Biodiversity Confusion: The Impact of ESG Biodiversity Ratings on Asset Prices

Abstract

The biodiversity components of ESG ratings are analysed to understand whether and how this disclosure mechanism can affect investment decisions, improve outcomes for biodiversity and nature or lead to better management of nature based risks. We analyse the relationship between stock returns and firms’ biodiversity ratings and how biodiversity ratings are related to firm characteristics. We conclude that biodiversity ratings are largely uncorrelated to firm characteristics other than via firm size, and do not predict stock returns. Analysis of operating performance sheds light on why: return on asset and profit margins are not affected by biodiversity ratings. Systematic risk, idiosyncratic risk and firm valuation are also not influenced by overall biodiversity performance, except that biodiversity exposure increases firm systematic risk. The effect is heterogeneous across industries though: biodiversity ratings predict negative returns in metals and mining but positive returns in utilities. Further, institutional investors and sell-side analysts are shown to ignore biodiversity ratings in their decision-making. A suite of tests suggests that biodiversity as measured in ESG ratings does not appear to provide useful additional information for financial decision makers. It is difficult to see how, on its own at least, the measurement and disclosure of biodiversity via ESG ratings currently helps achieve any target related to biodiversity and nature recovery or improves the management of nature-based risks.

Keywords: ESG, Biodiversity, Nature, Disclosure, Finance, Asset Pricing, Risk

JEL Classification: G12, G14, G23, Q56, Q57