We study the association between environmental, social, and governance (ESG) government risk management and firm-level IPO underpricing between 2008 and 2018. Examining 7446 IPOs issued in 36 countries, we find that IPO underpricing tends to be lower in countries with higher ESG Government Ratings. When we uniquely examine the environmental, social, and governance pillars, we find that underpricing tends to be lower in countries with stronger risk management practices in each of these areas. Additional analysis indicates that the negative impact of ESG ratings on IPO underpricing is more pronounced in countries with more transparent financial disclosures, higher liability standards, and stronger shareholder protections

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

We consider a network of equity mutual funds characterized by different levels of compliance with Environmental, Social, and Governance (ESG) aspects. We measure the impact of portfolio liquidation in a stress scenario on funds with different ESG ratings. Fire-sales spillover from portfolio liquidation propagates from one fund to another through indirect contagion mediated by common asset holdings. The analysis is conducted quarterly from March 2016 through June 2018 using daily data from different sources at the fund and firm levels. Our estimation strategy relies on a network analysis where funds are not taken as stand-alone entities but are interconnected components of a unified system. We find evidence that the relative market value loss of the High ESG ranked funds is lower than the loss experienced by the Low ESG ranked counterparts in the time span with lower volatility. In the higher-volatility period there is not always a clear dominance of one class over another. Results are robust when controlling for size and for feedback effects, and for different model specifications. Our analysis offers new insights to both asset managers and policymakers to exploit the aggregate effect of portfolio diversification related to the system as a whole

We review the financial economics-based research on Environmental, Social, and Governance (ESG) and Corporate Social Responsibility (CSR) with an emphasis on corporate finance. In doing so we focus on the most debated and researched issues. Although a firm's ESG/CSR profile and activities are shown to be strongly related to the firm's market, leadership and owner characteristics as well its risk, performance and value, there still exist conflicting hypotheses and results that we show are not resolved, leading to continued questions and a need for more research

We model investing that considers environmental, social, and governance (ESG) criteria. In equilibrium, green assets have low expected returns because investors enjoy holding them and because green assets hedge climate risk. Green assets nevertheless outperform when positive shocks hit the ESG factor, which captures shifts in customers’ tastes for green products and investors’ tastes for green holdings. The ESG factor and the market portfolio price assets in a two-factor model. The ESG investment industry is largest when investors’ ESG preferences differ most. Sustainable investing produces positive social impact by making firms greener and by shifting real investment toward green firms

This paper contributes to the literature by examining the impact of different forms of state ownership on corporate innovation and the moderating effects of environmental, social, and governance (ESG) practices, economic policy uncertainty (EPU), and corruption in this ownership–innovation nexus. Building on both agency theory and institutional theory, we identify and divide the ultimate controlling shareholders into three types: central government, local government, and private shareholders. This study draws on data from 2629 listed firms in China between 2007 and 2015. Our results suggest that state-owned enterprises (SOEs) controlled by the central government show the strongest innovation performance in all scenarios. In addition, private firms outperform local SOEs in terms of patent quantity in both manufacturing and nonmanufacturing sectors and in high-economic-development regions, whereas local SOEs outperform their private peers with respect to patent quality, mainly in the manufacturing sector and high-economic-development regions. Such an ownership–innovation nexus is then found to be more pronounced for firms engaging in more ESG practices, during periods of higher EPU, and when less corruption is present. These findings demonstrate the value of diversity in state capitalism in guiding SOEs' heterogeneous innovation activities in emerging economies

