Prague Economic Papers 2024, 33(2):137-163 | DOI: 10.18267/j.pep.854

ESG Score Uncertainty and Excess Stock Returns: European Stock Market Case

Michal Vyletelka ORCID...
Prague University of Economics and Business, Faculty of Finance and Accounting, Prague, Czech Republic

The study explores a relationship between divergence in ESG scores (measurements of a company's performance in environmental, social and governance issues) and excess stock returns on the European equity market. The sample consists of 851 European stocks in the period from January 2015 to May 2022. It is concluded that, despite previous findings on the US stock market, a similar effect is not observed for equities in Europe. Even though the stock portfolios with the most and the least divergent ESG scores bear excess returns, the effect disappears when it is adjusted for Fama-French factors. The effect is not relevant for any specific industry, nor does it depend on the level of ESG awareness of the issuer's country. Deeper exploration of the nature of ESG score divergence, specifically by decomposition of the individual elements of ESG scores, could further contribute to the understanding of the relationship between the quality of non-financial disclosures and stock performance.

Keywords: ESG score divergence, excess returns, Fama-French analysis, sustainable finance, ESG investing
JEL classification: E17, G11, G12, G24, M14, Q01, Q56

Received: March 13, 2023; Revised: November 18, 2023; Accepted: November 21, 2023; Published: May 3, 2024  Show citation

ACS AIP APA ASA Harvard Chicago Chicago Notes IEEE ISO690 MLA NLM Turabian Vancouver
Vyletelka, M. (2024). ESG Score Uncertainty and Excess Stock Returns: European Stock Market Case. Prague Economic Papers, 33(2), 137-163. doi: 10.18267/j.pep.854
Download citation
  • BibTeX (.bib)
  • Bookends (.ris)
  • EasyBib (.ris)
  • EndNote (.enw)
  • EndNote 8 (.xml)
  • ISI WoS (.isi)
  • Medlars (.medlars)
  • Mendeley (.ris)
  • MODS (.xml)
  • Papers (.ris)
  • RefWorks (.txt)
  • RefManager (.ris)
  • RIS (.ris)
  • MS Word (.xml)
  • Zotero (.ris)
    • Open full article

