菲沙研究所-ESG：神話與現(xiàn)實(shí)-ESG投資和資產(chǎn)回報(bào)（英）

2022

COLLECTEDESSAYS

ESG:I

ESGInvestingandAssetReturns

StevenGloberman

ABOUTTHISPUBLICATION

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DateofIssue

October2022

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ESGInvestingandAssetReturns

StevenGloberman

ExecutiveSummary

ESGinvestingisaninvestmentstrategythat

incorporatesenvironmental,social,andgov-

ernance(ESG)informationintheinvestment

decision-makingprocess.Thereisagrowing

interestinESGinvesting,andthusalargeand

growingempiricalliteratureexaminingthe

returnstoESGinvesting.Atthesametime,

thedemandformoreandbetterinformation

aboutfirms’ESGactivitiesisincreasing.In

responsetothisdemand,manyjurisdictions

(e.g.,theUSSecuritiesandExchangeCom-

mission)areconsideringESGreportingman-

datestoencourageESGinvestingbyhelpingtheinvestorssmoothlyidentifyfirmswithbetterESGmetrics(greenfirms)fromtheinferiorones(brownfirms).

Inthisessay,weprovideasummaryoftheprevioustheoreticalandempiricalacademicstudiesexaminingtherelationshipbetweenESGinvestingandassetreturns.WethenexplainhowthesefindingscanbearguablyrelevantforevaluatingthepublicpolicyofmandatoryESGreporting.WeonlyfocusonhowthispolicycanpotentiallychangethecostofcapitalandconsequentlygivefirmsincentivestoimprovetheirESGperformance,whichistheintendedgoalofthispolicy.

ManyclaimthatthereturntoESGinvestingisnegative.Themainconceptualframeworkthatsupportsthisclaimisthatinvestorshavenon-pecuniarypreferencesforgreenfirms,andthustheyarewillingtoacceptlowerexpectedreturnsforholdingstocksandbondsthatgreenfirmsissue.Thus,thesefirmsbenefitfromlowerfinancingcosts(costofcapital)inthecapitalmarket.Sogreenfirmscaninvestmoreandgrowmore.Moreover,brownfirmswillhaveanincentivetoimprovetheirESGpracticestolowertheirfinancingcoststoremaincompeti-tive.Ifthechannelthroughinvestors’preferencesworks,ESGinvestingmayhaveapositivesocialoutcomeaslongasempiricalevidenceconfirmsthatESGinvestingcansignificantly

2ESG:MythsandRealities

decreasetheexpectedreturns(decreasethecostofcapitalforfirms).Inthisscenario,man-datingESGreportingmaybejustifiedifinvestorshavedif-ficultyidentifyinggreenfirmsfrombrownfirms,andiffirmscanprovidebetterESGinfor-mationtoinvestorsunderthemandatoryregime.

Incontrast,manyESGadvo-

catesclaimthatthereisnotrade-offbetweenESGinvesting(doinggood)andassetreturns(doingwell).Themainconceptualframeworkthatcansupporttheirclaimisthatgreenfirmshavehigherprofit-abilityorlowerESG-relatedrisks,whileinvestorscannotreadilyidentifygreenfirmsfrombrownones.Therefore,greenassetsareunderpricedandsoprovidehigherexpectedreturnsforinvestorswhoholdthem.Inthisscenario,mandatoryESGreportingmightbejustifiedaslongasfirmscanprovidebetterandmoreESGinformationtoinvestorsundertheman-datoryregime.

Inthisessay,wefindthattheresultsofempiricalstudiesexaminingtherelationshipbetweenESGinvestingandassetreturns(costofcapital)areinconclusive.Manystudiesfindpositiveornegativerelationships,whilemanydonotfindanysignificantrelationship.ThisresultcanshedlightontheclaimthatmandatingESGreportingcanhaveapositivesocialimpactbysystematicallychangingfirms’costsofcapital.IfthereisnoagreementonhowESGinvestingisassociatedwithrisk-adjustedinvestmentreturns(costofcapital),advocatesofmandatingESGreportingfaceaburdenofprooftoshowthatthispolicycanhaveanetpositivesocialimpact.

