We analytically compare two dominant methodologies for the construction of an ESG factor: the time-series (ratings used to sort stocks) and cross-sectional (ratings used to weight stocks) approaches. Differences in ESG rating and exposure to other firm characteristics imply an ex ante expected return spread between the two factors. We construct a cross-sectional factor (i) featuring a targeted rating, thus allowing comparability with other factors, (ii) neutralizing exposure to other firm characteristics, and (iii) not harming diversification through stock screening. Using ratings from several data vendors, we document strong variations of the factor alpha in the time series and across vendors. The conditional alpha is negatively related to the level of media attention for ESG and positively related to variations in media attention

We study the impact of corporate social responsibility (CSR) on firm misvaluation in the US. Our results indicate that a firms Environmental, Social and Governance (ESG) profile significantly affects valuation: an improvement of a firms CSR leads to a higher ratio of actual to true firm value. Analyzing the relation between ESG and misvaluation separately, we find that ESG expands existing overvaluation whereas it reduces undervalued firms’ deviation from the true value. We argue that both valuation effects are attributable to the worldwide trend of sustainable investing. Further analyses reveal a moderating role of market sentiment towards sustainability in the ESG-misvaluation relationship. Our findings suggest that firms CSR is indeed perceived as valuable by shareholders and supports stakeholder theorys view in considering CSR as beneficial