Print
E-MailAneesh Raghunandan is Assistant Professor of Accounting at the London School of Economics, and Shivaram Rajgopal is Roy Bernard Kester and T.W. Byrnes Professor of Accounting and Auditing at Columbia Business School. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here).
In March 2021, the SEC created a new Climate and ESG Task Force to proactively identify misconduct related to ESG investing. This taskforce was created out of the SEC’s concern that asset managers may be misleading investors by marketing certain funds as ESG-friendly but not making investment decisions consistent with such marketing. This concern is shared by many members of the asset management industry. For example, in a recent op-ed, BlackRock’s former Chief Investment Officer for Sustainable Investing, Tariq Fancy, states:
“…our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.”
Given these concerns, in this paper we attempt to verify whether ESG-oriented funds’ claims, of picking portfolio firms that exhibit superior treatment of all stakeholders—consumers, employees, the environment, taxpayers, and shareholders—are borne out by the evidence. Our empirical approach focuses on whether self-labeled ESG-oriented mutual funds invest in firms with better track records with respect to these groups of stakeholders based on fundamental measures of behavior—or misbehavior—toward each group. Our primary measure of stakeholder-centric behavior is portfolio firms’ compliance with social (e.g., labor or consumer protection) and environmental laws. We also consider a host of other measures of stakeholder-centric behavior related to each of “E”, “S”, and “G”: carbon emissions, reliance on taxpayer-funded corporate subsidies, CEO compensation, board composition, and the balance of power between management and the shareholder.
We find no evidence that ESG funds’ portfolio firms outperform non-ESG funds’ portfolio firms with respect to most of the measures of stakeholder-centric behavior that we consider in this paper. In fact, we find that ESG funds’ portfolio firms have significantly more violations of labor and environmental laws and pay more in fines for these violations, relative to non-ESG funds issued by the same financial institutions in the same year. Moreover, we find that ESG funds’ portfolio firms, on average, exhibit worse performance with respect to carbon emissions. These results undermine such funds’ claims that they are picking socially responsible stocks for inclusion and suggest substantial greenwashing on the part of ESG funds. Our results are not driven by heterogeneity in asset managers or by asset managers gradually adapting their overall attitudes toward ESG over time; we limit our analyses to funds issued by financial institutions that also issued at least one non-ESG fund in the same year, i.e., we compare ESG funds to non-ESG funds managed by the same financial institutions in the same year.
Because carbon emissions disclosure is not mandatory, we also investigate voluntary emissions disclosure. We find that ESG funds are more likely to pick stocks that voluntarily disclose emissions. These tests suggest that ESG funds may be more concerned about the existence of firms’ disclosures than about the content of the information being disclosed, consistent with recent work on the determinants of ESG scores (Drempetic, Klein, and Zwergel 2017; Lopez de Silanes, McCahery, and Pudschedl 2019). Our findings suggest that ESG funds may rely on ESG scores rather than performing their own due diligence about firms’ environmental and social practices. This conjectured practice, in turn, may actually lead to investing in firms with poorer levels of stakeholder treatment relative to firms that do not actively incorporate ESG into portfolio allocation decisions. We provide support for this argument by assessing ESG scores directly. Although we do find that ESG funds’ portfolio firms contain firms with higher ESG scores on average, we also find that these scores are only correlated with metrics that capture news coverage and the existence and quantity of voluntary disclosure about ESG, but not with the actual content of such disclosures.
We further document that ESG funds’ portfolio firms spend more money on lobbying politicians and obtain more frequent and higher-value government subsidies, suggesting that ESG funds’ portfolio firms rely on higher levels of taxpayer-funded regulatory support relative to non-ESG funds. Our results suggest that ESG funds choose firms that are more likely to shift their costs of investment onto taxpayers.
A potential explanation for our findings thus far is that ESG funds may primarily focus on the “G” in ESG (i.e., corporate governance). We find mixed results in this regard. Relative to non-ESG funds, ESG funds’ portfolio firms have lower excess CEO compensation but also lower levels of board independence. The governance characteristics described are typical of high-technology firms, which often have powerful founder-CEOs and boards of directors with limited oversight and influence over top executives. This characterization is consistent with our finding that ESG-oriented funds contain 27% more technology stocks than non-ESG funds issued by the same financial institutions in the same year.
Why might fund managers want to offer ESG products, if these products don’t seem to actually deliver stakeholder-friendly investments? Recent media coverage (for example, here) suggests a cynical motive: ESG funds may simply represent a way for asset managers to command higher management fees in what has increasingly become a low-fee industry. We find evidence supportive of this hypothesis: relative to other funds run by the same financial institutions in the same years, that ESG funds (i) obtain lower stock returns but (ii) charge higher management fees. Moreover, while it is plausible that ESG funds invest in companies with the goal of improving how these companies treat their stakeholders, we test and find no empirical support for this conjecture. Our results raise questions about what exactly the purchasers of shares in self-labelled ESG or “socially responsible” mutual funds are getting in exchange for this higher management fee.
A key takeaway of our study is that asset managers do not necessarily “walk the talk” in following through on claims of picking stocks that engage in stakeholder-friendly behavior. In considering direct measures of stakeholder treatment, rather than commercial ESG scores, our paper is particularly timely and relevant to the SEC’s new Climate and ESG Task Force. In its April 2021 ESG Risk Alert bulletin, the SEC specifically highlighted overreliance on composite ESG scores as a sign of inadequate due diligence and of poor fund-level compliance more generally. The SEC’s bulletin emphasizes the need to understand whether ESG funds that claim to incorporate specific environmental or social factors into portfolio allocation decisions actually pick stocks that obtain superior performance with respect to these stated factors.
The complete paper is available for download here.
One Comment
There is an interesting link between ESG backed funds and the higher fees, subsidies and ultimately, investment.
With ESG framework now becoming mainstream in many governance measures, even with SME’s – it will be interesting to see if the investor becomes the consumer and the logic converts.