1.Introduction

ESGinvestingisaninvestmentstrategythatincorporatesenvironmental,social,andgov-ernance(ESG)informationintheinvestmentdecision-makingprocess.InvestorscanfindinformationabouttheESGactivitiesofthefirmsmainlythroughESGratingagencies,aswellasreportsissuedbycompanies.RatingagenciesprovideinformationtothepublicabouttheESGperformancesofthefirms.Forexample,firmswithlowercarbonemissions(E),ahigherregardforemployees’healthandsafetyintheworkplace(S),andmorediversityinleadership(G)havebetterESGratings.

Assetmanagersareincreasinglyapplying1ESGinvesting2tobuystocksandbondsoffirmsthatarealignedwithESGgoals.Asaresult,thereisalargeandgrowingempiricalliteratureexaminingthereturnstoESGinvesting.Investorscanhavedifferentincentivestoincorpo-rateESGinformationintheirinvestmentdecision-making.SomeinvestorsmayfindESG

ESGInvestingandAssetReturns3

informationfinanciallymaterial.This

materialinformationcanhelpinves-

torsbetterevaluatethefinancialrisks

andreturnsofafirm.Someinvestors

mayhavesocialobjectivesinaddition

tofinancialincentivesandwouldliketo

buythestocksandbondsoffirmswith

betterESGperformance.Bothgroups

ofinvestorswouldliketohaveaccess

torelevantinformationabouttheESG

activitiesofthefirms.

WithgrowinginterestinESGinvestinganddemandformoreandbetterinformationaboutfirms’ESGactivities,manyjurisdictions(e.g.,theU.S.SecuritiesandExchangeCommission)areconsideringESGreportingmandatestoencourageESGinvestingbyhelpinginvestorstoidentifyfirmswithbetterESGmetrics(greenfirms)fromtheinferiorones(brownfirms).

Inthisessay,weprovideasummaryofthetheoreticalandempiricalacademicliteratureexaminingthereturnstoESGinvesting.Wethenexplainhowthesefindingscanbeargu-ablyrelevantforevaluatingthepublicpolicyofmandatingmoreexpansiveESGreporting.Acomprehensivecost-benefitanalysisisneededtofullyevaluatethispublicpolicy.Inthisessay,wedonotdoacost-benefitanalysisofmandatedchangestoESGreporting.Rather,wediscussaspecificpotentialsourceofbenefitthatcanarisefrompricechangesofcapitalmarketassets.3

Inapublicpolicydebate,oneshouldidentifythemarketfailurethatallegedlycreatesaneedforregulation,aswellashowtheregulationcansolvetheissue.IntheongoingdiscussionaboutmandatoryESGreporting,themainostensiblemarketfailureisthatfirmsunder-performintheirESGactivitiescomparedtothesociallyoptimallevel.Forexample,itcanbearguedthatfirmsshouldhavelowercarbonemissions(EinESG),orhigherdiversityinleadership(GinESG).Therecanbevarioussourcesofthismarketfailure.ThepotentialsourcefocusedoninthisreportisthatinvestorsarebroadlyuninformedabouttheESGperformanceoffirmsand,therefore,cannotidentifygreenfirmsfrombrownfirms.InvestorscanpotentiallyuseESGratingsthatESGagenciesprovidetoidentifygreenfirms.However,Berg,Koelbel,andRigobon(2019)documentthattheESGratingsfromthemainsixratingprovidersdisagreesubstantially.

