The next is derived from the 2022 Scroll Award-winning article “Which Corporate ESG News Does the Market React To?” by George Serafeim and Aaron Yoon, from the Financial Analysts Journal.
Stock prices react only to financially material environmental, social, and governance (ESG) news and more so when the news is positive, receives more media coverage, and pertains to social capital issues. That’s the conclusion of research I conducted with George Serafeim. We also find that based on their response to news that was more likely to affect an organization’s fundamentals, ESG investors are motivated by financial moderately than nonpecuniary aspects.
Past Research
Previous studies by Philipp Krüger and Gunther Capelle-Blancard and Aurélien Petit, for instance, concluded that the market responds negatively to each positive and negative ESG news. Nonetheless, which specific ESG news most moves the market is unclear as is whether or not any prior evidence could be generalizable today. Earlier research has tended to have small sample sizes, deal with periods when capital markets dismissed ESG issues through an agency-cost lens, and never differentiate ESG-related news that was more likely to be material for a given industry. But now there’s increasing buy-in that ESG issues use firm resources and due to this fact should affect shareholder value.
Our Research
The info sample we analyze is orders-of-magnitude larger than those in prior studies. It includes 109,014 unique firm-day observations for 3,109 corporations with ESG news between January 2010 and June 2018. We divide our sample based on materiality classifications from the Sustainability Accounting Standards Board (SASB).
FactSet TruValue Labs (TVL) tracks ESG-related information every day across 1000’s of corporations, classifies news from different sources as positive or negative, and creates sentiment scores to gauge how positive or negative the news is for a firm-day and whether the news is financially material. TVL draws its data from many sources — including reports by analysts, media, advocacy groups, and government regulators — and its measures deal with vetted, reputable, and credible news sources which can be more likely to generate latest information and insights for investors.
Our primary research design is on a firm-day panel where the dependent variable is the each 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 rating. With this each day structure, we implement an event-study research design that measures short-term price reactions to ESG news day by day.
Our first set of analyses demonstrates that not all news events are related to significant changes in stock price. Only financially material news translates into big price movements. For instance, on firm-dates with at the very least three news articles — in line with TVL, sentiment evaluation requires at the very least three articles to be accurate — materially positive ESG news generated significant and positive price reactions. Negative news, nevertheless, didn’t generate similarly sized price swings. Our results increase in economic significance once we restrict the sample to material news that receives greater than five ESG articles on a coverage day. Negative news sends stock prices lower. In contrast, there are not any price movements for ESG news that isn’t material in line with SASB standards, no matter how we restrict our sample.
Once we evaluate ESG news themes, positive and negative news classified under social capital — that’s, news about product impact on customers as a result of product safety, quality, affordability, and access issues — generates the biggest and most important market responses. This is especially interesting provided that ESG data and rankings contain little details about product impacts, with most metrics reflecting operational activities. We do see smaller but significant price movements related to negative natural capital-related news and positive human capital and business model innovation-related news, amongst other themes.
Finally, we examine how investors react to ESG news relative to expectations a few firm’s ESG activities. Using the MSCI ESG rating as a proxy for 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 a firm’s ESG performance rating to find out whether unexpected news or news predicted by a firm’s ESG rating influences stock prices. In line with our results, the unexpected component of positive news drives investor behavior. This means that ESG performance scores have predictive power regarding future ESG news and that investors incorporate this predictive component of their stock price reactions.
Our Results
Our study paints a distinct picture of how investors reply to ESG news than its predecessors. We show that investors react positively to positive ESG news and far more strongly for positive than negative news. Why are our results different from those of earlier studies? Because we examine a period when ESG was far more prevalent and depend on technological advancements that systematically measure ESG news using natural language processing (NLP). This yields higher measurement quality and fewer selection bias in comparison with studies that relied on human analysts subjectively codifying ESG news. Further, we extend our understanding of economic materiality of ESG issues. For instance, in “Corporate Sustainability: First Evidence on Materiality,” Mozaffar Khan, Serafeim, and I determine that corporations with good rankings on material sustainability issues exhibit superior long-term stock returns compared with corporations with poor rankings. But firms with good rankings on immaterial issues didn’t outperform those with poor rankings. The market reacts to financially material information even during a short-term window by utilizing data that gives each day ESG news data and classifies ESG news in line with financial materiality.
How can our results inform investment evaluation? First, as more investors integrate ESG issues into their portfolio allocation decisions, related news should generate greater stock price movements. That said, we still know little about which specific issues create essentially the most meaningful price swings when disseminated as news. Our results suggest that certain sorts of news lead to greater swings. Second, we document that for much of our sample, corporate ESG news evokes little tangible response. This finding is intriguing. In spite of everything, if investors consider the market doesn’t appreciate the importance of some news, they’ve a chance for further investment evaluation, due diligence, and capital deployment.
Finally, we consider the evaluation by variety of news since it reveals vital information that investors need about social capital issues. This might grow to be fertile ground for deeper investment evaluation and product development.
For more from Aaron Yoon, don’t miss “Which Corporate ESG News Does the Market React To?” co-authored with George Serafeim and winner of the 2022 Scroll Award, from the Financial Analysts Journal.
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All posts are the opinion of the creator. As such, they mustn’t be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the creator’s employer.
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