This Research Spotlight provides a summary of the academic literature on environmental, social, and governance (ESG) activities including: • The relation between ESG activities and firm value • The impact of environmental and social engagements on firm performance • The market reaction to ESG events • The relation between ESG and agency problems • The performance of socially responsible investment (SRI) funds This Research Spotlight expands upon issues introduced in the Quick Guide “Investors and Activism”.

1. David F. Larcker and Brian Tayan
Corporate Governance Research Initiative
Stanford Graduate School of Business
ESG ACTIVITIES
RESEARCH SPOTLIGHT

2. KEY CONCEPTS
Environmental, social, and governance (ESG) activities involves activities or
investment that companies make to address environmental or social issues
that impact the firm from a total stakeholder perspective.
– ESG is alternatively referred to as corporate social responsibility (CSR) or
socially responsible investing (SRI).
• Potential benefits.
– Considers the interests of all stakeholders, not just shareholders.
– Can decrease risk by internalizing costs that might damage the firm or its
constituents over the long-term.
• Potential costs.
– Can reduce value if it requires substantial investment.
Research shows that ESG is modestly associated with higher firm performance.

3. ESG AND FIRM VALUE
• Dowell, Hart, and Yeung (2000) study the relation between corporate
commitment to environmental standards and firm value.
• Sample: 89 S&P 500 firms, 1994-1997. Environmental data from IRRC.
• Categorize companies according to whether they adhere to 1. local
environmental standards, 2. U.S. standards, or 3. internal standards that are
more stringent than any national standard.
• Find that companies that adopt stringent internal standards have higher value
(Tobin’s Q) than companies that adopt local or U.S. standards.
• Conclusion: companies committed to the environment perform better.
“This paper refutes the idea that adoption of global environmental standards by
[multinational corporations] constitutes a liability that depresses market value.”

4. ESG AND FIRM VALUE
• Lins, Servaes, and Tamayo (2017) study the performance of companies with
high CSR scores during the financial crisis.
• Sample: 1,673 nonfinancial firms, 2005-2013. CSR data from MSCI.
• Find that during the crisis, high-CSR firms experienced higher returns,
profitability, growth, and sales per employee than low-CSR firms.
• Find no significant associations during the periods before and after the crisis.
• Conclusion: companies committed to CSR have lower risk.
“Trust between a firm and both its stakeholders and investors, built
through investments in social capital, pays off when the overall level
of trust in corporations and markets suffers a negative shock.”

5. ESG AND FIRM VALUE
• Manchiraju and Rajgopal (2017) study the relation between CSR and firm
value in the context of a law that required minimum CSR spending.
• Sample: 2,120 Indian companies, 2009-2013.
– Indian Companies Act 2013 required companies meeting certain thresholds for net
worth, sales, and profit to spend at least 2% of average profits on CSR activities.
• Find that companies affected by the law declined by a market-adjusted 4.1%
over the 4 years between introduction of the bill and final passage.
• Interpret results as evidence that firms choose optimal levels of CSR spending
and that mandatory spending beyond this is value decreasing.
• Conclusion: forced CSR spending decreases firm value.
“Mandatory CSR activities can impose social burdens on
business activities at the expense of shareholders.”

6. ESG AND FIRM VALUE: ACQUISITIONS
• Deng, Kang, and Low (2013) study the relation between CSR and firm value by
examining stock price returns around acquisition announcements.
• Sample: 1,556 successful mergers, 801 firms, 1992-2007. CSR data from KLD.
• Find modest evidence that companies with high CSR scores exhibit:
– Higher returns around the announcement (3-day period, but not 5- or 10-day).
– Higher long-term operating performance (operating cash flow, 2 years post-merger).
– Difference in returns is driven by the fact that firms with low CSR perform below
average; high CSR firms do not perform above average.
• Conclusion: companies committed to social goals might perform better.
“Firms that integrate various stakeholders’ interests …
ultimately increase shareholder wealth and corporate value.”

