How is ESG Affecting Stock Returns? A Portfolio- and Panel Data Analysis of US Firms in the S&P 500
Abstract: The last two decades, socially responsible investing has emerged such that there is a value in itself to invest responsibly. This paper analyzes the relationship between Environmental, Social, Governance (ESG) and stock returns, and investigate if any of these three individual pillars have a more significant impact during the period 2005 – 2018. The study contributes to the field by applying an ESG portfolio approach using the Fama-French Five-factor Model with momentum, as well as studying the direct- and indirect effect of ESG using a time- and firm fixed effects model with double-clustered standard errors. The results show that portfolios with a low ESG score outperform the market and portfolios with a higher score in general, where the impact of the environmental pillar is distinctive. Whether or not we conditioned the analysis on the financial crisis in 2008, a portfolio with lower ESG score still performs better in terms of abnormal returns. The panel data study finds support for an indirect positive effect of the ESG variable interacting with the market-based measure, while the environmental pillar displays a negative effect through accounting-based measures. The paper concludes that it is more beneficial for a mean-variance investor to hold stocks with lower ESG ratings since higher-rated portfolios cannot outperform the market.
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