ESG Performance and Disclosure: A Cross-Country Analysis

Florencio Lopez-de-Silanes is Professor of Finance at SKEMA Business School; Joseph McCahery is Professor of International Economic Law at Tilburg University; and Paul C. Pudschedl is Research Associate in Finance and Applied Economics at the University Wiener Neustadt. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Over the last few years, there have been growing interest in the influence of environmental, social and governance (ESG) factors in the investment decisions of institutional investors and future portfolio performance. This coincides with major changes in the market for sustainable investment. In our paper, ESG Performance and Disclosure: A Cross-Country Analysis, we use a unique dataset to examine the relation between ESG disclosure and quality through a cross-country comparison of disclosure requirements and stewardship codes.

Largely in response to the rapid increase in ESG investments, there has been a debate whether corporate reporting on sustainability issues should be mandatory. On the one hand, various voluntary comply-or-explain measures were introduced in Asia and Europe. For some of these new reporting measures, such as in France, the main aim has been to enhance awareness of ESG issues and to elaborate best practices for institutional investors. The effectiveness of comply-or-explain reporting of ESG investments, on the other hand, is limited or not directly comparable across jurisdictions.

We develop two competing hypotheses regarding the relationship between ESG investments and financial performance. The first view holds that there is a weak or negative relationship between ESG ratings and corporate financial performance. In contrast, the second view argues that an ESG filter strategy can have a positive effect on performance and help investors manage portfolio risk (Bannier, Bofinger, Rock (2017); Hanson, Lyons, Bender, Bertocci, Lamy (2017); Boze, Krivitski, Larcker, Tayan, Zlotnika (2019)).

In our study, we build a dataset of six countries from which we construct a sample of 4476 companies, with market capitalizations over $700 million from 2015 to 2018. Our findings show a strong positive relationship between the quantity of ESG data disclosed by companies—as measured by Bloomberg ESG scores—and the quality of a firm’s ESG criteria—as measured by Sustainalytics ESG rankings. Our analysis suggests that most of this relationship can be attributed to the fact that firms are simply disclosing more information, while the actual quality of the firms’ ESG factors are less important. In fact, we find no statistically significant relationship between ESG factors and financial performance.

We next investigate the effect of ESG criteria on the riskiness associated with investments in the firm, as measured by the volatility of equity prices. Studies in the literature generally suggest that if ESG is related to risk, we can expect a statistically significant relationship with volatility. Our results show a negative relationship between volatility and the Bloomberg ESG disclosure scores for the full dataset and for the United States. Similarly, the relationships are also negative for United Kingdom, Switzerland, Australia, and France, but lack statistical significance. We find similar results when we use Sustainalytics ESG quality rankings in place of Bloomberg ESG disclosure scores.

In conclusion, our analyses of ESG suggest that the quantity of ESG disclosures shows a positive association with the quality of this data, and that the differences across countries seem to be driven by more-stringent ESG disclosure requirements and stewardship codes imposing ESG disclosure. While we found little or no evidence of a relationship between ESG and risk-adjusted returns, the results suggest that ESG may have a small but statistically significant impact on reducing volatility, which may mean there are portfolio diversification benefits from high-quality ESG investment in certain situations. These findings leave open the possibility for the creation of portfolios that, over some time, may generate superior financial performance by incorporating specific ESG screening and weighting rules into portfolio construction.

The complete paper is available for download here.

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