Which Corporate ESG News Does the Market React To?

George Serafeim is the Charles M. Williams Professor of Business Administration at Harvard Business School, and Aaron Yoon is an Assistant Professor of Accounting Information and Management at Northwestern University Kellogg School of Management. 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 a recent paper, we use a unique dataset that tracks daily ESG news across thousands of companies and examine to which ESG news the investors react to and why. This question is an important one as ESG related news can be found every day for hundreds of companies as events unfold, and as the media, analysts, regulators, and other stakeholders uncover information. More investors are integrating ESG information in their portfolio management as ESG news can have a major impact on companies. For example, Bank of America Merrill Lynch examined 24 major ESG controversies of S&P 500 companies during 2014-2019 and found that the total market cap loss amounted to $534 billion. In sum, more companies are investing resources in improving their performance on ESG issues and regulators are placing an increasing emphasis on understanding how ESG information flows to the market, seeking to learn how capital-market participants react to this information.

We find that market reacts only to ESG news that are identified as financially material for a given industry by sustainability accounting standards. For example, we find that the average price reaction to positive news that is classified as financial material by SASB is 60 basis points on the day of the news and 75 basis points during the two-day window from the day prior to the day of the news when there are at least three news articles. In addition, the market reaction is larger for news that receive more attention. Specifically, when we restrict the sample to have at least five news articles, the market reaction to positive news increases to 218 basis points and the reaction to negative news is 70 basis points on the day of the news. In contrast, we find no price reaction for the sample of ESG issues that are not classified as material according to SASB standards regardless of how we restrict our sample. Last, but not least, we find that the market reacts to news that is related to social capital issues (i.e., news that primarily relates to product safety, quality, affordability, and access). On average, the price reaction to positive news is 187 basis points on the day of the news and 241 basis points during the three-day window around the day of the news when there are at least three news articles. Overall, we conlcude that investors differentiate their reactions based on whether the news is likely to affect a company’s fundamentals, and therefore their reactions are motivated by a financial rather than a nonpecuniary motive.

We show the above using a sample that includes 111,020 unique firm–day observations for 3,126 companies with ESG news between January 2010 and June 2018. The data from TruValue Labs (TVL) track ESG-related information every day across thousands of companies, classify news to positive or negative, provide insights on how positive or negative the news is, and what specific ESG topic the news is related to. This dataset includes information from a wide variety of sources—including reports by analysts, media, advocacy groups, and government regulators—and emphasizes that the measures focus on vetted, reputable, and credible sources that are likely to generate new information and insights for investors.

Our results extend prior academic research that examined the market reaction to ESG regulations, eco-friendly initiatives, and engagements by providing new evidence on which ESG news the market reacts to and why. This is because we do not know much about which ESG news the market would react to and it is ex-ante unclear whether any prior evidence would be generalizable in recent years for the following reasons. First, prior research conducted small sample analyses on periods when capital markets did not pay nearly as much attention to ESG issues or viewed such issues through an agency-cost lens. For example, investment associations such as the United Nations Principles for Responsible Investment was set up in 2006 and at the time of initiation the signatories only had a few hundred billion dollars in assets under management in the first few years, but by 2020 the assets under management had reached $110 trillion. Therefore, investor awareness around ESG issues was very limited during the sample period of prior work. Second, past research did not differentiate between news on ESG issues that are likely to be financially material for a given industry. Third, the samples analyzed in most of prior work were events identified by human analysts and more limited in range. We overcome this limitation using recent technological developments in natural language processing, which allows us with a much larger set of companies and events.

The complete paper is available for download here.

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