ESG Confusion and Stock Returns: Tackling the Problem of Noise

69 Pages Posted: 17 Oct 2022 Last revised: 31 Jan 2023

See all articles by Florian Berg

Florian Berg

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Julian Koelbel

University of St. Gallen

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 2022

Abstract

How does ESG (environmental, social, and governance) performance affect stock returns? Answering this question is difficult because existing measures of ESG perfor- mance — ESG ratings — are noisy and, therefore, standard regression estimates suffer from attenuation bias. To address the bias, we propose two noise-correction procedures, in which we instrument ESG ratings with ratings of other ESG rating agencies, as in the classical errors-in-variables problem. The corrected estimates demonstrate that the effect of ESG performance on stock returns is stronger than previously estimated: after correcting for attenuation bias, the coefficients increase on average by a factor of 2.6, implying an average noise-to-signal ratio of 61.7%. The attenuation bias is stable across horizons at which stock returns are measured. In simulations, our noise-correction pro- cedures outperform the standard approaches followed by practitioners such as averages or principal component analysis.

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Suggested Citation

Berg, Florian and Koelbel, Julian and Pavlova, Anna and Rigobon, Roberto, ESG Confusion and Stock Returns: Tackling the Problem of Noise (October 2022). NBER Working Paper No. w30562, Available at SSRN: https://ssrn.com/abstract=4249591 or http://dx.doi.org/10.2139/ssrn.4249591

Florian Berg (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Julian Koelbel

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Anna Pavlova

London Business School ( email )

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Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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