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We examine whether the uncertainty related to environmental, social, and governance (ESG) regulation developments is reflected in asset prices. We proxy the sensitivity of firms to ESG regulation uncertainty by the disparity across the components of their ESG ratings. Firms with high ESG disparity have a higher option-implied cost of protection against downside tail risk. The impact of the misalignment across the different dimensions of the ESG score is distinct from that of ESG score level itself. Aggregate downside risk bears a negative price for firms with low ESG disparity.
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.
The transition to a sustainable economy currently involves a fundamental transformation of our capital markets. Lawmakers, in an attempt to overcome this challenge, frequently seek to prescribe and regulate how firms may address environmental, social, and governance (ESG) concerns by formulating conduct standards. Deviating from this conceptual starting point, the present paper makes the case for another path towards achieving greater sustainability in capital markets, namely through the empowerment of investors.
This trust in the market itself is grounded in various recent developments both on the supply side and the demand side of financial markets, and also in the increasing tendency of institutional investors to engage in common ownership. The need to build coalitions among different types of asset managers or institutional investors, and to convince fellow investors of a given initiative, can then act as an in-built filter helping to overcome the pursuit of idiosyncratic motives and supporting only those campaigns that are seconded by a majority of investors. In particular, institutionalized investor platforms have emerged over recent years as a force for investor empowerment, serving to coordinate investor campaigns and to share the costs of engagement.
ESG engagement has the potential to become a very powerful driver towards a more sustainability-oriented future. Indeed, I show that investor-led sustainability has many advantages compared to a more prescriptive, regulatory approach where legislatures are in the driver’s seat. For example, a focus on investor-led priorities would follow a more flexible and dynamic pattern rather than complying with inflexible pre-defined criteria. Moreover, investor-promoted assessments are not likely to impair welfare creation in the same way as ill-defined legal standards; they will also not trigger regulatory arbitrage and would avoid deadlock situations in corporate decision-making. Any regulatory activity should then be limited to a facilitative and supportive role.
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.
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.