HowcanmandatingESGreportingdrivechangebygivingfirmsanincentivetoimprovetheirESGperformance?4ThepotentialchannelthatwefocusonisthatmandatingmoreESGreportingcanmakeinvestorsbetterinformedabouttheESGperformanceofindi-vidualfirmsandtherebychangetheirinvestmentdecisionsinthecapitalmarket.Firmsraisefunds(capital)throughthecapitalmarket,whetherthroughissuingstocks,bonds,orborrowingfromfinancialinstitutions.Ifinvestorscanbetteridentifygreenfirms,theymayinvestmoreingreenfirmsanddivestfrombrownfirms.Thisreallocationininvestors’

4ESG:MythsandRealities

“ThepolicyofmandatingmoreexpansiveESGreportingcandrivechangeandthereforeimprovesocialefficiencythroughassetpricechangesinthecapitalmarket.”

portfolioscanincreasethepricesofthestocksandbondsofgreenfirms.Greenfirmsthereforebenefitfromlowerfinancingcostsinthecapi-talmarket.Hence,greenfirmscaninvestmoreandgrowrelativetobrownfirms.Moreover,brownfirmswillhaveanincentivetoimprovetheirESGpracticestolowertheirfinancingcoststoremaincompetitive.Therefore,thepolicyofmandatingmoreexpansiveESGreportingcandrivechangeandthereforeimprovesocialeffi-

ciencythroughassetpricechangesinthecapitalmarket.

HowcantheempiricalfindingsofreturnstoESGinvestingforinvestors(costofcapitalforfirms)berelevantforevaluatingthepublicpolicyofmandatoryESGreporting?WeexaminethetheoreticalliteratureonESGinvesting.Inparticular,wediscusshowvarioustheoreticalframeworksmightjustifythemandate,andwhattheseframeworkspredictforreturnstoESGinvesting.Iftheempiricaltestsdocumentedintheliteratureareconsistentwiththerelevantconceptualframework,theexistenceofanetsocialbenefittomandatoryESGreportingcouldbepotentiallyjustified.Below,wehighlighttwodominantconceptualframeworksthatcanbeidentifiedintheliterature.

Inthisessay,weprovideasummaryoftheacademicliteraturesurroundingESGinvestingtoassesswhetherthereisconclusiveevidenceontherelationshipbetweenESGinvestingandassetreturns.Inthenextsection,wesummarizethetheoreticalstudiesexaminingtherela-tionshipbetweenESGinvestmentandassetreturns.Thegoalofthissectionisnottoreviewcomplicatedmathematicalmodels.Instead,wewanttosummarizethechannelsthroughwhichESGinvestingcanpotentiallyaffecttheexpectedreturnstoandcostofcapital.Insection3,wediscusstheempiricalstudiesexaminingtherelationshipbetweenESGinvest-ingandreturns.Weconcludethattheempiricalevidenceisinconclusive.InSection4,weprovidesomeexplanationsforwhytheempiricalresultsexaminingtherelationshipbetweenESGinvestingandreturnsfindmixedresults.

InSection5,weconcludefrominconclusiveempiricalresultsexaminingreturnstoESGinvestingthatwedonotknowwhethermandatoryESGreportingcanreducethecostofcapitalforgreenfirms.Assuch,theadvocatesofmandatingESGdisclosuresshouldclarifyhowmandatingESGreportingcanhaveanynetpositivesocialimpact.

2.Theoreticalframeworks

Incontrasttotheargumentmadebysomeprominentinvestmentmanagersthat“GreenInvesting”offershigherrisk-adjustedreturnstoinvestors,manyacademicsassertthatthereturntoESGinvestingisnegative(e.g.,HongandKacperczyk,2009).5Themainconceptualframeworkthatsupportsthisclaimisthatinvestorshavenon-pecuniarypreferencesforgreenfirms,andthustheyarewillingtoacceptlowerreturnsforholdingstocksandbonds

ESGInvestingandAssetReturns5

thatareissuedbygreenfirms(Berkandvan

Binsbergen,2021).Infact,investorsshould“Ifinvestorscanmaterially

Inthisframework,ESGinvestingimpliesbet-greenfirms,thesefirmswill

increasetheassetpricesof

tersocialoutcomesonlyifinvestorstilttheirfacelowerfinancingcosts

investmentportfoliotowardgreenfirmsso(lowercostofcapital)sothat

thattheycanmateriallyincreasethestockandtheycaninvestmoreandgrow

assetpricesofgreenfirms,thesefirmswillfaceoutcomes.”

