This paper analyzes the asset pricing and portfolio implications of an important barrier to sustainable investing: uncertainty about the corporate ESG profile. In equilibrium, the market premium increases and demand for stocks declines under ESG uncertainty. In addition, the CAPM alpha and effective beta both rise with ESG uncertainty and the negative ESG-alpha relation weakens. Employing the standard deviation of ESG ratings from six major providers as a proxy for ESG uncertainty, we provide supporting evidence for the model predictions. Our findings help reconcile the mixed evidence on the cross-sectional ESG-alpha relation and suggest that ESG uncertainty affects the risk-return trade-off, social impact, and economic welfare

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 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

This paper investigates the divergence of environmental, social, and governance (ESG) ratings based on data from six prominent ESG rating agencies: Kinder, Lydenberg, and Domini (KLD), Sustainalytics, Moody’s ESG (Vigeo-Eiris), S&P Global (RobecoSAM), Refinitiv (Asset4), and MSCI. We document the rating divergence and map the different methodologies onto a common taxonomy of categories. Using this taxonomy, we decompose the divergence into contributions of scope, measurement, and weight. Measurement contributes 56% of the divergence, scope 38%, and weight 6%. Further analyzing the reasons for measurement divergence, we detect a rater effect where a rater’s overall view of a firm influences the measurement of specific categories. The results call for greater attention to how the data underlying ESG ratings are generated

We show that banks with high environmental, social, and governance (ESG) ratings issue fewer mortgages in poor localities—in number and dollar amount—than banks with low ESG ratings. This lending disparity happens at both the county and census tract level, worsens in disaster areas of severe hurricane strikes, is robust to alternative ESG ratings (including using only the social (S) component), and cannot be explained by banks’ differential deposit networks. We find no difference in mortgage default rates between high- and low-ESG banks, rejecting an alternative explanation based on differential credit screening quality. We report a complementary, not substitution, relation between high-ESG banks’ mortgage lending and their community development investments (like affordable housing projects) in poor localities. Loan-application-level analyses confirm that high-ESG banks are more likely than low-ESG banks to reject mortgage loans in poor neighborhoods. The evidence hints at social wash: banks deploy prosocial rhetoric and symbolic actions while not lending much in disadvantaged communities, the social function they arguably ought to perform. Community Reinvestment Act (CRA) examinations partially undo the social wash effect

We document that U.S. mutual funds with investment objectives designated as “Sustainable Investment Overall” by Morningstar (ESG funds) are more likely than other mutual funds to vote in support of environmental and social (ES) shareholder proposals and governance (G) shareholder proposals. We also find that the higher support for ES proposals by ESG funds relative to other funds is more pronounced in index funds than in active funds, consistent with trading constraints influencing voting behavior. While these results provide evidence that ESG funds “walk the talk” with their voting behavior on average, we find that fund families play a significant role in that walk. Additionally, in an analysis of fund families that are signatories of the United Nations Principles for Responsible Investment (PRI), we find that ESG funds of PRI families are significantly more likely to support ES proposals and G proposals than non-ESG funds of PRI families. We determine that this significant difference stems from non-ESG funds of PRI families providing less support than non-ESG funds from non-PRI families. Taken together, these results provide evidence that ESG funds available to U.S. investors provide more support for shareholder proposals aligned with their designated investment objective, but the type and family of the fund influence that support

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 examine how natural disasters affect the corporate environmental, social, and governance (ESG) disclosure policies of firms located close to disaster areas. We study firms located in counties neighboring those impacted by natural disasters and find that, on average, these firms increase their ESG disclosure transparency over the period subsequent to the disaster. Given that our sample firms are located outside of the area directly impacted by the disaster, the changes in disclosure transparency after the disaster are consistent with managers increasing their preference for transparency as their risk salience increases. Further, we find that firms with a higher percentage of local institutional ownership are more likely to increase ESG disclosure after experiencing nearby disasters. The findings suggest that managers strategically react to a change in investors' risk perception by increasing ESG disclosure

Despite the rising use of environmental, social, and governance (ESG) ratings, there is substantial disagreement across rating agencies regarding what rating to give to individual firms. As what drives this disagreement is unclear, we examine whether a firm's ESG disclosure helps explain some of this disagreement. We predict and find that greater ESG disclosure actually leads to greater ESG rating disagreement. These findings hold using firm fixed effects and using a difference-in-differences design with mandatory ESG disclosure shocks. We also find that raters disagree more about ESG outcome metrics than input metrics (policies), and that disclosure appears to amplify disagreement more for outcomes. Last, we examine consequences of ESG disagreement and find that greater ESG disagreement is associated with higher return volatility, larger absolute price movements, and a lower likelihood of issuing external financing. Overall, our findings highlight that ESG disclosure generally exacerbates ESG rating disagreement rather than resolves it. Data Availability: The data used in this study are publicly available from the sources cited in the text

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