How material is a material issue? Stock returns and the financial relevance and financial intensity of ESG materiality

ABSTRACT

This paper investigates the role of the intensity and relevance of ESG materiality in equity returns. Adopting the classifications of materiality provided by the Sustainability Accounting Standards Board (SASB), the paper introduces the concept of the financial relevance and financial intensity of ESG materiality in order to estimate how it explains equity returns. The results of the analysis, based on a large sample of U.S. companies included in the Russell 3000 from January 2008 to July 2019 show that not only do ESG rating changes (ESG momentum) have a consistent impact on equity performance, but also that the market seems to reward more those companies operating in industries with a high level of concentration of ESG materiality. The implication is that the equity premium of listed companies is better explained by the concentration of material issues (i.e. the Gini index) than by the ESG momentum.

KEYWORDS:

• SASB
• ESG materiality
• nonfinancial information
• Fama-French

Disclosure statement

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

Notes

1 https://materiality.sasb.org/

2 The 13 value drivers considered by SASB are: Market share, New markets, Pricing power, Cost of revenues, Capex, R&D, Extraordinary expenses, Tangible assets, Intangible assets, Contingent Liabilities, Pension and other liabilities, Cost of capital, Industry divestment risk.

3 The Pulse score is a measure of near-term (daily) ESG performance changes that highlights opportunities and controversies, enabling real-time monitoring of companies.

4 Factors included in Equations (1) and (2) were retrieved from Kenneth French’s data library: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html#Developed.

5 For each firm, the ESG momentum included in the weighting has been standardized at the industry level.