    References

    1. Avramov, D., Cheng, S., Lioui, A., Tarelli, A. (2022). Sustainable Investing with ESG Rating Uncertainty. Journal of Financial Economics, 145(2), 642-664. https://doi.org/10.1016/j.jfineco.2021.09.009 Go to original source...
    2. Bae, K. H., El Ghoul, S., Gong, Z. J., Guedhami, O. (2021). Does CSR Matter in Times of Crisis? Evidence from the COVID-19 Pandemic. Journal of Corporate Finance, 67, 101876. https://doi.org/ 10.1016/ j.jcorpfin.2020.101876 Go to original source...
    3. Bajic, S., Yurtoglu, B. (2018). Which Aspects of CSR Predict Firm Market Value? Journal of Capital Markets Studies, 2(1), 50-69. https://doi.org/10.1108/JCMS-10-2017-0002 Go to original source...
    4. Barko, T., Cremers, M., Renneboog, L. (2021). Shareholder Engagement on Environmental, Social, and Governance Performance. Journal of Business Ethics, 1-36. https://doi.org/10.1007/s10551-021-04850-z Go to original source...
    5. Barth, F., Hübel, B., Scholz, H. (2022). ESG and Corporate Credit Spreads. Journal of Risk Finance, 23(2), 169-190. https://doi.org/10.1108/JRF-03-2021-0045 Go to original source...
    6. Bénabou, R., Tirole, J. (2010). Individual and Corporate Social Responsibility. Economica, 77(305), 1-19. https://doi.org/10.1111/j.1468-0335.2009.00843.x Go to original source...
    7. Bentley, J. W., Lambert, T. A., Wang, E. (2021). The Effect of Increased Audit Disclosure on Managers' Real Operating Decisions: Evidence from Disclosing Critical Audit Matters. The Accounting Review, 96(1), 23-40. https://doi.org/10.2308/tar-2017-0486 Go to original source...
    8. Berg, F., Koelbel, J. F., Rigobon, R. (2022). Aggregate Confusion: The Divergence of ESG Ratings. Review of Finance, 26(6), 1315-1344. https://doi.org/10.1093/rof/rfac033 Go to original source...
    9. Biddle, G. C., Hilary, G. (2006). Accounting Quality and Firm-level Capital Investment. The Accounting Review, 81(5), 963-982. https://doi.org/10.2308/accr.2006.81.5.963 Go to original source...
    10. Biddle, G. C., Hilary, G., Verdi, R. S. (2009). How Does Financial Reporting Quality Relate to Investment Efficiency? Journal of Accounting and Economics, 48(2-3), 112-131. https://doi.org/10.1016/j.jacc eco.2009.09.00 Go to original source...
    11. Bolton, P., Kacperczyk, M. T. (2020). Carbon Premium Around the World. CEPR Discussion Paper No. DP14567.
    12. Brandon, R., Krueger, P., Mitali, S. F. (2020). The Sustainability Footprint of Institutional Investors: ESG Driven Price Pressure and Performance. Swiss Finance Institute Research Paper, (17-05).
    13. Brandon, R., Krueger, P., Schmidt, P. S. (2021). ESG Rating Disagreement and Stock Returns. Financial Analysts Journal, 77(4), 104-127. https://doi.org/10.1080/0015198X.2021.1963186 Go to original source...
    14. Camilleri, M. A. (2020). The Market for Socially Responsible Investing: a Review of the Developments. Social Responsibility Journal, 17(3), 412-428. https://doi.org/10.1108/SRJ-06-2019-0194 Go to original source...
    15. Carhart, M. M. (1997). On Persistence in Mutual Fund Performance. Journal of Finance, 52(1), 57-82. https://doi.org/10.1111/j.1540-6261.1997.tb03808.x Go to original source...
    16. Chatterji, A. K., Durand, R., Levine, D. I., Touboul, S. (2016). Do Ratings of Firms Converge? Implications for Managers, Investors and Strategy Researchers. Strategic Management Journal, 37(8), 1597-1614. https://doi.org/10.1002/smj.2407 Go to original source...
    17. Christensen, D. S., Serafeim, G., Sikochi, A. (2019). Why Is Corporate Virtue in the Eye of the Beholder? The Case of ESG Ratings. Harvard Business School (No. 20-084).
    18. Climate Bonds Initiative. (2016). Bonds and Climate Change: State of the Market 2016. Climate Bonds Initiative and HSBC Climate Change Centre of Excellence.
    19. Climate Bonds Initiative. (2022). Sustainable Debt. Global State of the Market 2021. London.
    20. Cornell, B. (2021). ESG Preferences, Risk and Return. European Financial Management, 27(1), 12-19. https://doi.org/10.1111/eufm.12295 Go to original source...
    21. Crespi, F., Migliavacca, M. (2020). The Determinants of ESG Rating in the Financial Industry: The Same Old Story or a Different Tale? Sustainability, 12(16), 6398. https://doi.org/10.3390/su12166398 Go to original source...
