Journal for Financial Analysts
Stock prices respond only to financially relevant environmental, social and governance (ESG) news and much more so when the news is positive, receives more media coverage and pertains to social capital issues. This is the results of a study I conducted with George Serafeim. We also find that ESG investors are motivated by financial quite than intangible aspects because of their response to news that’s prone to impact an organization’s fundamentals.
Previous research
Previous studies by Philipp Kruger And Gunther Capelle-Blancard and Aurélien Petitfor instance, concluded that the market reacts negatively to each positive and negative ESG news. However, it’s unclear which specific ESG news is driving the market essentially the most and whether previous findings can be generalizable today. Previous research tends to have small sample sizes and deal with time periods as capital markets dismissed ESG issues from an agency cost perspectiveand ESG-related news that’s prone to be relevant to a specific industry just isn’t differentiated. However, it’s now increasingly assumed that ESG issues demand firm resources and will subsequently impact shareholder value.
Our research
The data sample we analyzed is orders of magnitude larger than that in previous studies. It includes 109,014 unique day by day observations for 3,109 corporations with ESG news between January 2010 and June 2018. We divide our sample based on Sustainability Accounting Standards Board (SASB) materiality classifications.
FactSet TruValue Labs (TVL) tracks ESG-related information from hundreds of corporations day by day, classifies news from various sources as positive or negative, and creates sentiment scores to evaluate how positive or negative the news is for a corporation day and whether the news is financially material is. TVL obtains its data from many sources – including reports from analysts, media, interest groups and government regulators – and its actions deal with verified, reputable and credible news sources which can be prone to generate recent information and insights for investors.
Our primary research design is predicated on a day by day panel where the dependent variable is the day by day market-adjusted stock return and our key independent variables are indicators of positive and negative news on that day based on TVL’s ESG News Score. With this day by day structure, we implement an event study research design that measures short-term price reactions to ESG news each day.
Our initial evaluation shows that not all news events are related to significant changes in stock price. Only financially relevant news results in large price movements. For example, in corporate meetings with not less than three news articles – in response to TVL, sentiment evaluation requires not less than three articles to be accurate – materially positive ESG news resulted in significant and positive price reactions. However, negative news didn’t result in similarly large price swings. Our results gain more economic significance once we restrict the sample to material news stories that contain greater than five ESG articles on a reporting day. Negative news causes stock prices to fall. In contrast, there are not any price movements for ESG news that just isn’t material by SASB standards, no matter how we limit our sample.
When we evaluate ESG news topics, positive and negative news related to social capital – that’s, news about product impacts on customers because of product safety, quality, affordability and access issues – generate the most important and most important market reactions. This is especially interesting since ESG data and Reviews contain little details about product effects, with most key figures reflecting operational activities. We see smaller but significant price movements related to, amongst other things, negative news on natural capital and positive news on human capital and business model innovation.
Finally, we examine how investors reply to ESG news relative to expectations of an organization’s ESG activities. When we use MSCI’s ESG rating as an indicator of investor expectations, we discover that it predicts future ESG news. We then separate the positive and negative news into predicted and residual components as a function of an organization’s ESG performance rating to find out whether unexpected news or news predicted by an organization’s ESG rating influences stock prices. According to our results, the unexpected component of positive news determines investor behavior. This suggests that ESG performance scores have predictive power for future ESG news and that investors incorporate this predictive component into their stock price reactions.
Our results
Our study paints a unique picture of how investors reply to ESG news than its predecessors. We show that investors respond positively to positive ESG news, rather more strongly to positive news than to negative news. Why are our results different from those of previous studies? This is because we examine a time when ESG was rather more prevalent and draw on technological advances that systematically measure ESG messages using natural language processing (NLP). This leads to higher measurement quality and lower selection bias in comparison with studies that relied on human analysts subjectively codifying ESG news. We are also expanding our understanding of the financial materiality of ESG issues. For example in “Corporate sustainability: initial findings on materiality,“Mozaffar Khan, Serafeim and I find that companies with good ratings on material sustainability issues have better long-term stock returns compared to companies with poor ratings.” But corporations with good rankings on non-material issues didn’t outperform those with poor rankings. The market also responds to financially material information during a short-term window using data that gives day by day ESG news data and classifies ESG news by financial materiality.
How can our results be incorporated into the investment evaluation? First, as more investors incorporate ESG issues into their portfolio allocation decisions, news of such news should result in larger share price movements. However, we still know little about which specific topics trigger the most important price fluctuations when disseminated as news. Our results suggest that certain forms of news end in larger fluctuations. Second, we document that ESG corporate news elicits little tangible response from much of our sample. This finding is fascinating. Because if investors consider that the market doesn’t recognize the importance of some news, they’ve a possibility for further investment evaluation, due diligence and capital deployment.
Finally, we consider evaluation by news type because it reveals key information investors need on social capital issues. This could possibly be fertile ground for deeper investment evaluation and product development.
To learn more from Aaron Yoon, don’t miss “What corporate ESG news is the market reacting to?” Co-author with George Serafeim and winner of the 2022 Scroll Award from the .
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