more,whichdrivesbettersocial

lowerfinancingcosts(lowercostofcapital)so

thattheycaninvestmoreandgrowmore,whichdrivesbettersocialoutcomes.Ifthechannelthroughinvestors’preferencesworks,ESGinvestingmayhavepositivesocialoutcomesaslongasempiricalevidenceconfirmsthatESGinvestingisassociatedwithsignificantlylowerexpectedreturns(lowercostofcapitalforfirms).Inthisscenario,mandatingESGreportingmaybejustifiedifinvestorscannotdistinguishgreenfirmsfrombrownfirms,andiffirmsprovidebetterESGinformationtoinvestorsunderthemandatoryregime.

Second,manyESGadvocatesclaimthattheoutperformanceofESGstrategiesisbeyonddoubt;thereisnotrade-offbetweenESGinvesting(doinggood)andassetreturns(doingwell)(Kynge,2017,September3).Themainconceptualframeworkthatcansupporttheirclaimisthatgreenfirmshavehigherprofitabilityand/orlowerESG-relatedrisks,whilethesefirmsdonotinformtheirinvestorsofthismaterialinformation.Therefore,greenassetsareunderpricedandsoprovidehigherexpectedreturnsforinvestorswhoholdthem.Inthisscenario,mandatoryESGreportingmightbejustifiedaslongasfirmscanprovidebetterandmoreESGinformationtoinvestorsunderthemandatoryregime.

ThestandardconceptualframeworktoanalyzetheinteractionbetweenESGinvestingandassetreturnsisbasedonthesingle-periodCapitalAssetPricingModel(CAPM)developedbySharpe(1964)andMossin(1966).CAPMdescribestherelationshipbetweentheexpectedreturnandtheriskofinvestinginasecurity.Themodelshowsthattheexpectedreturn,orsimplytheaveragereturn,onasecurityisequaltotherisk-freereturnplusamarketriskpremium.Themarketriskmainlyexistsbecauseeconomiccyclesareunpredictable.Iftheeconomyisinaboom,dividendsandstockpricesarehigher;iftheeconomyisinareces-sion,thedividendsandpricesarelower.Aninvestorwhobuysawell-diversifiedportfolioofstocks(e.g.,anS&P500indexfund)expectstoreceiveanexcessreturncomparedtoholdinggovernment-issuedbonds,whichprovideguaranteedcouponsregardlessofeconomiccycles.Notethatmarketriskexistseveninawell-diversifiedportfolio.TheimplicationofCAPMisthatiftheexpectedreturnofthestockoffirmA(say7percent)ishigherthanthatoffirmB(say6percent),itmeansthatfirmAisriskierwithhigherpricevolatility.BecauseoftheextrariskinstockA,theinvestorswhobuythosestocksexpecttogetanextra1percentreturn.Therefore,otherthanriskpremium,stockAshouldnotprovideanexcessreturn(Alpha).

6ESG:MythsandRealitiesAlphaisatermwidelyusedbyinvestors.Itisameasureoftheperformanceofaninvestmentafterremovingtheriskpremium.BasedonCAPM,thealphaofallstocksshouldbezero.TheextensionstoCAPM(e.g.,thethree-factorpricingmodel)incorporateriskfactorsinadditiontothemarketrisktoexplaintheexpectedreturns.Theintuitionbehindalltheseextensionsisthesame.Aslongasthereisaknownriskfactor,itisalreadyreflectedinthepriceandreturnofthestockasahigherriskpremium.Adjustingforalltheserisks,thestockshouldnotbeabletooutperformthebenchmarkindex(zeroalpha).

InthissectionwediscusstwomainchannelsthroughwhichESGinvestingcanaffect

expectedreturns:1)investors’preferencesand2)ESG-relatedrisks.ThenwediscussunderwhatconditionstheorypredictsthatESGinvestingcanprovidehigherexpectedreturns.