    22. Crous, C., Battisti, E., Leonidou, E. (2022). Non-financial Reporting and Company Financial Performance: A Systematic Literature Review and Integrated Framework. EuroMed Journal of Business, 17(4), 652-676. https://doi.org/10.1108/EMJB-12-2020-0134 Go to original source...
    23. Di Giuli, A., Kostovetsky, L. (2014). Are Red or Blue Companies More Likely to Go Green? Politics and Corporate Social Responsibility. Journal of Financial Economics, 111(1), 158-180. https://doi.org/10.1016/j.jfineco.2013.10.002 Go to original source...
    24. Daugaard, D. (2020). Emerging New Themes in Environmental, Social and Governance Investing: A Systematic Literature Review. Account Finance, 60, 1501-1530. https://doi.org/10.1111/acfi.12479 Go to original source...
    25. Derwall, J., Guenster, N., Bauer, R., Koedijk, K. (2005). The Eco-Efficiency Premium Puzzle. Financial Analysts Journal, 61(2), 51-63. https://doi.org/10.2469/faj.v61.n2.2716 Go to original source...
    26. Derwall, J., Koedijk, K. (2009). Socially Responsible Fixed-income Funds. Journal of Business Finance & Accounting, 36(1-2), 210-229. https://doi.org/10.1111/j.1468-5957.2008.02119.x Go to original source...
    27. Dhaliwal, D. S., Li, O. Z., Tsang, A., Yang, Y. G. (2011). Voluntary Nonfinancial Disclosure and the Cost of Equity Capital: The Initiation of Corporate Social Responsibility Reporting. The Accounting Review, 86(1), 59-100. https://doi.org/10.2308/accr.00000005 Go to original source...
    28. Dhaliwal, D., Li, O. Z., Tsang, A., Yang, Y. G. (2014). Corporate Social Responsibility Disclosure and the Cost of Equity Capital: The Roles of Stakeholder Orientation and Financial Transparency. Journal of Accounting and Public Policy, 33(4), 328-355. https://doi.org/10.1016/j.jaccpubpol.2014.04.006 Go to original source...
    29. Dimson, E., Karakaº, O., Li, X. (2015). Active Ownership. Review of Financial Studies, 28(12), 3225-3268. https://doi.org/10.1093/rfs/hhv044 Go to original source...
    30. Dorfleitner, G., Halbritter, G., Nguyen, M. (2015). Measuring the Level and Risk of Corporate Responsibility - An Empirical Comparison of Different ESG Rating Approaches. Journal of Asset Management, 16, 450-466. https://doi.org/10.1057/jam.2015.31 Go to original source...
    31. Douglas, E., Van Holt, T., Whelan, T. (2017). Responsible Investing: Guide to ESG Data Providers and Relevant Trends. Journal of Environmental Investing, 8(1), 91-114.
    32. Edmans, A. (2011). Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices. Journal of Financial Economics, 101(3), 621-640. https://doi.org/10.1016/j.jfineco.2011.03.021 Go to original source...
    33. Edwards, T. (2013a). Employee Responses to Changing Aspects of the Employer Brand Following a Multinational Acquisition: A Longitudinal Study. Human Resources Management, 52, 27-54. https://doi.org/10.1002/hrm.21519 Go to original source...
    34. Edwards, T. (2013b). Multinational Companies in Cross-National Context: Integration, Differentiation, and the Interactions between MNCS and Nation States: Introduction to a Special Issue of the ILR Review. ILR Review, 66(3), 547-587. https://doi.org/10.1177/001979391306600301 Go to original source...
    35. Eichholtz, P., Kok, N., Quigley, J. M. (2010). Doing Well by Doing Good? Green Office Buildings. American Economic Review, 100(5), 2492-2509. https://doi.org/10.1257/aer.100.5.2492 Go to original source...
    36. Eichholtz, P., Kok, N., Quigley, J. M. (2013). The Economics of Green Building. Review of Economics and Statistics, 95(1), 50-63. https://doi.org/10.1162/REST_a_00291 Go to original source...
    37. El Ghoul, S., Guedhami, O., Kwok, C. C., Mishra, D. R. (2011). Does Corporate Social Responsibility Affect the Cost of Capital? Journal of Banking & Finance, 35(9), 2388-2406. https://doi.org/10.1016/j.jbankfin.2011.02.007 Go to original source...
    38. Elliott, W. B., Jackson, K. E., Peecher, M. E., White, B. J. (2014). The Unintended Effect of Corporate Social Responsibility Performance on Investors' Estimates of Fundamental Value. The Accounting Review, 89(1), 275-302. https://doi.org/10.2308/accr-50577 Go to original source...
