{"id":6265,"date":"2021-11-29T07:20:27","date_gmt":"2021-11-29T05:20:27","guid":{"rendered":"http:\/\/variances.eu\/?p=6265"},"modified":"2021-12-01T12:54:02","modified_gmt":"2021-12-01T10:54:02","slug":"integrating-esg-into-investment-decisions-what-does-academic-literature-tell-us","status":"publish","type":"post","link":"https:\/\/variances.eu\/?p=6265","title":{"rendered":"Integrating ESG into investment decisions: what does academic literature tell us?*"},"content":{"rendered":"

Les membres des fonds de pension manifestent un app\u00e9tit croissant pour l’investissement socialement responsable (ISR). Dans cet article, qui s\u2019appuie sur une revue de la litt\u00e9rature acad\u00e9mique sur ces sujets, nous discutons de la performance de l’investissement ISR, en particulier de la relation entre la politique de responsabilit\u00e9 sociale (RSE) des entreprises et leur performance financi\u00e8re, et de l’impact sur les rendements de l’\u00e9volution des pr\u00e9f\u00e9rences des investisseurs envers des consid\u00e9rations environnementales, sociales et de gouvernance (ESG). Enfin, nous discutons du r\u00f4le de la politique d\u2019engagement actionnarial des investisseurs institutionnels, qui permet aux membres des fonds de pension d’avoir un impact sur les entreprises et la soci\u00e9t\u00e9 dans son ensemble.<\/span><\/p>\n

There is increasing appetite from pension schemes members for socially responsible (SR) investment[1]<\/a>. In this article, we discuss the performance of SR investment, in particular the relationship between firms\u2019 corporate social responsibility (CSR) policy and their financial performance, and the impact on returns of shifting investors\u2019 preferences towards environmental, social and governance (ESG) considerations. Finally, we discuss the role of institutional investors\u2019 active ownership, which allows pension funds members to play a key role and impact firms and society at large.<\/p>\n

Firms\u2019 corporate social responsibility (CSR) and financial performance <\/strong><\/h3>\n

There is a large debate on the relationship between firms\u2019 CSR and their financial performance. For example, focusing just on the pricing of firms\u2019 CO2 emissions, some previous empirical evidence shows that environmentally sustainable firms tend to outperform[2]<\/a>, while others find that firms with higher CO2 emissions earn higher returns[3]<\/a>. Meta-analyses show that academic findings are mixed[4]<\/a>. One of the reasons for this conflicting evidence is related to limited data availability, the potentially changing relationship between CSR and firms\u2019 financial performance over time[5]<\/a>, and the absence of standardised measures of environment and social performance[6]<\/a>. Moreover, one major issue when trying to evaluate the causal impact of CSR on firms\u2019 performance is the so called \u201cendogeneity issue\u201d. Are firms doing well by doing good vs are they doing good by doing well[7]<\/a>?<\/strong> Research studies not only vary in their sample period and ESG data used, they also differ substantially in terms of methods used. For example, some research uses event studies to assess the impact of an exogenous, environment-related event on a firm\u2019s stock price (for example, environmental data releases or regulation enactments; or a firm-specific news). Event-study approaches focus on short-time windows around an event, which may limit the endogeneity problem, but also make their scope more limited. Regression analyses can be used to examine the relationship between CSR and financial performance within a larger sample. However, simple regression studies cannot differentiate between correlation and causality[8]<\/a>. Papers using regression discontinuity design[9]<\/a> attempt to demonstrate that corporate environmental actions, such as the passage of an environmental resolution by a close margin, have a causal impact on economic success and thus firms\u2019 value. Finally, some researchers use portfolio analysis to evaluate the performance of investing in environmentally sustainable firms: they form portfolios sorted by firms\u2019 ESG policies and compare the average abnormal returns of those portfolios[10]<\/a>. The theoretical arguments explaining how a firm\u2019s sustainability might affect its value are also debated[11]<\/a>. Some argue that a firm\u2019s environmental or social improvement may not be compatible with profit maximisation. They regard a firm\u2019s environmental or social activity as a manifestation of managerial agency problems, which might destroy shareholder wealth[12]<\/a>. Others see environmental improvement as a risk-mitigation instrument and source of market competitiveness in a world rapidly transitioning to lower-carbon technologies[13]<\/a>. On the investors\u2019 side, stocks of firms with bad CSR policies (for example high CO2 emissions) could be considered as \u201csin stocks\u201d; and be shunned by socially responsible investors, which could lead to significantly depressed valuations (and more attractive expected returns going forward). But it could also be that the risks are underpriced and not fully integrated by investors, who ignore information about global warming and its related risks.<\/p>\n

