Why Investors Prioritize ESG-Related News for Returns
Investors are increasingly paying attention to news about a company’s environmental, social, and governance activities. A recent study co-authored by Professor Edward Watts explores how retail investors react to this type of information, shedding light on how these factors influence investment decisions.
In the United States, the Securities and Exchange Commission has implemented rules that require companies to disclose climate-related risks to help investors make informed choices. However, some states have taken a different approach, pushing for public pension funds to focus solely on financial returns and preventing them from avoiding fossil fuel investments or making decisions based on environmental, social, and governance (ESG) considerations.
Professor Watts’ study, which was referenced in the new SEC rules, provides insights that are relevant to both sides of the debate. The research reveals that individual retail investors are already making investment decisions based on ESG factors, but interestingly, it appears that they do so for financial reasons rather than purely ethical ones.
The study, conducted by Professor Watts along with Stanford PhD student Qianqian Li and Christina Zhu from the Wharton School, analyzed the behavior of retail investors in response to over 54,000 ESG-related news events affecting nearly 3,300 publicly traded firms between 2015 and 2022. The findings show that retail trading increases by 6% on days with ESG-related news compared to non-event days (and by 8% post-2020).
The researchers delved deeper into understanding why trading activity spiked. They discovered that investors tend to buy securities when the news is favorable for their stock’s performance and sell when it has negative implications. For example, more investors sold Boeing stock after the 737 Max scandal settlement, which had a negative impact on performance. Conversely, investors also sold Occidental Petroleum shares after the company announced increased clean energy investments, even though the news was seemingly positive for ESG but coincided with a stock price drop.
Professor Watts uses an extreme hypothetical example in his ESG investing class to emphasize that investors prioritize returns. He explains that while it may be socially responsible to raise employees’ salaries significantly, the stock price would likely plummet, discouraging investors.
The study contributes valuable insights to the ESG investing landscape by providing empirical evidence of how retail investors react to ESG-related information in their investment decisions. The research indicates that ESG information influences investment behavior, but primarily in the context of how it impacts portfolios rather than purely ethical considerations.
Overall, investors treat ESG information similarly to other data that affects their returns. The authors suggest that ESG is essential but not extraordinary, advocating against bans on considering ESG and cautioning against assuming that investors prioritize ESG for non-financial reasons.
Professor Watts believes that the politicization of ESG has fueled contentious debates and calls for a more balanced perspective on the significance of ESG factors in investment decisions. Ultimately, the study encourages a nuanced understanding of how investors respond to ESG-related news and underscores the importance of considering all relevant factors in investment strategies.
