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Amid a year-end flood of research, among several, research from the MIT Sloan School stood out.

“The Economic Impact of ESG Ratings” (attached below) – examines the impact of ESG ratings on stock returns, and investor (mutual fund) and corporate behavior, sticking with our theme recently – does ESG have an impact?

Analyzing nearly 4,000 US listed companies, and 4,500+ ESG (MSCI) ratings changes on these companies between 2013 and 2020, the authors find:

ESG Mutual Funds Respond: “ESG ownership reacts significantly to both ESG rating upgrades and downgrades. Two years after a downgrade, ESG ownership is on average 13.1% lower; two years after an upgrade, it is 17.1% higher than one month before the rating change.” Though overall “ESG mutual funds adjust their holdings gradually over the two years following ESG rating changes.”

Stock Returns are Affected: “We detect significant negative effects on buy-and-hold returns, for … up to 24 months after a downgrade” and “…a weaker and slower positive effect on returns…” from upgrades.

Don’t Much Impact Companies: “ESG rating changes have no discernible effect on the subsequent level of firms’ capital expenditure over a two-year time horizon.” In terms of other behaviors, the authors find that companies don’t react to changes in their environmental or social scores, but for governance did “find that firms react to both upgrades and downgrades: following a downgrade, firms improve their governance practices; following an upgrade, firms tend to let their governance practices deteriorate.”

So overall

We find that, at least for ESG mutual funds, ESG commitments are not merely “cheap talk” and that ESG ratings do affect stock markets. However, the real economic impact of ESG investing seems limited, given our results.

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