Impact of investors\u2019 changing preferences towards ESG <\/strong><\/h3>\n

The past decade has seen significant changes in the way investors perceive environmental risks and this has led to tremendous growth in climate-conscious investing<\/strong>. More than 3000 organisations have become signatories of the United Nations Principles of Responsible Investment (PRI)[14]<\/a>. There are several reasons for this. First, the information available on climate-change costs (for example on extreme weather events such as major hurricanes or wildfires) has grown considerably. In addition, regulatory initiatives have emerged, especially in Europe (the European Commission action plan for sustainable finance, green taxonomy, European labels, etc.), to improve the transparency of available climate information and encourage investors to take environmental criteria into account in their portfolio construction. Many initiatives have emerged, bringing together bankers or investors (such as the Climate Finance Leadership Initiative \/ Climate Action 100+ and Principles for Responsible Banking) for joint actions such as engagement or divestment campaigns[15]<\/a>. Finally, individual investors\u2019 appetite for responsible investments has also increased considerably[16]<\/a>. These changes in investors\u2019 concerns for the environment have several consequences. On the one hand, they modify investors\u2019 appreciation of climate risks, e.g., the way investors incorporate fundamental climate information into asset prices. On the other hand, they can modify investors\u2019 demand for green assets by changing their relative preferences for the different types of investments available, such as \u201cgreen\u201d and \u201cbrown\u201d. Several theoretical works suggest that investors\u2019 preferences for green assets affect stock prices[17]<\/a>. In particular, the model in Pastor et al. (2020) predicts that green assets should outperform following unexpected upward shifts in investors\u2019 environmental preferences. However, from an empirical perspective, identifying those shifts is far from obvious. Both climate risk and changing investors\u2019 preferences can potentially have an impact on asset valuations. When we observe an increase in the price of green assets relative to conventional assets, we do not know whether this price change is related to the incorporation of fundamental information or to a change in investor preferences. Bri\u00e8re and Ramelli (2021b) tackle this question and propose a way to estimate the changes in investors\u2019 preferences for green assets that are not related to fundamental information, and to measure their impact on long-term equity returns. To do this, they evaluate arbitrage activity on the climate ETFs[18]<\/a> market and estimate the changes in investor appetite for this theme, which are not yet incorporated in the value of the underlying securities that make up these ETFs. By measuring the difference between these arbitrage flows on green and conventional ETFs, they can obtain an estimate of the non-fundamental demand for green assets. They find that green sentiment influences the value that investors attach to corporate environmental responsibility as priced by stock markets<\/strong>. A one-standard-deviation higher green sentiment is associated with an outperformance of a one standard-deviation more environmentally responsible firm of approximately 30 basis points over a one-month horizon and 60 basis points over a six-month horizon, net of the effects of other firm characteristics. The effect of green sentiment is independent from, and additional to, the effect of the news-based climate risk. Investor environmental preferences also have an impact on real corporate decisions. Higher green sentiment is associated with an increase in firms\u2019 capital expenditures and cash holdings. Understanding the effects of investors\u2019 changing preferences for ESG on assets returns and real economic outcomes is crucial. These changing preferences can have a key impact on the expected returns of SR vs conventional investment going forward, which in turn influence firms\u2019 cost of capital and incentives to transition to a greener economy.<\/p>\n

The role of active ownership <\/strong><\/h3>\n

Large institutional investors, which own diversified and long-term portfolios, are often universal owners, with substantial equity stakes in most firms[19]<\/a>. This exposes them to the risks of large externalities resulting from environmentally and socially irresponsible firms\u2019 behaviour. Shareholder activism, <\/strong>which refers to investors\u2019 influence on firms\u2019 policy though the use of an ownership position, can be a key tool at their disposal to have an impact on firms\u2019 decisions<\/strong>. Environmental and social activism is often motivated by a misalignment of preferences between shareholders and management. In the presence of externalities generated by the firms, it will be in investors\u2019 interest to minimise the potential costs of those externalities by influencing the firms\u2019 businesses. Shareholder activism can take various forms. The most popular ones are (1) exiting (selling shares), (2) voting actively at general meetings, and (3) engaging behind-the-scenes with the firms\u2019 management and board[20]<\/a>.<\/p>\n