Modeling demand for ESG

Abstract

Existing approaches have considered characteristics of Environmental, Social and Corporate Governance (ESG) focused investments from a return-oriented perspective without paying due consideration to investors’ utility and how ESG features impact utility. We contribute to this literature by providing a model that captures the implications for investment if ESG is valued by the investor as well as wealth. We first present the necessary theory and discuss the rather challenging problem of calibration of the various risk and preference parameters. Using Thomson Reuters ESG data from 2002 to 2018, we provide further empirical evidence that investors who value ESG factors have improved utility which does not come at the cost of return performance.

KEYWORDS:

• ESG
• sustainable investing
• demand model
• investors’ utility

JELs:

• G11
• G14
• G17
• G23
• G41

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 For academic evidence, see Starks, Venkat, and Zhu (2017), Giese et al. (2019), Henriksson et al. (2019), and Statman (2020). For practical evidence, see 2018 Global Sustainable Investment Review issued by Global Sustainable Investment Alliance (GSIA) for example, which states that sustainable investing assets in the five major markets grow rapidly in each of them with a more than 30% increase in total in two years, from $22.9 trillion in 2016 to $30.7 trillion in 2018. Details can be found in http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf. See CFA Handbook on Sustainable Investments for further evidence.

2 Note, Ahmed and Satchell (2021) do not consider ESG specifically and their analysis is restricted to a generic attribute Z.

3 Our model does allow us to use ESG levels after normalizing. These results are available upon request.

4 Tables corresponding to different values of $\lambda$ and $\varphi$ are available upon request. These correspond to the results in Table 2.