Investors’preferences

Investors’tasteforESGcriteriaistheprimarychannelinthetheoreticalmodelstorational-

izehowESGinvestingcanaffectexpectedreturns.Heinkel,Kraus,andZechner(2001)isthefirstpaperthatincorporatestastesforESGinanassetpricingmodel.Theauthorsassume

investmentsense…brownfirms

“Greeninvestorsboycott,inanthatgreeninvestorsdonotlikethefirmswith

Inthisenvironment,therearebrownfirms.Inthisenvironment,thereare

fewerinvestorsavailable(lessfewerinvestorsavailable(lessdemand)tohold

demand)toholdthestockofthestockofbrownfirms,causingthoseshare

brownfirms,causingthosepricestofall.Thisimpliesalowercostofcapital

sharepricestofall.”

Thiscreatesincentivesforthebrownfirmsto

followpracticestobecomegreen,whichresultsinpresumedpositivesocialoutcomes.Thelowercostofcapitalmeanslowerexpectedreturnsforgreeninvestorsinequilibrium.Yetgreeninvestorsarenotunhappybecausetheyenjoynon-pecuniaryreturns,i.e.,increasedpersonalsatisfactionfromholdinggreenstocks.

Theclaimthatgreeninvestorsgetalowerexpectedreturninequilibriumwhilegreenstocks’pricesincreasetohigherlevelscanbeconfusing.Toclarify,Iprovideasimpleexample.Sup-posethattherearetwofirms:agreenfirm(sayabatterymaker),andabrownfirm(afossilfuelfirm).Forsimplicity,supposethatbothareinitiallytradingattheidenticalstockpriceof$100.Moreover,let’sassumethattheexpectedreturnofbothisidenticalat6percent.NowassumethatinvestorsbecomeconcernedaboutESGissuesandwouldliketoholdfirmswithbetterESGratings.Theshort-termeffectofthischangeisthatthestockpriceofthegreenfirmincreasesasinvestorsbidupthepriceofthegreenfirm’ssharesinordertobuythem,andthestockpriceofthebrownfirmdropsasdemandforthosesharesdeclines.Supposethatthegreenfirmisnowpricedat$105andthebrownfirmispricedat$95.Duringtheperiodoverwhichthepriceofgreenisrisingandthepriceofbrownisfalling,investors’returnwillbehigherforthegreencompanythanforthebrowncompany.However,after

ESGInvestingandAssetReturns7

thetransitionperiod,theexpectedreturn

ofthegreenfirmfallsbelow6percent,say

to5percent,andtheexpectedreturnto

thebrownfirmrisesabove6percent,say

to7percent.

Whywillthegreenfirmhavealower

futureexpectedreturninthenewequilib-

rium?Thereasonisthat,inthenewequi-

librium,investors’desiretoholdgreen

firmsforreasonsbeyondtheirexpected

monetaryreturn.Sotheinvestorswho

holdgreenstocksarefinewithalower

monetaryreturnof5percentbecausethey

gettheequivalentofa1percentnon-monetaryreturnfrombeingsociallyresponsible.Sim-ilarly,theinvestorswhoholdbrownstocksexpecttoreceiveahighermonetaryreturnof7percenttocompensateforthenon-monetarylossof1percent.6Sobothgroupsofinvestorsgetatotalreturnof6percentinequilibrium(i.e.,afterthetransitionperiod)ifweconsiderbothmonetaryandnon-monetaryreturns.Therefore,duringtheperiodoftransitioninwhichthepreferencesofinvestorsarebeingreflectedinchangingstockprices,greenstocksoutperformbrownstocks.Afterthetransitionperiod,greenstockswillunderperformthebrownstocks.Thiscanbeoneexplanationforwhytheresultsofempiricalstudiesinvesti-gatingtheeffectofESGinvestingonassetreturnsaremixed.Wediscussthisfurtherinalatersection.

