are the main drivers of biodiversity loss (IPBES, 2019; Jaureguiberry et al., 2022). These incidents range from deforestation and habitat destruction to violations of indigenous land rights and marine ecosystem damage. Over the 2007–2022 period, the dataset comprises 15,891 incidents across 8,309 U.S. firms.

Institutional ownership and biodiversity risk exposure

My analysis suggests that institutional ownership is associated with a lower incidence of biodiversity-related risk events, indicating a potential role for institutional investors in mitigating biodiversity loss.

Recognising that institutional investors are not a homogeneous group, I further explore heterogeneity across investor types. Drawing on prior research examining the influence of investment horizons (Starks et al., 2017; Krüger et al., 2020; Döring et al., 2021) and investor origins (Kim et al., 2019; Döring et al., 2023; Brockman et al., 2024), I find that the negative association between institutional ownership and biodiversity risk incidents is more pronounced for investors with longer investment horizons and for domestic investors. Although foreign investors appear to exacerbate biodiversity risks, this adverse relationship is attenuated when the foreign investors originate from countries with greater environmental and biodiversity awareness (Liang & Renneboog, 2017; Dyck et al., 2019).

Causality: Do investors really drive change?

A central concern in any observational analysis is the issue of causality. Do institutional investors actively reduce firms’ biodiversity risks, or do they merely gravitate toward firms that are already environmentally responsible? To address this question, I employ an identification strategy that exploits exogenous variation in investor attention as a shock to their monitoring activity (Kempf et al., 2017).

Investor attention is a limited cognitive resource (Kahneman, 1973). When extreme returns occur within certain industries, investors tend to shift their focus toward those sectors, thereby temporarily relaxing monitoring constraints for firms in unrelated industries. Supporting a causal interpretation of the results, I find that the biodiversity-related benefits of institutional ownership dissipate when investors are distracted. A reverse causality explanation appears unlikely, as the shocks to attention are plausibly orthogonal to firm-specific biodiversity risks, given that they arise in industries unrelated to the focal firm itself (Kempf et al., 2017).

Moreover, the findings remain robust after controlling for firms’ prior biodiversity risk incidents, further suggesting that institutional investors influence biodiversity risk management practices rather than simply selecting firms based on their historical environmental performance.

Biodiversity risk and the cost of capital

Finally, I examine the pricing implications of biodiversity risk. As investors become increasingly aware of the potential financial consequences associated with biodiversity loss—similar to carbon emission risks (Bolton & Kacperczyk, 2021, 2023)—they demand compensation for bearing such risks (Garel et al., 2024). This risk premium likely manifests in the form of an increased cost of capital. In other words, I aim to understand whether institutional investors care about biodiversity risks from a value perspective (Starks, 2023).

Consistent with this conjecture, I document a positive association between biodiversity risk and firms’ implied cost of equity capital, supporting the notion that investors indeed demand compensation for exposure to biodiversity risks.

Conclusion: Doing well by doing good?

My study shows that institutional investors can contribute meaningfully to mitigating biodiversity risks, particularly those with long-term horizons, domestic ties, and origins in environmentally conscious countries. Their impact highlights the potential of financial market mechanisms to support biodiversity conservation.

These findings suggest that institutional investors not only respond to biodiversity risks but can actively influence corporate behaviour. Recognising their heterogeneity is crucial for designing effective regulatory frameworks. Ultimately, institutional investors can align financial performance with environmental responsibility—doing well by doing good

This blog is based on my job market paper.