    39. Epstein, M. J. (2008). Making Sustainability Work: Best Practices in Managing and Measuring Corporate Social, Environmental and Economic Impacts (1st ed.). Routledge. ISBN 978-1576754863.
    40. Fama, E. F., French, K. R. (1993). Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics, 33(1), 3-56. Go to original source...
    41. Fama, E. F., French, K. R. (2017). International Tests of a Five-factor Asset Pricing Model. Journal of Financial Economics, 123(3), 441-463. Go to original source...
    42. Flammer, C. (2013). Corporate Social Responsibility and Shareholder Reaction: The Environmental Awareness of Investors. Academy of Management Journal, 56(3), 758-781. https://doi.org/10.5465/amj.2011.0744 Go to original source...
    43. Friede G., Busch T., Bassen A. (2015). ESG and Financial Performance: Aggregated Evidence from More Than 2000 Empirical Studies. Journal of Sustainable Finance & Investment, 5(4), 210-233. https://doi.org/10.1080/20430795.2015.1118917 Go to original source...
    44. Girerd-Potin, I., Jimenez-Garces, S., Louvet, P. (2011). The Link Between Social Rating and Financial Capital Structure. FINANCE, 322(2), 9-52. https://doi.org/10.3917/fina.322.0009 Go to original source...
    45. Goss, A., Roberts, G. S. (2011). The Impact of Corporate Social Responsibility on the Cost of Bank Loans. Journal of Banking & Finance, 35(7), 1794-1810. https://doi.org/10.1016/j.jbankfin.2010.12.002 Go to original source...
    46. Gubler, T., Larkin, I., Pierce, L. (2018). Doing Well by Making Well: The Impact of Corporate Wellness Programs on Employee Productivity. Management Science, 64(11), 4967-4987. https://doi.org/10.1287/mnsc.2017.2883 Go to original source...
    47. Guenster, N., Bauer, R., Derwall, J., Koedijk, K. (2011). The Economic Value of Corporate Eco-efficiency. European Financial Management, 17(4), 679-704. https://doi.org/10.1111/j.1468-036X.2009.00532.x Go to original source...
    48. Gyönyörová, L., Stachoò, M., Sta¹ek, D. (2021). ESG Ratings: Relevant Information or Misleading Clue? Evidence from the S&P Global 1200. Journal of Sustainable Finance & Investment, 1-35. https://doi.org/10.1080/20430795.2021.1922062 Go to original source...
    49. Hamilton, S., Jo, H., Statman, M. (1993). Doing Well While Doing Good? The Investment Performance of Socially Responsible Mutual Funds. Financial Analysts Journal, 49(6), 62-66. https://doi.org/10.2469/faj.v49.n6.62 Go to original source...
    50. Heinkel, R., Kraus, A., Zechner, J. (2001). The Effect of Green Investment on Corporate Behavior. Journal of Financial and Quantitative Analysis, 36(4), 431-449. https://doi.org/10.2307/2676219 Go to original source...
    51. Huber, B. M., Comstock, M., Polk, D., Wardwell, L. L. P. (2017). ESG Reports and Ratings: What They Are, Why They Matter. Corporate Governance Advisor, 25(5), 1-12.
    52. Ilhan, E., Sautner, Z., Vilkov, G. (2021). Carbon Tail Risk. Review of Financial Studies, 34(3), 1540-1571. https://doi.org/10.1093/rfs/hhaa071 Go to original source...
    53. Kotsantonis, S., Serafeim, G. (2019). Four Things No One Will Tell You About ESG Data. Journal of Applied Corporate Finance, 31(2), 50-58. https://doi.org/10.1111/jacf.12346 Go to original source...
    54. Li, F. (2008). Annual Report Readability, Current Earnings, and Earnings Persistence. Journal of Accounting and Economics, 45(2-3), 221-247. https://doi.org/10.1016/j.jacceco.2008.02.003 Go to original source...
    55. Li T.-T., Wang K., Sueyoshi T., Wang D.-D. (2020) ESG: Research Progress and Future Prospects. Sustainability, 13(21), 11663. https://doi.org/10.3390/su132111663 Go to original source...
    56. Lins, K. V., Servaes, H., Tamayo, A. (2017). Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis. Journal of Finance, 72, 1785-1824. https://doi.org/10.1111/jofi.12505 Go to original source...
    57. Margolis, J. Elfenbein, H., Walsh, J. (2009). Does it Pay to Be Good...And Does it Matter? A Meta-Analysis of the Relationship between Corporate Social and Financial Performance. Go to original source...
