The Expected Returns of ESG Excluded Stocks. Shocks to Firms Costs of Capital? Evidence From the World’s Largest Fund

We investigate the link between ESG-based portfolio exclusions and the expected returns of excluded firms. The exclusions of Norway's "Oil Fund," the world's largest SWF, provide a sample of stocks that face widespread exclusions by institutional investors. The portfolio of excluded firms have significantly superior performance (alpha) of about 5%. Excluded stocks have a return premium, as predicted by e.g. Pastor et.al (2021). Investigating the corporate reactions to exclusion, we find that companies with low ESG score at the time of exclusion (scope for improvement), and higher revenue growth (investment needs) are more likely to get their exclusion revoked, which we interpret as evidence of dynamics: Firms improve their ESG to revoke exclusions and achieve lower cost of capital. In fact, firms that get off the exclusion list do not have superior performance going forward.

Keywords: ESG investing; Exclusion; Cost of Capital

JEL Classification: G10; G20

Suggested Citation: Suggested Citation

Berle, Erika Christie and He, Wangwei and Ødegaard, Bernt Arne, The Expected Returns of ESG Excluded Stocks. Shocks to Firms Costs of Capital? Evidence From the World’s Largest Fund (June 30, 2023). Available at SSRN: https://ssrn.com/abstract=4095395 or http://dx.doi.org/10.2139/ssrn.4095395