Investor Sentiment and the Time-varying Sustainability Premium

Abstract

Studies show inconclusive results regarding the relation between corporate social and environmental responsibility (CSR and CER) and expected returns. We argue that the reason for these mixed results is that the sustainability premium (i.e., the return difference of high-intensity minus low-intensity CSR/CER firms) is time-varying and correlated with investor sentiment. We find that high-intensity CSR (CER) firms have a monthly excess return that is 0.70 (0.88) p.p. higher following periods of low investor sentiment as compared to periods of high sentiment. Given that standard pricing factors cannot fully explain the abnormal returns caused by investor sentiment on the sustainability premium, we propose a sustainability pricing factor, estimated as the second principal component of portfolios sorted based on environmental and social variables, which corrects this mispricing.

Keywords: sustainability, corporate social responsibility, corporate environmental responsibility, expected returns, financial performance, investor sentiment

JEL Classification: G12, G19, M41