The authors’ objective is to contribute to the existing literature on the economic significance of social norms and their behavioral effects in equity markets. Previous work has paid little attention to the underlying heterogeneity in social norms among countries, which has led researchers to assume that all societies view “sin stocks” (e.g., tobacco, alcohol, and gambling) similarly. The authors develop an empirical method to differentiate among the attitudes of different nations, and then they apply this method to demonstrate that variances in social attitudes result in varying valuation effects on sin stocks.

One aspect of social norms that has gained attention is the shunning of sin stocks and the creation of funds that invest in such companies. Practitioners will be particularly interested in the potential for excess returns when investors disregard “sin firms” (firms that issue sin stocks) on moral grounds.

The authors’ research indicates that societal views of sin stocks vary substantially across countries depending on the social norms in the country. In countries where sin stocks are considered immoral and shunned, the average sin firm’s Tobin’s q is a statistically and economically significant 8% lower than that of the average non-sin firm. In contrast, in countries where sin stocks are not viewed as immoral, the difference in Tobin’s q between sin and non-sin firms is insignificant.

Additionally, the authors demonstrate, via a four-factor model, that sin stocks in countries that regard them as sinful have average excess returns ranging from 12.2 to 19.9 bps per month for each of the three sin industries studied. These excess returns are statistically and economically significant compared with the excess returns in nations where these industries are not regarded as sinful. It is notable that these excess returns are largely arbitraged away in countries where there are no barriers to capital and language.

The authors’ conclusion provides persuasive evidence that practitioners should consider the differences in social norms among countries, as well as investment distortions created by societal views toward companies that operate in sin industries.

To examine cross-country cultural heterogeneity in attitudes toward sin stocks, the authors develop a “social sin measure” of time-varying social norms pertaining to sin stocks in G–20 nations.

Countries are designated as being a “sin country” based on two different measures. First, using data collected from the World Values Survey (WVS), the authors create a social sin measure that classifies each country as viewing tobacco, alcohol, and gambling as sinful based on social norms represented in the WVS. Second, because of the possibility that the social measure may inadequately capture the actual behavior of a society, the authors use a principal components measure based on a composite of WVS data, time-varying consumption data, and time-varying legal statutes across countries.

The sample used consists of all stocks in G–20 nations (19 nations plus the European Union) between 1 January 1995 and 31 December 2009. The adjusted dataset results in a sample of 26,937 firms, or a total of 91,618 firm-year observations, in 19 different nations.

The authors test three hypotheses: (1) Sin firms will have lower valuations in sin countries than in non-sin countries, (2) lower valuations in sin stock nations lead to higher equity returns in sin nations versus non-sin nations, and (3) differences in equity returns are either arbitraged away over time or persist because of restrictions in international capital flows.

The first hypothesis is studied by using Tobin’s q (measured as market value of equity plus the book value of debt divided by the book value of equity plus book value of debt) as a valuation metric in sin countries and non-sin countries. To determine whether the second hypothesis holds, the authors compute average monthly returns for each national market followed by an examination of the monthly average returns regressed on controls for size, book-to-market value, momentum, beta, and a dummy variable for sin stocks for both sin and non-sin nations broken out by industry and based on their composite sin stock dummy variable. To test the third hypothesis, the authors sort nations into two categories—easy-to-arbitrage countries and difficult-to-arbitrage countries—and rerun the return regressions based on the difficulty of arbitraging away excess returns.

The authors present compelling evidence that future researchers should consider the social norms of a nation when doing comparative international research. For practitioners, the study reveals significant potential benefits from analyzing the differences in social norms among nations as well as the investment biases created by societal views toward certain industries.