Material ESG Alpha: A Fundamentals-Based Perspective

The Accounting Review, Forthcoming

52 Pages Posted: 17 Jan 2024 Last revised: 27 Feb 2024

See all articles by Byung Hyun Ahn

Byung Hyun Ahn

University of California, Berkeley - Haas School of Business

Panos N. Patatoukas

University of California, Berkeley - Haas School of Business

George S. Skiadopoulos

University of Piraeus, Department of Banking and Financial Management; Queen Mary, University of London, School of Economics and Finance

Date Written: January 4, 2024

Abstract

Using SASB’s materiality framework, prior research finds alpha for the portfolio of firms with improving ratings on material ESG issues. We replicate this finding and provide a fundamentals-based perspective on why the materiality portfolio outperforms. Our basic premise is that changes in material ESG issues reflect fundamental firm characteristics. More financially established firms—firms with larger size, lower growth, and higher profitability relative to their sector—are more likely to not only create material strengths but also resolve material weaknesses in their ESG scoring. This fundamental link dictates that one should comprehensively control for fundamental determinants of stock returns before attributing portfolio outperformance to improving material ESG scores. Indeed, we find that the materiality portfolio does not generate alpha after we account for its exposure to profitability and growth factors. Our evidence underscores the issue of correlated omitted fundamental factors in the debate of ESG alpha.

Keywords: SASB, Sustainability Reporting, Materiality, ESG, Alpha, Fundamentals

JEL Classification: G11, G12, G14, M14, M41, Q51

Suggested Citation

Ahn, Byung Hyun and Patatoukas, Panos N. and Skiadopoulos, George and Skiadopoulos, George, Material ESG Alpha: A Fundamentals-Based Perspective (January 4, 2024). The Accounting Review, Forthcoming , Available at SSRN: https://ssrn.com/abstract=4684380

Byung Hyun Ahn

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Panos N. Patatoukas (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

HOME PAGE: http://https://sites.google.com/berkeley.edu/panos

George Skiadopoulos

University of Piraeus, Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

HOME PAGE: http://https://sites.google.com/view/george-skiadopoulos

Queen Mary, University of London, School of Economics and Finance

Lincoln's Inn Fields
Mile End Rd.
London, E1 4NS
United Kingdom

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