Articlehybrid2023

The contributions of betas versus characteristics to the ESG premium

Rocco Ciciretti · Ambrogio Dalò · Lammertjan Dam

55 citations0/0 files storedJournal of Empirical Finance

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Corporate Social Responsibility Reporting Financial Markets and Investment Strategies Sustainable Finance and Green Bonds

Abstract

Firms that score high on environmental, social, and governance (ESG) indicators exhibit lower expected returns. This negative ESG premium might be driven by the lower risk associated with high ESG scores (betas), or it could signal investors’ preferences for firms with high ESG scores (characteristics). We show that ESG as a characteristic mainly drives the premium. Specifically, a one standard deviation increase in the ESG characteristic is associated with a decrease in expected returns of 2.73% annually. In addition, the ESG characteristic explains a higher proportion of the cross-sectional variation in expected returns compared to ESG betas. We further caution for the presence of an ESG bias within the ESG premium that is due to positive realized returns preceding lower long-term expected returns. When correcting our estimates for the ESG bias the decrease in expected returns turns out to be 3.41% on an annual basis. The ESG bias correction, together with a firm-level methodology, can help clarify the mixed findings documented in the literature.

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References

1993Common risk factors in the returns on stocks and bonds 1997On Persistence in Mutual Fund Performance 1992The Cross-Section of Expected Stock Returns 1973Risk, Return, and Equilibrium: Empirical Tests 2014A five-factor asset pricing model 1987A Simple Model of Capital Market Equilibrium with Incomplete Information 1988The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors 1972The capital asset pricing model: Some empirical tests

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