The Price of Ignoring ESG Risks

Abstract

This paper finds that environmental, social, and governance (ESG) risks generate negative long-run stock returns. A value-weighted U.S. portfolio of controversial firms with a known history of ESG incidents exhibits a four-factor alpha of -3.5% per year, even when controlling for other risk factors, industries, or firm characteristics. The negative alpha stems from recurrent ESG incidents and from negative earnings surprises. These findings make three contributions. First, stock markets fail to fully incorporate value-relevant ESG information into investment decisions. Second, weak corporate social responsibility destroys shareholder value. Third, excluding controversial firms is a socially responsible investment screen that may improve investment performance.

Keywords: Environmental Social and Governance Risks, Corporate Social Responsibility, Controversial Firms, Market Efficiency, Socially Responsible Investment

JEL Classification: G11, G14, M14