Impact of ESG Scores on Stock Returns: studies looking into the COVID-19 Pandemic, ESG Momentum, Region & Firm Size

The question of whether a socially responsible company is inherently more profitable, or if being a responsible corporate citizen negatively affects financial performance, has been a matter of enduring interest. The literature contains arguments both in favor and against the impact of Environmental, Social, and Governance (ESG) scores on a firm’s stock returns, as a measure of financial performance. Empirical reports attempting to disentangle these effects show mixed results. All the studies in this dissertation tackle this question and are consistent with the segment of the literature that finds a negative relationship between ESG and stock returns. However, each study digs deeper into this relationship contributing with a contrast between ESG and ESG Momentum, a comprehensive analysis of ESG and its components across regions and firm sizes, and an analysis of ESG’s impact during the COVID-19 pandemic. Return and its related volatility are the central elements that define an investment, and the suitable balance between these two variables is contingent upon each investor profile. Chapter 2 aims to explore the relationship between ESG ratings and the change in ESG scores, or ESG Momentum, concerning both returns and risk of a sample of 3,856 stocks traded on U.S. exchanges. The analysis employs a dataset spanning 20 years of quarterly information, from December 2002 to December 2022. We applied multi-factor models and tested them through pooled ordinary, fixed effects, and random effects panel regression methods. The main implication of our findings is that while high ESG scores are associated with lower stock returns in the long run, an improvement in a company’s ESG score tends to yield immediate positive returns. So, the primary contribution of this research lies in the revelation that ESG Momentum has a significant positive impact on stock returns. This might explain why the literature has some mixed results, since some of them could confound the effects of ESG scores and ESG Momentum. A longstanding debate in finance centers on whether social responsibility has an influence on a firm’s long-term profitability. The study in Chapter 3 aims to provide a broad viewpoint of the relationship between ESG, its individual components, and stock returns. It examines time-entity observations from December 2014 to December 2023 for European and US companies, applying panel regression models to analyze the data collectively, by region, and by firm size. The findings consistently reveal a negative relationship between ESG ratings, their individual components, and stock returns, which we attribute to both risk reduction from social responsibility and decreased profitability due to the associated costs of ESG policies implementation. ESG and its individual pillars’ coefficients used as explanatory variables of stock returns are significant in most cases, with some exceptions for the governance and environmental pillars. In the case of the environmental pillar, the results reveal it has a stronger influence in Europe, across firm sizes while, in the US that influence is observed among larger companies only. In the case of governance, the observed variations are consistent with the argument of different ownership structures across regions, and evolving investor concerns as firms grow, with the influence being stronger in Midcaps of both regions and in US Large Caps. The study in Chapter 4 analyzes the relationship of firm-level Environmental, Social and Governance (ESG) scores and stock returns from a worldwide database of the automotive industry. It measures the significance of the ESG and Corporate Financial Performance (CFP) relationship during the last decade and includes a comparison of those firms with different levels of ESG scores, as well as between firms with ESG scores and firms that lack such scores. A quasi-experimental difference-in-differences (DID) design, and panel data regressions are estimated to examine the impact of ESG scores and ESG Combined (ESGC1) scores on firms’ stock returns before and during the COVID-19 pandemic period. The results suggest that sustainable policies during the pandemic lessened stock returns, as evidenced by the negative coefficients of the ESGC and ESG scores. The interaction terms of ESGC and ESG with firm size had a positive relationship with stock returns during the pandemic. Thus, larger firms’ returns benefited from higher ESG scores during the COVID-19 crisis. This research in the context of the COVID-19 sanitary emergency is an original contribution to the literature on the ESG-CFP relationship.