We develop a continuous-time model in which an ESG investor hires a manager to run a project and incentivizes the manager to fulfill ESG responsibilities. The manager’s private efforts and ESG investing determine the project’s cash flow and ESG performance subject to random shocks. We derive the optimal contract and its implementation after introducing carbon credits following the cap-and-trade program in practice. We provide comparative static analysis and empirical implications. The results demonstrate that ESG investing enhances contract efficiency. The more significant the carbon emission reduction, or the less the cost of ESG investing, the higher the contract efficiency, the average q, the marginal q, and the optimal investment–capital ratios, implying that ESG investing mitigates inefficiencies arising from information asymmetry and enhances investment values. Our model predictions are partially verified by empirical facts

We show that banking relationships promote corporate environmental, social, and governance (ESG) policies. Specifically, banks are more likely to grant loans to borrowers with ESG profiles similar to their own and positively influence the borrower’s subsequent ESG performance. Their influence is more pronounced when (1) banks have significantly better ESG ratings than borrowers and (2) borrowers are bank dependent. We exploit M&A among lenders as a source of quasi-exogenous variation in the lender’s ESG standard to alleviate endogeneity concerns. Overall, our study presents the first evidence on the interplay between responsible bank lending and borrowers’ ESG behavior

We investigate the portfolio frontier and risk premia in equilibrium when institutional investors aim to minimize the tracking error variance and to attain a certain ESG score (ESG mandate). Provided that a negative ESG premium is priced by the market, we show that an ESG mandate can reduce the mean–variance inefficiency of the portfolio frontier when the asset manager targets a limited over-performance return with respect to the benchmark. In equilibrium, with mean–variance investors and asset managers endowed with an ESG mandate, a negative ESG premium arises if the mandate is binding for asset managers. The negative ESG premium is due to the ESG constraint (institutional investors over-invest in virtuous ESG stocks). We find empirical evidence of such a negative premium in the US market

We propose a theory in which each stock's environmental, social, and governance (ESG) score plays two roles: (1) providing information about firm fundamentals and (2) affecting investor preferences. The solution to the investor's portfolio problem is characterized by an ESG-efficient frontier, showing the highest attainable Sharpe ratio for each ESG level. The corresponding portfolios satisfy four-fund separation. Equilibrium asset prices are determined by an ESG-adjusted capital asset pricing model, showing when ESG raises or lowers the required return. Combining several large data sets, we compute the empirical ESG-efficient frontier and show the costs and benefits of responsible investing. Finally, we test our theory's predictions using proxies for E (carbon emissions), S, G, and overall ESG

This paper offers the first systematic evidence on environmental, social, and governance (ESG) disclosures provided by a large global sample of private equity (PE) firms. Using historical websites from 2000 to 2022, we develop and validate a novel dictionary‐based measure of voluntary PE firm ESG disclosures. Descriptive statistics reveal an increasing time trend in these disclosures, with social topics becoming as important as environmental topics recently. Multivariate analyses show that the demand for ESG information from fund investors is a significant determinant of PE firms’ ESG disclosures. Leveraging data on PE firms’ portfolio companies, we document that more PE firm ESG disclosures are associated with better ESG outcomes at the portfolio company level, suggesting that voluntary ESG disclosures align with real actions for the average PE firm

This paper explores the relationship between environmental, social and governance (ESG) information and systemic risk, an increasingly important issue for both regulators and investors. While ESG ratings are widely used to assess a company’s non-financial performance, the impact of these factors on financial stability and systemic risk is still under debate. By extending the Forecast Error Variance Decomposition (FEVD) method with a double regularization on both the underlying vector autoregressive (VAR) parameters and the covariance matrix of the VAR residuals, we are able to address the curse of dimensionality within each estimation. This allows us to examine how vulnerable a company is and how much systemic impact a company has given its specific ESG. Looking at a larger sample of European stocks over the period 2007-2022, we empirically show that both the best and worst ESG performers have the largest impact on the financial system in normal times. However, during a crisis, companies with the best ESG ratings generate significant spillovers throughout the system. These findings highlight the importance of incorporating ESG factors into systemic risk assessments and monitoring companies’ ESG performance to ensure financial stability. Policymakers can benefit from this research by supporting investment in high ESG companies to mitigate relevant spillovers during stressed market conditions, when such companies are more interconnected

This paper examines whether capital structure is irrelevant for enterprise value and investment when investors care about environmental, social, and governance issues, which we refer to as “ESG-Modigliani-Miller” (ESG-MM). Theoretically, we show that ESG-MM holds with linear pricing and additive ESG. ESG-MM means that issuing low-yielding green bonds does not lower the overall cost of capital because it makes the issuer’s other securities browner. Hence, a firm’s incentive to make a green investment does not depend on its financing choice. We provide suggestive evidence of failure of ESG-MM, implying that firms and governments can exploit inconsistent ESG attribution or segmented markets

In this study, we examine whether environmental, social, and governance (ESG) funds' investment decisions are sensitive to the existence and extent of firms' voluntary environmental disclosures. We create our measures of voluntary environmental disclosure using bigrams extracted from the Global Reporting Initiative standards. We provide robust evidence that voluntary environmental disclosure in conference calls is associated with greater ESG fund ownership in the subsequent period, incremental to firms' ESG ratings. We also provide evidence that fund managers' reliance on environmental disclosure is concentrated in water, waste, emissions, and compliance disclosures. ESG fund ownership increases with environmental disclosure that is more positive and specific. Our primary finding persists both when we rely on the sustainability report as an alternative proxy for environmental disclosure and when we use fund‐level tests. Overall, our evidence is consistent with ESG funds relying on firms' disclosures when making investing decisions and inconsistent with recent regulatory concerns that ESG fund managers are not following through on their stated investing strategies

This study examines the determinants and consequences of broker in-house ESG research. Using manually collected brokerage ESG research data, we find that the provision of in-house ESG research is positively related to both demand-side factors (client demand, internal demand, and local ESG awareness) and supply-side factors (broker size and coverage of sustainable industries). Regarding the consequences of such research, we find that in-house ESG research is associated with improved earnings forecast accuracy in industries where ESG is more salient. Further, the market reaction to earnings forecast revisions is stronger when equity analysts have access to in-house ESG research. Finally, we observe a consistent pattern suggesting that ESG analysts support equity analysts beyond forecast accuracy, as equity analysts with access to in-house ESG research issue more accurate target prices, more informative recommendation upgrades for ESG-heavy industries, and discuss ESG issues more extensively in their analyst reports. Data Availability Statement: The data used in this study are obtained from publicly available sources identified in the paper, as well as job posting data licensed from Lightcast. Sample construction procedures are described in the paper. Researchers interested in the job posting data should contact Lightcast directly, as access is subject to licensing restrictions

We study the equilibrium effects of the “S” dimension of ESG under imperfect competition. ESG policies are pledges made by firms that constrain managers to treat their stakeholders better than market conditions alone dictate. Moderate policies limit market power and prompt managers to be more competitive; aggressive polices backfire, both for adopting firms and intended beneficiaries. In contrast to the “shareholder primacy” paradigm, competition in ESG policies under the “stakeholder capitalism” paradigm is a panacea for market power, delivering the first-best outcome in equilibrium. We discuss drivers behind the recent rise in ESG, ESG-linked compensation, and disclosure practices