BerkandvanBinsbergen(2021)arguethatESGinvestingimplieslowerexpectedreturns(costofcapital).TheyarguethatforESGinvestingtohaveanimpactitmustchangethecostofcapitalmaterially.TheyfindasimpleexpressionforthechangeinthecostofcapitalfromESGinvesting:(1)thefractionofESGinvestors,(2)thefractionofgreenstocks,and(3)thecorrelationbetweentheassetreturnsofthegreenandbrownstocks.Theycarefullyestimatetheseparametersfromdata.Theyfindthattheeffectonthecostofcapitalissmall,and,hence,theexpectedreturnsforgreeninvestorsandbrowninvestorsarealmostequal.Theyarguethattheriskandreturnofthegreenstocksandbrownstocksarehighlysimilar,sotheyarehighlysubstitutable.Aninvestorcaneasilygetthesameexpectedreturnandriskinaportfoliowithorwithoutbrownstocks.Anotherreasonforfindingasmalleffectistheirclaimthatonly2percentoftheinvestorsaregreeninvestors,whichisaverysmallfraction.

ExpectedESG-relatedrisks

Inadditiontoinvestors’preferences,riskcanalsoaffecttheexpectedreturnsforgreenorbrownfirms.IfESGisariskfactor,itcanaffecttheexpectedreturnofthestocksinadditiontootherriskfactorslikemarketrisk.Forexample,fossilfuelproducersmayfacerisksassociatedwithclimateorregulatoryshockstowhichrenewableenergyproducersareimmune.Cornell(2021)arguesthatifESGisariskfactor,brownstocksshouldhaveahigherriskpremiumcomingfromESG-relatedrisk.Investorsthatbuygreenstockswillget

8ESG:MythsandRealities

lowerexpectedreturns.YettheyarehappybecausetheyhaveaportfoliothathedgesthemagainstESG-relatedrisks.IfthereareESG-relatedrisksandinvestorsdonotknowaboutthem,thegreenstocksareunderpriced.Sothosewhoholdthemcanenjoyhigherrisk-adjustedexpectedreturns(posi-tivealpha).IfinvestorslearnthatthereareESG-relatedrisksandgreenstockscanreducethatrisk,theystartbuyingthosestockswhichimpliesanincrease

intheirstockprices.Asinthecaseofthetransitionperioddiscussedforpreferences,greeninvestorsenjoytemporaryhigherreturns.However,inthenewequilibrium,theexpectedreturnsofthegreeninvestorsarelower.YettheyarehappybecausetheyhaveaportfoliothatinsuresthemagainstESG-relatedrisks.

LuoandBalvers(2022)studythetheoreticaleffectofdivestmentinbrownstocks.Theyidentifyaboycottfactorriskpremiumandshowthatthisispositive.Pastor,Stambaugh,andTaylor(2020)alsoprovideamodelfeaturingagentswithESGpreferencesandESGinvest-ingasastrategyforahedgeagainstclimaterisk.Inequilibrium,greenassetshavenegativeCAPMalphas,whereasbrownassetshavepositivealphas.Greenassets’negativealphasstemfrominvestors’preferenceforgreenholdingsandfromgreenstocks’abilitytohedgeclimaterisk.Therefore,theexpectedreturnsofgreeninvestorsarelowerinequilibrium.

Isthereanytheorythatshowsgreenstockscanoutperformbrownstocks?

Sofar,wehavearguedthatbothinvestors’preferencesandESG-relatedrisksimplylowerexpectedreturnstoESGinvestinginequilibrium.Wealsoarguedthatduringatransitionperiodwhengreenstockpricesincrease,greenstocksoutperformbrownstocks,butthere-after,brownstocksoutperformgreenstocks.Beyondthischannel,fewotherstudiestrytorationalizehowgreenassetscanoutperformbrownassetsexceptunderspecific,usuallytransitory,conditions.