7. ESG AND FIRM VALUE: ACQUISITIONS
• Atkas, de Bodt, and Cousin (2011) also study the relation between SRI and firm
value by examining merger-announcement and post-merger performance.
• Sample: 106 mergers, 1997-2007. SRI data from Innovest.
• Find that companies that acquire targets with high SRI scores:
– Have higher announcement returns (3-day period).
– Exhibit an increase in their own SRI score following the announcement
(measurement term not specified).
• Conclusion: ESG increases firm value.
“Our results support the idea that the acquirer learns from the
target’s SRI practices and experiences, and socially responsible
investing pays for acquiring shareholders.”

8. ESG AND FIRM VALUE: ACTIVIST ENGAGEMENTS
• Dimson, Karakaş, and Li (2015) study the impact of activist engagements on
firm performance.
• Sample: 2,152 ESG activist engagement, 1999-2009. Proprietary dataset.
– Subdivided: 900 governance-related, 1,252 ES-related engagements.
• Find that successful ES-related engagements are associated with:
– Positive abnormal returns (7.2% over 18 months).
– Improved accounting performance (ROA).
• Conclusion: ESG increases firm value.
“Consistent with arguments that ESG activities attract socially conscious customers
and investors, we find that, after successful engagements, particularly for those on
ES issues, engaged companies experience improvements in their operating
performance, profitability, efficiency, shareholding, and governance.”

9. ESG AND FIRM VALUE: EVENT RETURNS
• Krüger (2015) examines how shareholders respond to CSR-related events.
• Sample: 2,115 events, 745 companies, 2001-2007. Event data from KLD.
– “Events” consist of instances where KLD makes positive or negative note of a
social, environmental, or product-related occurrence at the company.
• Find that shareholders:
– React negatively to negative events (0.9% over 11-day period).
(breakdown: no reaction to events related to diversity or human rights; negative
reaction to those related to environment, product, community, or employees.)
– Have no reaction to positive events.
• Conclusion: some CSR-related events can impact firm value.
“A negative reaction with respect to negative events is consistent with the view
that a substantial cost is associated with corporate social irresponsibility.”

10. ESG, FIRM VALUE, AND AGENCY PROBLEMS
• Ferrell, Liang, and Renneboog (2016) study the relations between CSR, agency
problems, and firm value.
• Sample: 2,500 global companies, 1999-2011. CSR data from MSCI and Vigeo.
• Find that firms with:
– Low agency problems have higher CSR ratings.
– Low agency problems and high CSR ratings also have higher value (Tobin’s Q).
• Conclusion: companies committed to CSR do not have higher agency
problems.
“Corporate social responsibility … can be consistent with a core value of
capitalism, generating more returns to investors, through enhancing firm value
and shareholder wealth.”

11. ESG AND FIRM VALUE
• Margolis, Elfenbein, and Walsh (2011) conduct a meta-analysis of the research
on CSR and firm performance.
• Sample: 251 studies, 1972-2007.
• Find:
– Small positive relation between CSR and firm performance.
– Over time, the positive relation declines (i.e., it is more prominent in early studies
than later studies).
• Conclusion: CSR might increase value; it does not decrease value.
“After thirty-five years of research, the preponderance of evidence indicates a
mildly positive relationship between corporate social performance and corporate
financial performance. The overall average effect … across all studies is
statistically significant, but, on an absolute basis, it is small.”

12. ESG MUTUAL FUND PERFORMANCE
• Geczy, Stambaugh, and Levin (2005) study the investment returns generated
by mutual funds dedicated to socially responsible investing (SRI).
• Sample: 49 SRI funds out of 894 total funds, 1963-2001.
• Find that:
– SRI mutual funds have higher annual fees (1.36%) than non-SRI funds (1.10%).
– SRI mutual funds have lower performance (0.3% per month).
– Shareholders do not receive diversification benefits.
• Conclusion: SRI investments underperform peers.

13. ESG MUTUAL FUND PERFORMANCE
• Renneboog, Ter Horst, and Zhang (2008) also study the performance of SRI
mutual funds.
• Sample: 440 SRI mutual funds out of 16,036 funds, 17 countries. 1991-2003.
• Find that:
– SRI mutual funds underperform their benchmarks by 2.2% to 6.5% annually.
– Risk-adjusted returns in many countries are not significantly different from
comparable funds.
• Conclusion: SRI mutual funds might underperform peers.
“It seems that investors pay a price for ethics.”