    58. Matos, P. (2020). ESG and Responsible Institutional Investing Around the World: A Critical Review. ISBN: 978-1944960971. Go to original source...
    59. Matsumura, E. M., Prakash, R., Vera-Munoz, S. C. (2014). Firm-value Effects of Carbon Emissions and Carbon Disclosures. The Accounting Review, 89(2), 695-724. https://doi.org/10.2308/accr-50629 Go to original source...
    60. Menz, K. M. (2010). Corporate Social Responsibility: Is It Rewarded by the Corporate Bond Market? A Critical Note. Journal of Business Ethics, 96(1), 117-134. https://doi.org/10.1007/s10551-010- 0452-y Go to original source...
    61. Moroney, R., Trotman, K. T. (2016). Differences in Auditors' Materiality Assessments When Auditing Financial Statements and Sustainability Reports. Contemporary Accounting Research, 33(2), 551-575. https://doi.org/10.1111/1911-3846.12162 Go to original source...
    62. Nyame-Asiamah, F., Ghulam, S. (2020). The Relationship between CSR Activity and Sales Growth in the UK Retailing Sector. Social Responsibility Journal, 16(3), 387-401. https://doi.org/10.1108/SRJ-09-2018-0245 Go to original source...
    63. Painter, M. (2020). An Inconvenient Cost: The Effects of Climate Change on Municipal Bonds. Journal of Financial Economics, 135(2), 468-482. https://doi.org/10.1016/j.jfineco.2019.06.006 Go to original source...
    64. Pástor, ¥., Stambaugh, R. F., Taylor, L. A. (2021). Sustainable Investing in Equilibrium. Journal of Financial Economics, 142(2), 550-571. https://doi.org/10.1016/j.jfineco.2020.12.011 Go to original source...
    65. Pedersen, L. H., Fitzgibbons, S., Pomorski, L. (2021). Responsible Investing: The ESG-efficient Frontier. Journal of Financial Economics, 142(2), 572-597. https://doi.org/10.1016/j.jfineco.2020.11.001 Go to original source...
    66. Revelli, C., Viviani, J. L. (2015). Financial Performance of Socially Responsible Investing (SRI): What Have We Learned? A Meta-analysis. Business Ethics: A European Review, 24(2), 158-185. https://doi.org/10.1111/beer.12076 Go to original source...
    67. Sachs, J., Kroll, C., Lafortune, G., Fuller, G., Woelm, F. (2022). Sustainable Development Report 2022. Cambridge University Press.
    68. Semenova, N., Hassel, L. G. (2015). On the Validity of Environmental Performance Metrics. Journal of Business Ethics, 132, 249-258. https://doi.org/10.1007/s10551-014-2323-4 Go to original source...
    69. Serafeim, G., Yoon, A. (2022). Which Corporate ESG News Does the Market React To? Financial Analysts Journal, 78(1), 59-78. https://doi.org/10.1080/0015198X.2021.1973879 Go to original source...
    70. UN. (2022). Annual Report 2021. London.
    71. Velte, P. (2021). Meta-Analyses on Corporate Social Responsibility (CSR): A Literature Review. Management Review Quarterly, 72, 627-675. https://doi.org/10.1007/s11301-021-00211-2 Go to original source...
    72. Waheed, A, Yang, J. (2019). Effect of Corporate Social Responsibility Disclosure on Firms' Sales Performance: A Perspective of Stakeholder Engagement and Theory. Corporate Social Responsibility and Environmental Management, 26, 559-566. https://doi.org/10.1002/csr.1701 Go to original source...
    73. Widyawati, L. (2021). Measurement Concerns and Agreement of Environmental Social Governance Ratings. Account Finance, 61, 1589-1623. https://doi.org/10.1111/acfi.12638 Go to original source...
    74. Wong, C., Brackley, A., Petroy, E. (2019). Rate the Raters 2019: Expert Views on ESG ratings. Sustainability.
    75. Yannan, D., Ahmed, A. A. A., Kuo, T. H., Malik, H. A., Nassani, A. A., Haffar, M., Iramofu, D. P. F. (2022). Impact of CSR, Innovation, and Green Investment on Sales Growth: New Evidence from Manufacturing Industries of China and Saudi Arabia. Economic Research-Ekonomska Istra¾ivanja, 35(1), 4537-4556. https://doi.org/10.1080/1331677X.2021.2015610 Go to original source...

    This is an open access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License (CC BY NC ND 4.0), which permits non-comercial use, distribution, and reproduction in any medium, provided the original publication is properly cited. No use, distribution or reproduction is permitted which does not comply with these terms.


    Return to the content