The following 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 relates 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 likely to affect a company’s fundamentals, ESG investors are motivated by financial rather than nonpecuniary factors.
Previous studies by Philipp Krüger and Gunther Capelle-Blancard and Aurélien Petit, for example, concluded that the market responds negatively to both positive and negative ESG news. However, which specific ESG news most moves the market is unclear as is whether any prior evidence would be generalizable today. Earlier research has tended to have small sample sizes, focus on periods when capital markets dismissed ESG issues through an agency-cost lens, and not differentiate ESG-related news that was likely to be material for a given industry. But now there is increasing buy-in that ESG issues use firm resources and therefore should affect shareholder value.
The data sample we analyze is orders-of-magnitude larger than those in prior studies. It includes 109,014 unique firm-day observations for 3,109 companies 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 each day across thousands of companies, 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 focus on vetted, reputable, and credible news sources that are likely to generate new information and insights for investors.
Our primary research design is on a firm-day panel where the dependent variable is the daily 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 daily structure, we implement an event-study research design that measures short-term price reactions to ESG news every day.
Our first set of analyses demonstrates that not all news events are associated with significant changes in stock price. Only financially material news translates into big price movements. For example, on firm-dates with at least three news articles — according to TVL, sentiment analysis requires at least three articles to be accurate — materially positive ESG news generated significant and positive price reactions. Negative news, however, did not generate similarly sized price swings. Our results increase in economic significance when we restrict the sample to material news that receives more than five ESG articles on a coverage day. Negative news sends stock prices lower. In contrast, there are no price movements for ESG news that is not material according to SASB standards, regardless of how we restrict our sample.
When we evaluate ESG news themes, positive and negative news classified under social capital — that is, news about product impact on customers due to product safety, quality, affordability, and access issues — generates the largest and most significant market responses. This is particularly interesting given that ESG data and ratings contain little information about product impacts, with most metrics reflecting operational activities. We do see smaller but significant price movements associated with negative natural capital-related news and positive human capital and business model innovation-related news, among other themes.
Finally, we examine how investors react to ESG news relative to expectations about a firm’s ESG activities. Using the MSCI ESG score as a proxy for investor expectations, we find 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 score to determine whether unexpected news or news predicted by a firm’s ESG score influences stock prices. According to our results, the unexpected component of positive news drives investor behavior. This suggests that ESG performance scores have predictive power regarding future ESG news and that investors incorporate this predictive component in their stock price reactions.
Our study paints a different picture of how investors respond to ESG news than its predecessors. We show that investors react positively to positive ESG news and much 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 much more prevalent and rely on technological advancements that systematically measure ESG news using natural language processing (NLP). This yields better measurement quality and less selection bias compared to studies that relied on human analysts subjectively codifying ESG news. Further, we extend our understanding of financial materiality of ESG issues. For example, in “Corporate Sustainability: First Evidence on Materiality,” Mozaffar Khan, Serafeim, and I determine that companies with good ratings on material sustainability issues exhibit superior long-term stock returns compared with companies with poor ratings. But firms with good ratings on immaterial issues did not outperform those with poor ratings. The market reacts to financially material information even during a short-term window by using data that provides daily ESG news data and classifies ESG news according to financial materiality.
How can our results inform investment analysis? 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 the most meaningful price swings when disseminated as news. Our results suggest that certain types of news lead to bigger swings. Second, we document that for much of our sample, corporate ESG news evokes little tangible response. This finding is intriguing. After all, if investors believe the market doesn’t appreciate the importance of some news, they have an opportunity for further investment analysis, due diligence, and capital deployment.
Finally, we consider the analysis by type of news because it reveals important information that investors need about social capital issues. This could become fertile ground for deeper investment analysis 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 author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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