14. ESG MUTUAL FUND PERFORMANCE
• El Ghoul and Karoui (2017) also study the performance of CSR mutual funds.
• Sample: 2,168 U.S. mutual funds, 2003-2011. CSR data from KLD.
– Rather than compare SRI-funds with unconstrained funds, the authors use the CSR
ratings of the companies in the portfolio to derive a CSR score for the fund.
– CSR is graded on a spectrum, not a binary metric.
• Find that funds with high CSR scores perform worse than those with low scores.
• Conclusion: CSR investments underperform non-CSR investments.
“Our empirical results reveal that the CSR score of the portfolio is negatively
related to risk-adjusted performance. … Furthermore, we find that the CSR
score negatively predicts future fund performance.”

15. ESG: EQUITY AND CREDIT PERFORMANCE
• Gerard (2018) conducts a literature review of the research on ESG, including
equity and fixed income performance.
• Sample: 55 studies, 2000-2018.
• Finds that:
– High ESG scores are related to higher profitability and stock value (Tobin’s Q).
– Relation between ESG scores and fixed income price and risk is mixed.
– Positive performance differentials recorded in the 1990s decreased in the early
2000s and disappeared in the 2010s.
• Conclusion: companies committed to ESG perform better and have lower risk
but their actions are largely priced into securities markets.

16. CONCLUSION
• The research generally shows that companies committed to environmental
and social goals have better performance and lower risk.
• The relations in most studies are modest.
• Research generally suffers from a problem of causality: does a commitment
to environmental or social goals make companies more profitable, or are
more profitable companies able to spend more on these activities?
• Socially responsible investing is associated with lower risk-adjusted
returns; any corporate benefit to ESG is priced in the market.
• It is not clear that the metrics that third-party firms develop to measure
companies on ESG dimensions are accurate or reliable.

17. BIBLIOGRAPHY
Glen Dowell, Stuart Hart, and Bernard Young. Do Corporate Global EnvironmentalStandards Create or Destroy Market Value? Do
Corporate Global Environmental Standards Create or Destroy Market Value? 2000. Management Science.
Karl V. Lins, Henri Servaes, and Ane Tamayo. Social Capital, Trust, and Firm Performance: The Value of Corporate Social
Responsibility During the Financial Crisis. 2017. Journal of Finance.
Hariom Manchiraju and Shiram Rajgopal. Does Corporate Social Responsibility (CSR) Create Shareholder Value? Evidence from the
Indian Companies Act 2013. 2017. Journal of Accounting Research.
Xin Deng, Jun-koo Kang, and Buen Sin Low. Corporate Social Responsibility and Stakeholder Value Maximization: Evidence from
Mergers. 2013. Journal of Financial Economics.
Nihat Atkas, Eric de Bodt, and Jean-Gabriel Cousin. Do Financial Markets Care about SRI? Evidence from Mergers and Acquisitions.
2011. Journal of Banking & Finance.
Elroy Dimson, Oğuzhan Karakaş, and Xi Li. Active Ownership. 2015. Review of Financial Studies
Philipp Krüger. Corporate Goodness and Shareholder Wealth. 2015. Journal of Financial Economics.
Allen Ferrell, Hao Liang, and Luc Renneboog. Socially Responsible Firms. 2016. Journal of Financial Economics.
Joshua D. Margolis, Hillary Anger Elfenbein, and James P. Walsh. Does It Pay to Be Good… and Does It Matter? A Meta-Analysis of
the Relationship Between Corporate Social and Financial Performance. 2011. Social Science Research Network.

18. BIBLIOGRAPHY
Christophe C. Geczy, Robert F. Stambaugh, and David Levin. Investing in Socially Responsible Mutual Funds. 2005.
Luc Renneboog, Jenke Ter Horst, and Chendi Zhang. The Price of Ethics and Stakeholder Governance: The Performance of Socially
Responsible Mutual Funds. 2008. Journal of Corporate Finance.
Sadok El Ghoul and Aymen Karoui. Does Corporate Social Responsibility Affect Mutual Fund Performance and Flows? Journal of
Banking & Finance.
Bruno Gerard. ESG and Socially Responsible Investment: A Critical Review. 2018. Social Science Research Network.