Knowledge that Transforms

This paper provides evidence that the #MeToo movement revised investors’ beliefs about the costs (benefits) of fostering an exclusive (inclusive) culture, as reflected by the absence (presence of a critical mass) of women directors in the board room. Tracking a timeline of events associated with the #MeToo movement that begin with the Harvey Weinstein exposé in October 2017 in the New York Times , we document contrasting market reactions to the movement depending on the existing culture of the firm. Firms that historically excluded women from their board experienced a negative market response as momentum for the cause increased, whereas investors responded favorably to firms that historically embraced the inclusion of women on their boards. In contrast, we do not detect differences in the market’s response to randomly generated pseudo-events during the same time frame when comparing firms with exclusive and inclusive cultures. In the context of increased regulator attention to board gender diversity, as well as the ESG activist campaigns by large institutional investors, our study documents a shift in investors’ beliefs about the risks associated with sexual misconduct and about the value of having women in the boardroom shaping the culture of the firm.

Investment funds that claim to focus on socially responsible stocks have proliferated in recent times. In this paper, we verify whether ESG mutual funds actually invest in firms that have stakeholder-friendly track records. Using a comprehensive sample of self-labelled ESG mutual funds (as identified by Morningstar) in the United States from 2010 to 2018, we find that these funds hold portfolio firms with worse track records for compliance with labor and environmental laws, relative to portfolio firms held by non-ESG funds managed by the same financial institutions in the same years. Relative to other funds offered by the same asset managers in the same years, ESG funds hold stocks that are more likely to voluntarily disclose carbon emissions performance but also stocks with higher carbon emissions per unit of revenue. Despite these findings, ESG funds hold portfolio firms with higher average ESG scores. We show that ESG scores are correlated with the quantity of voluntary ESG-related disclosures but not with firms’ compliance records or actual levels of carbon emissions. Finally, ESG funds appear to underperform financially relative to other funds within the same asset manager and year, and to charge higher fees. Our findings suggest that socially responsible funds do not appear to follow through on proclamations of concerns for stakeholders.

We investigate two related questions about the trade-off between the short-term pressures on managers to meet earnings targets and the long-term environmental benefits of reduced pollution. Do firms release more toxins by cutting back on pollution abatement costs to boost earnings in years they meet earnings benchmarks? If so, is that relation weaker for firms with higher environmental ratings? Using Environmental Protection Agency (EPA) data on toxic emissions, we find that U.S. firms pollute more when they meet or just beat consensus earnings per share (EPS) forecasts, suggesting that meeting expectations is a more important goal than reducing pollution. We find this relation is stronger, not weaker, for firms with higher environmental ratings: they increase pollution even more when meeting earnings benchmarks than firms with lower ratings. This suggests that highly rated firms build regulatory and reputational slack over time and use it when needed to soften the negative impact of increased pollution. We contribute to the real earnings management and environmental economics literatures by documenting a negative externality of financial reporting incentives on the environment and society. We also contribute to the corporate sustainability literature by showing that an environmental, social, and governance (ESG) focus does not curb managerial short-termism.