Which corporate ESG news does the market react to?

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Here’s a note from Professor George Serafeim:

Which ESG issues generate the largest price reactions? In our new analysis with Aaron Yoon we find that news related to social capital issues as defined by the SASB generate the largest price reactions. Those relate primarily to product impacts: the way products affect customer welfare in terms of safety, quality, affordability etc. Take as an example Peloton stock price crashing today by close to 14% due to product safety issues.

Many interesting insights on how markets react to human capital, natural capital, and business model innovation news in the paper.

Here is a note from Andreas Posavac:

Can ESG ratings and scores predict performance and future ESG news-flow? A topic widely debated, also at IHS Markit, where we try to understand the impact of ESG scores and ratings on the financial market and investment community. Another great paper by George Serafeim and Aaron Yoon analyses this relationship.

By analysing about 32,000 observations and using datasets from MSCI, Sustainalytics, Refinitiv and Truvalue Labs, they document which ratings have forecasting power over future news in the presence of rating disagreement and find that:

– the consensus rating predicts future news, but its predictive ability diminishes for firms with large disagreement between raters.
– the relation between news and market reaction is moderated by the consensus rating.
– in the presence of high disagreement between ratings, the relation between news and market reactions weakens while the rating with most predictive power predicts future stock returns.
– while rating disagreement hinders the incorporation of value relevant ESG news into prices, ratings predict future news and proxy for market expectations of future news.

Also good intel on the difference between financially material and non-material news.

In comparison, this note from Nawar Alsaadi provides an example of how a governance rating could have saved some investors some pain:

Screening for ESG risks could provide notable downside protection, and here is a great example from last year: Wirecard, the German payment processor, which lost 98% of its value within 10 days after the discovery of accounting fraud and its forced filing for bankruptcy was red flagged prior to their bankruptcy by ESG data provider MSCI for poor governance, poor management and lack of board industry expertise. As a matter of fact, Wirecard was granted a score of 4/100 in the governance dimension of S&P’s financial materiality based on Corporate Sustainability Assessment before it’s the fraud was discovered.

Governance risks of this nature don’t register on a traditional financial screen. Months before its collapse, Wirecard revenues and profits were supposedly surging and investing in the company based on these financial results alone would have exposed an investor to a significant loss of capital. ESG assessments are truly unique in their capacity to capture risks of this nature.