The Contributions of Betas versus Characteristics to the ESG Premium
34 Pages Posted: 20 Dec 2019 Last revised: 3 Aug 2022
Date Written: November 21, 2019
Firms that score low on environmental, social, and governance (ESG) indicators exhibit higher expected returns. This negative ESG premium might be driven by higher risk associated with low ESG scores, or it could signal investors’ preferences for firms with high ESG scores. The first driver implies an underlying, systematic ESG risk factor, such that ESG risk factor betas explain differences in expected returns. The second driver implies that firm-specific ESG characteristics explain the ESG premium. To identify the separate contributions of ESG betas and ESG characteristics for explaining variation in expected returns, this study uses two global data sets from 2004-2018 and reveals that ESG characteristics mainly explain variation in expected returns. A one standard deviation decrease in ESG scores is associated with an increase of 13 basis points in monthly expected returns. This study also sheds new light on how the term structure of the ESG premium has changed over time.
Keywords: Socially Responsible Investment, ESG Premium, EIV Correction
JEL Classification: G11, C58
Suggested Citation: Suggested Citation