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We raise some critical points against a naïve interpretation of “green finance” products and strategies. These critical insights are the background against which we take a closer look at instruments and policies that might allow green finance to become more impactful. In particular, we focus on the role of a taxonomy and investor activism. We also describe the interaction of government policies with green finance practice – an aspect, which has been mostly neglected in policy debates but needs to be taken into account. Finally, the special case of green government bonds is discussed.
We present evidence on the way personal and institutional factors could together guide public company directors in decision-making concerning shareholders and stakeholders. In a sample comprising more than nine hundred directors originating from over fifty countries and serving in firms from twenty three countries, we confirm that directors around the world hold a principled, quasi-ideological stance towards shareholders and stakeholders, called shareholderism, on which they vary in line with their personal values. We theorize and find that in addition to personal values, directors’ shareholderism level associates with cultural norms that are conducive to entrepreneurship. Among legal factors, only creditor protection exhibits a negative correlation with shareholderism, while general legal origin and proxies for shareholder and employee protection are unrelated to it.
We study the design features of disclosure regulations that seek to trigger the green transition of the global economy and ask whether such regulatory interventions are likely to bring about sufficient market discipline to achieve socially optimal climate targets.
We categorize the transparency obligations stipulated in green finance regulation as either compelling the standardized disclosure of raw data, or providing quality labels that signal desirable green characteristics of investment products based on a uniform methodology. Both categories of transparency requirements can be imposed at activity, issuer, and portfolio level.
Finance theory and empirical evidence suggest that investors may prefer “green” over “dirty” assets for both financial and non-financial reasons and may thus demand higher returns from environmentally-harmful investment opportunities. However, the market discipline that this negative cost of capital effect exerts on “dirty” issuers is potentially attenuated by countervailing investor interests and does not automatically lead to socially optimal outcomes.
Mandatory disclosure obligations and their (public) enforcement can play an important role in green finance strategies. They prevent an underproduction of the standardized high-quality information that investors need in order to allocate capital according to their preferences. However, the rationale behind regulatory intervention is not equally strong for all categories and all levels of “green” disclosure obligations. Corporate governance problems and other agency conflicts in intermediated investment chains do not represent a categorical impediment for green finance strategies.
However, the many forces that may prevent markets from achieving socially optimal equilibria render disclosure-centered green finance legislation a second best to more direct forms of regulatory intervention like global carbon taxation and emissions trading schemes. Inherently transnational market-based green finance concepts can play a supporting role in sustainable transition, which is particularly important as long as first-best solutions remain politically unavailable.
The salience of ESG ratings for stock pricing: evidence from (potentially) confused investors
(2021)
We exploit the a modification to Sustainanlytics’ environmental, social, and governance (ESG) rating methodology, which is subsequently adopted by Morningstar, to study whether ESG ratings are salient for stock pricing. We show that the inversion of the rating scale but not new information leads some investors to make incorrect assessments about the meaning of the change in ESG ratings. They buy (sell) stocks they misconceive as ESG upgraded (downgraded) even when the opposite is true. This trading behavior exerts transitory price pressure on affected stocks. Our paper highlights the importance of ESG ratings for investors and consequently for asset prices.
Doing safe by doing good : ESG investing and corporate social responsibility in the U.S. and Europe
(2019)
This paper examines the profitability of investing according to environmental, social and governance (ESG) criteria in the U.S. and Europe. Based on data from 2003 to 2017, we show that a portfolio long in stocks with the highest ESG scores and short in those with the lowest scores yields a significantly negative abnormal return. Interestingly, this is caused by the strong positive return of firms with the lowest ESG activity. As we find that increasing ESG scores reduce firm risk (particularly downside risk), this hints at an insurance-like character of corporate social responsibility: Firms with low ESG activity need to offer a corresponding risk premium. The perception of ESG as an insurance can be shown to be stronger in more volatile capital markets for U.S. firms, but not for European firms. Socially responsible investment may therefore be of varying attractiveness in different market phases.