The ESG-Risk Relationship - A study of the relationship between ESG and firm-specific risk of publicly traded firms in Sweden

Abstract: Non-financial metrics have come to play a larger role in financial markets as years pass, impacting decisions made by businesses, investors and policy makers alike. A significant non-financial metric captured by the term ESG or Environmental, Social and Governance. The purpose of this thesis is to investigate how ESG relates to risk at a firm-specific level. More specifically, we analyze this relationship from a market perspective using publicly traded companies in Sweden, ranging between the time period 2009-2019. To study the relationship between ESG and firm-specific risk, we use a two-step approach which utilizes a Fama-French three-factor model to estimate the idiosyncratic volatility followed by panel data regressions. We run the regressions on idiosyncratic volatility using aggregated ESG and its individual pillars as explanatory variables while controlling for leverage, size, ROA and P/B as well as year dummies. The results in the thesis indicate that there is a negative relationship between ESG and idiosyncratic volatility, both on the aggregated level and on individual pillars. However, this can only be statistically proven on the aggregate level on a 10% confidence level. Due to the high correlation amongst the ESG pillars we fit three specifications with the pillars on an individual basis. However, these regressions lead to the same conclusion reached earlier, namely a negative but insignificant relationship.