Repeat Offenders: ESG Incident Recidivism and Investor Underreaction

Abstract

This paper captures poor environmental, social, and governance (ESG) practices based on a firm’s history of negative ESG incidents. I find that firms’ past ESG incident rates predict more future incidents, weaker profitability, and lower risk-adjusted stock returns. These abnormal returns are consistent with markets underreacting to incidents, as past incident rates also predict larger analyst forecast errors, more negative stock price reactions when firms announce their quarterly earnings or have subsequent incidents, and more pronounced abnormal returns in firms with weaker investor attention. I further document that ESG-aware mutual funds profit from this underreaction. Overall, these findings suggest that the negative long-term value implications of poor ESG practices are not fully reflected in stock prices.

Keywords: ESG incidents, Corporate sustainability, Corporate social responsibility, Socially responsible investment, Managerial myopia, Limited investor attention

JEL Classification: G11, G14, M14