Recognizing corporate citizenship: market reactions

Abstract

This research addresses whether corporations take on environmental, social and governance (ESG) integration at shareholders’ expense or whether ESG integration is a mechanism to increase shareholder value. It therefore investigates stock market reactions to recognition of good (or bad) corporate citizens using additions to (removals from) the Jantzi Social Index as a signal of good (bad) corporate citizenship. The Jantzi Index is a 60-security market index for which inclusion is based on ESG-related criteria. The study measures stock return dynamics around the announcement date of stock additions to/removals from the index. Accordingly, the findings are supportive of the view that ESG integration is a value-enhancing activity for shareholders and that the market therefore acknowledges socially responsible corporate citizens in a favourable way. It is worth noting that these findings are situated in the context of well-established capital markets comprising generally well-informed investors and are robust to alternative models of stock return-generating functions.

Keywords:

• corporate responsibility
• ESG
• stock price reactions
• announcement event study
• valuation
• socially responsible management

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Merton (1987) shows, with his equilibrium model, that an increase in the relative size of the firm's investor base will reduce the firm's cost of capital.

2. Jensen (2010, 42) points out,

stakeholder arguments played an important role in persuading the U.S. courts and legislatures to limit hostile takeovers through legalization of poison pills and state control shareholder acts. And we will continue to see more political action limiting the power of these markets to constrain managers.

3. The results of Richardson and Welker (2001) contradict those of El Ghoula et al. (2011), who report a negative relation between CSR performance and cost of equity. This may suggest that the level of voluntary disclosure is not a good proxy for the level of the corporation's EGS integration. Alternatively, this contradiction between the two studies may be due to the change in public awareness of CSR, which has increased substantially over the last decade.

4. Currently, several institutions maintain indexes consisting of publicly traded corporations with superior ESG measures. Those include: the Domini 400 Social Index for the USA, the NPI Social Index for the UK and the Dow Jones Sustainability Group Indexes for international stocks (Santiso 2005). Morgan Stanley Capital International launched 13 stock and 3 fixed income indexes based on sustainability, social responsibility and environmental performance. In Canada, the research firm, Sustainalytics, also maintains four ethical indexes, namely Jantzi Social Index, S&P/TSX Renewable Energy and Clean Technology Index, STOXX Global ESG Leaders Index and Access to Medicine Index.

5. http://www.sustainalytics.com (accessed on 3 March 2014). In May 2007, Blackrock, a US multinational investment management company, launched iShares Jantzi Social Index Fund with the ticker symbol of XEN.

6. http://www.sustainalytics.com/JSI.

7. http://www.sustainalytics.com/press-releases (accessed on 1 April 2014).

8. In the robustness check, companies that undertook some corporate action around the day of addition/removal were excluded from the analysis.

9. By assumption, Z_t follows a t-distribution with T-2 degrees of freedom.

10. Note that the analyses were repeated with three additional alternative models, as described in the methodology section, to ensure that these results are not a construct of the choice of the model used to estimate counterfactual returns. While the actual values of course differ from those shown above, the patterns described in the following are consistent across all four methodological approaches. However, positive post-announcement returns for added stocks, and consequently, the difference in returns between added and removed stocks, are not as strong when sector and size-matched, as well as size and book-to-market-matched, portfolios are used as benchmarks. The selection of sector and size-matched and size and book-to-market-matched portfolios are to some extent subjective, which might also explain this difference in result.

11. Based on the binomial z-score test.

12. This might be the reason that the significance level of positive returns is somewhat weak (positive post-announcement returns for added stocks are not as strong when sector and size-matched, as well as size and book-to-market-matched, portfolios are used as benchmarks).

13. Santiso (2005, 501) describes the dilemma faced by Sustainalitics (the management company of the Jantzi Index): the Canadian market is dominated by mining and forestry industries, which are often associated with questionable practices in terms of environmental concerns. However, exclusion of those stocks makes the index effectively vacuous. The index therefore uses a “best-of-sector approach”, which allows it to include the “least bad” stock in a questionable industry (NPI Social Index in UK also employs this approach for similar reasons).

Santiso also reports a high variation of ethical criteria across different social indexes/ethical funds. For example, while the Jantzi and the Domini 400 Social Indexes both exclude firms in the tobacco, arms and nuclear power generation sectors, the former includes firms in gambling and alcohol sectors, unlike the latter.

14. Finance studies consistently find positive net-of-market returns for stocks added to an index (such as S&P TSX Composite Index) around the announcement day of such an inclusion, attributing such positive returns to increased demand (e.g. Harris and Gurel 1986; Shleifer 1986) or increased liquidity (e.g. Sanger and Peterson 1990) for those stocks.

15. There appears a time lag between the announcement of an inclusion/exclusion and its implementation, which is approximately one month (Jog and Okumura 2003). Thus, if portfolio rebalancing and/or liquidity explanation is valid, abnormal returns are significant at a higher level on the day the actual inclusion/exclusion is implemented and around. For this reason, abnormal returns on and around the announcement day are more likely due to the market reaction to the firm's superior/poor ESG record, rather than the effect of the announcement on liquidity and portfolio rebalancing. A future study should address this point.

16. For example, Enbridge was excluded from the index on 14 September 2012, for the reason of spills that had occurred on 19 June, 26 and 27 July 2012. It is possible that the market had already reacted negatively to the spills in June and July 2012, and thus did not show any negative reaction on the day of Enbridge's exclusion from the index.