Capital Market Reactions to ESG Materiality Classifications

Abstract

We investigate the capital market reactions to the publication of the Sustainability Accounting Standards Board’s (SASB) standards on the financial materiality of environmental, social, and governance (ESG) issues. We argue that the SASB’s participatory standard-setting process leads to a classification system that provides a prioritization framework based on second-order observation by representing relevant stakeholders’ views. As no comparable framework was previously available to investors, we expect the publications of the standards to reduce the uncertainty about and clarify the prioritization of ESG issues’ financial materiality, which affects investors’ assessments of firms’ ESG ratings. We employ an event study design exploiting the staggered release of sector-specific standards from 2013 to 2016 and find a short-term negative capital market reaction following their publication, particularly for event sector firms with lower material than overall ESG performance. Our findings indicate that the SASB standards and their embedded ESG classifications influence investors’ weighting of ESG issues vis à vis each other, leading to short-term changes in their firm value assessments.

Keywords: Accounting standards, ESG, materiality, SASB, event study