How engaging with stakeholders on ESG reduces “downside risk”

Here’s this note from Alex Edmans:

“ESG Shareholder Engagement and Downside Risk” is published in the current issue of the Review of Finance. The authors obtain proprietary data on 1,443 ESG engagements by a large UK institutional investor and find the following:

1. ESG engagements reduce both Value at Risk and the Lower Partial Moment, two measures of downside risk.
2. Environmental engagement – particularly on climate change – is most effective in reducing downside risk.
3. Companies with high downside risk reductions also enjoy a decrease in subsequent environmental incidents (as measured by RepRisk), suggesting the latter is a channel through which the risk reductions occur.

With any study on engagement, correlation may not be causation – some investors might engage with companies who were on a positive trend anyway, so that they can claim victory. The authors find that engagement only has consequences if the target acknowledged that there is an issue (after the investor raised it), moving us towards a causal interpretation.