UnexpectedESG-relatedrisks

Pastor,Stambaugh,andTaylor(2020)arguethatifESGconcernsstrengthenunexpectedly,greenassetscanoutperformbrownonesdespitehavinglowerexpectedreturns.Forexample,ifthegovernmentsurprisesinvestorsbyintroducingnewregulationsthatpenalizefirmswithhighcarbonemissions,thedemandforfirmswithlowcarbonemissions(goodperformanceofEinESG)increases.Thisresultsinhigherpricesforthosestocks,soduringtheperiodthatnewinformationisincorporatedintotheassetprices,greenstocksoutperformbrownstocks.Notethattheshockshouldbeunexpected.Ifitisanexpectedshock,itisalreadyreflectedinassetpricesandanESG-relatedriskpremium.Moreover,notethatthischannelagainprovideshigherreturnsforgreenassetsonlyduringatransitionperiod.

ESGInvestingandAssetReturns9

ESG,profitability,andmis-pricing

Pedersen,Fitzgibbons,andPomorski(2020)deriveamodelthatincludesinvestorswhosepreferencesdependonESGscores.Moreover,ESGscorescanbeusedasasignalforprofit-abilityofthefirms.Theyassumetherearethreetypesofinvestors:ESG-unaware,ESG-aware,andESG-motivated.ESG-unawareinvestorsarethosewhodonotknowthatESGscoresareasignalfortheprofitabilityofthefirm,sotheydonotconsiderESGscoresintheirinvestmentdecision-making.ESG-awareinvestorsknowthatthereisalinkbetweenprofitabilityandESGscores,sotheyusethisinformation.ESG-motivatedinvestorsareawareinvestorswhoalsoenjoynon-pecuniaryutilityfromholdingstockswithhighESGscores.Likepreviousstudies,iftheeconomyincludesESG-awareandESG-motivatedinvestors,ESG-motivatedinvestorsbidupthepriceofhighESG-scoringstocks.Inequilibrium,theaverageESGscoreoftheESG-motivatedinvestorsishigher,andtheirexpectedreturnsarelowercomparedtoESG-awareinvestors.IftheeconomyonlyincludesESG-awareinvestors,theexpectedreturnofstocksisindependentofESGscores.ThereasonisthatESGscoresareassumedtobeasignalofprofit,notrisk.IffirmswithhighESGscoreshavehigherprofitscomparedtothelowESGscoreones,thestockpricesoffirmswithhighESGscoreswillbehighersuchthattheexpectedreturnsoffirmswithanyESGscoreareequal.TheyarguethatthereisacaseinwhichhighESG-scoringstocksoutperformlowESG-scoringstocks.ThisisthecasewheretheeconomyhasalargeenoughfractionofESG-unawareinvestorsandESGisapositivesignalforprofitability.Iftheseassumptionshold,highESG-scoringstocksdeliverhighexpectedreturns.ThisisbecausehighESG-scoringstocksareprofitable,yettheirpricesarelowerthantheyshouldbe,leadingtorelativelyhighfuturereturns.

DisagreementinESGratings

“ThereisasubstantialliteraturedocumentingthedivergenceofESGratingsforthesamefirms.TheratingorganizationsdiffernotonlyinhowtomeasurethevariousESGcriteriabutalsoonthecriteriathataredeemedworthyofmeasurement.”

TherelationshipbetweenESGinvestment

andperformancecanalsobeambiguous

duetouncertaintyinESGratings.When

attemptingtoassesstheimpactofESGinfor-

mationoninvestmentperformanceitshould

beclearwhatismeantby“ESGinformation.”

Therearealargenumberoforganizations

attemptingtoanswerthatquestion.Liand

Polychronopoulos(2020)reportthatasof

year-end2019theyhadidentified70dif-

ferentfirmsthatprovidesomesortofESG

rankingsystem.Thisproblemwouldnotbe

sobadifalltheratingswereeffectivelysimilar,butthisisnotthecase.ThereisasubstantialliteraturedocumentingthedivergenceofESGratingsforthesamefirms.Theratingorga-nizationsdiffernotonlyinhowtomeasurethevariousESGcriteriabutalsoonthecriteriathataredeemedworthyofmeasurement.

Howdoesdisagreementam