We construct optimal portfolios of mutual funds whose objectives include socially responsible investment (SRI). Comparing portfolios of these funds to those constructed from the broader fund universe reveals the cost of imposing the SRI constraint on investors seeking the highest Sharpe ratio. This SRI cost crucially depends on the investor’s views about asset pricing models and stock-picking skill by fund managers. To an investor who strongly believes in the CAPM and rules out managerial skill, that is, a market index investor, the cost of the SRI constraint is typically just a few basis points per month, measured in certainty-equivalent loss. To an investor who still disallows skill but instead believes to some degree in pricing models that associate higher returns with exposures to size, value, and momentum factors, the SRI constraint is much costlier, typically by at least 30 basis points per month. The SRI constraint imposes large costs on investors whose beliefs allow a substantial amount of fund-manager skill, that is, investors who heavily rely on individual funds’ track records to predict future performance. ( JEL G11, G12, C11) In 2005, when we released what ultimately proved to be the final version of this study, socially responsible investment (SRI) had already become a major presence on the investment landscape. In the years since, this approach, now often called “sustainable” investment, has grown even more rapidly and often encompasses a broad set of “ESG” (environmental, social, and governance) criteria. As evidence of the rapid growth, Morningstar (2020) notes, “one need look no further than the nearly fourfold increase in assets that flowed into sustainable funds in the United States in 2019.” Sustainable investing has also received increased attention in the academic literature, in subsequent studies too numerous to list. Some of the studies are especially related to ours in that they also examine mutual funds. In our study, mutual funds constitute an asset universe faced by an investor imposing an SRI/ESG constraint. A number of the subsequent studies use mutual funds to address other dimensions of sustainable investing. For example, Bollen (2007), Benson and Humphrey (2008), Renneboog, Ter Horst, and Zhang (2011), Bialkowski and Starks (2016) and Hartzmark and Sussman (2019) investigate determinants of mutual fund flows into sustainable funds versus other funds. Riedl and Smeets (2017) use survey and experimental data to explore investors’ preferences for sustainable funds. Madhavan et al. (2020) examine sustainable active equity mutual funds, relating factor loadings and residual returns to ESG characteristics. While we focus on mutual funds, our study also intends that the basic aspects of the SRI setting extend to other institutional investors. That intent is supported, for example, by the recent evidence of Bolton and Kacperczyk (forthcoming, 2020) providing broader perspectives on the SRI portfolio tilts of various types of institutional investors.One conclusion of our study is that an SRI/ESG constraint is especially binding for investors wishing to tilt toward value or small-cap funds. It seems reasonable to infer that such is still the case, though we have not updated our formal analysis. For example, Morningstar (2020) identifies, as of 2019, 99 sustainable U.S. equity funds categorized within its 3 × 3 style box that sorts along the dimensions of value/blend/growth and small/mid-cap/large. Of those 99 funds, only 8 are classified as value, versus 24 as growth and 67 as blend. Only 7 of the 99 are small-cap funds, versus 79 large-cap and 13 mid-cap. More generally, our 2005 study is early in noting meaningful differences in factor loadings between sustainable versus other funds, in both three- and four-factor models.An SRI/ESG constraint is also especially binding for investors who see much information in individual funds’ historical alphas. The basic reason we discuss in our study is seemingly still at work. That is, despite the rapid growth noted earlier, the number of sustainable funds is still well less than those in the total fund universe, so many of the highest track records appear among funds outside that subset. Not mentioned in our original study is that the case of an investor who sees much information in historical alpha confronts the argument of Berk and Green (2004): if fund flows rationally respond to historical alpha, an investor will not view historical alpha as being informative about future alpha. That argument relies on investors correctly assessing the degree of fund-level decreasing returns to scale. One might view an investor who sees historical alpha as informative about future alpha as also having beliefs that favor a lower degree of decreasing returns to scale, as compared to other investors. Moreover, the equilibrating effects of fund flows might interact with the nonpecuniary utility that SRI-conscious investors derive from their fund choices, as suggested by the evidence of Bollen (2007) that flows respond to returns differently for SRI funds versus conventional funds. In any event, when prior beliefs admit substantial information from historical alphas, Busse and Irvine (2006) find that Bayesian predictive alphas computed as in Pástor and Stambaugh (2002a, 2002b), as are the alphas in our study, do predict future performance.While not one we address, a question often asked is whether sustainable investments perform better or worse than other investments. A number of studies do pursue this question, obtaining a range of findings that include both higher and lower performance for sustainable investments. Pástor, Stambaugh, and Taylor (forthcoming) discuss the challenge in interpreting such findings’ implications about expected future performance. A wedge between ex ante and ex post performance of sustainable investments arises during any period that witnesses unanticipated shifts in either customers’ demands for sustainable products or investors’ demands for sustainable holdings.1 As those authors note, sorting out such effects is an important challenge for future research. Our study conducts its analysis under a variety of asset pricing models and prior beliefs. In each case, an investor conditions on funds’ past returns and thus takes account of any historical performance differences between the sustainable funds and other funds in our sample. We do not, however, include models in which expected asset returns depend on sustainability. In this respect, our study does not attempt to provide direct evidence about a potential relation between sustainability and expected investment performance.We are grateful to the Review of Asset Pricing Studies for the opportunity to publish our original study, which follows below with only the references updated to reflect subsequent publications. The study’s abstract is also unchanged from its original version

Institutional investors expect infrastructure to deliver long-term stable returns but gain exposure to infrastructure predominantly through finite-horizon closed private funds. The cash flows delivered by infrastructure funds display similar volatility and cyclicality as other private equity investments, and their performance similarly depends on quick deal exits. Despite weak risk-adjusted performance and failure to match the supposed characteristics of infrastructure assets, closed funds have received more commitments over time, particularly from public investors. Public institutional investors perform worse than private institutional investors. ESG preferences and regulations explain 25%–40% of their increased allocation to infrastructure and 30% of their underperformance

This paper examines the role of the “Big Three” (i.e., BlackRock, Vanguard, and State Street Global Advisors) on the reduction of corporate carbon emissions around the world. Using novel data on engagements of the Big Three with individual firms, we find evidence that the Big Three focus their engagement effort on large firms with high CO2 emissions in which these investors hold a significant stake. Consistent with this engagement influence being effective, we observe a strong and robust negative association between Big Three ownership and subsequent carbon emissions among MSCI index constituents, a pattern that becomes stronger in the later years of the sample period as the three institutions publicly commit to tackle Environmental, Social, and Governance (ESG) issues