Impact of ESG Factors on Emerging Market Stock Returns

Abstract

Empirical evidence indicates that environmental, social, and governance (ESG) practices are associated with a company’s financial performance, but little has been mentioned about investors’ attention toward stock performance. In this article, the authors conduct a test of the relationship between ESG performance disclosures and a company’s financial or capital market performance. They choose a stratified sample of large-cap companies across eight sectors drawn from the S&P 100 from 2016–2021. The changes in ESG ratings—namely, for governance and the environment—exhibit a small but significant impact on the stock’s performance. Their results show that a few ESG disclosures are positively related and dominate over the usual company-level determinants of return on assets. They find corporate governance practices to be more significant than climate change disclosures. These outcomes are robustly demonstrated on use cases of top stocks with investor safety recommendations. The results could have useful implications for investors, fund managers, and regulators.

Key Findings

• ▪ This article outlines a method for valuing climate risk assets and reviews the relationship between financial performance and ESG performance disclosures.

• ▪ The research emphasizes the importance of integrating ESG disclosures into portfolio construction.

• ▪ The authors show that corporate governance practices are more impactful than climate change disclosures.