Archiv der Kategorie: Impact

Supplier ESG – Researchpost #144

Supplier ESG: 17x new research on SDG, green behavior, subsidies, SMEs, ESG ratings, real estate, risk management, sin stocks, trading, suppliers, acting in concert, AI and VC by Alexander Bassen, Andreas G.F. Hoepner, and many more (#: SSRN downloads on Sept. 21^st, 2023)

Too late? Earth beyond six of nine planetary boundaries by Katherine Richardson and many more as of Sept. 13^th, 2023: “This planetary boundaries framework update finds that six of the nine boundaries are transgressed, suggesting that Earth is now well outside of the safe operating space for humanity. Ocean acidification is close to being breached, while aerosol loading regionally exceeds the boundary. Stratospheric ozone levels have slightly recovered. The transgression level has increased for all boundaries earlier identified as overstepped. As primary production drives Earth system biosphere functions, human appropriation of net primary production is proposed as a control variable for functional biosphere integrity. This boundary is also transgressed. Earth system modeling of different levels of the transgression of the climate and land system change boundaries illustrates that these anthropogenic impacts on Earth system must be considered in a systemic context“ (abstract).

Ecological research (corporate perspective)

Social measures: How useful are convenient measures of pro-environmental behavior? Evidence from a field study on green self-reports and observed green behavior by Ann-Kathrin Blankenberg, Martin Binder, and Israel Waichmann as of Aug. 20^th, 2023 (#12): “We conduct a field study with n = 599 participants recruited in the town hall of a German medium-sized town to compare self-reports of pro-environmental behavior of our participants with observed behavior (green product choice and donation to real charities). Our results indicate that self-reports are only weakly correlated to incentivized behavior in our sample of an adult population (r = .09∗ ), partly because pro-environmental behavior measures can conflate prosocial and pro-environmental preferences. … Our results … cast some doubt on the validity of commonly used convenient measures of pro-environmental behavior“ (abstract).

Expensive subsidies: Converting the Converted: Subsidies and Solar Adoption by Linde Kattenberg, Erdal Aydin, Dirk Brounen, and Nils Kok as of July 25^th, 2023 (#18): „… there is limited empirical evidence on the effectiveness of subsidies that are used to promote the adoption of such (Sö: renewable energy) technologies. This paper exploits a natural experimental setting, in which a solar PV subsidy is assigned randomly within a group of households applying for the subsidy. Combining data gathered from 100,000 aerial images with detailed information on 15,000 households … The results show that, within the group of households that applied for the subsidy, the provision of subsidy leads to a 14.4 percent increase in the probability of adopting solar PV, a 9.6 percent larger installation, and a 1-year faster adoption. However, examining the subsequent electricity consumption of the applicants, we report that the subsidy provision leads to a decrease in household electricity consumption of just 8.1 percent, as compared to the rejected applicant group, implying a cost of carbon of more than €2,202 per ton of CO2”.

Regulatory SME effects: The EU Sustainability Taxonomy: Will it Affect Small and Medium-sized Enterprises? by Ibrahim E. Sancak as of Sept. 6^th, 2023 (#52): “The EU Sustainability Taxonomy (EUST) is a new challenge for companies, particularly SMEs and financial market participants; however, it potentially conveys its economic value; hence, reliable taxonomy reporting and strong sustainability indicators can yield enormously. … We conclude that the EU’s sustainable finance reforms have potential domino effects. Backed by the European Green Deal, sustainable finance reforms, and in particular, the EUST, will not be limited to large companies or EU companies; they will affect all economic actors having business and finance connections in the EU“ (p. 14).

ESG rating credits: Determinants of corporate credit ratings: Does ESG matter? by Lachlan Michalski and Rand Kwong Yew Low as of Aug. 19^th, 2023 (#25): “We show that environmental and social responsibility variables are important determinants for the credit ratings, specifically measures of environmental innovation, resource use, emissions, corporate social responsibility, and workforce determinants. The influence of ESG variables become more pronounced following the financial crisis of 2007-2009, and are important across both investment-grade and speculative-grade classes” (abstract).

Climate risk management: Climate and Environmental risks and opportunities in the banking industry: the role of risk management by Doriana Cucinelli, Laura Nieri, and Stefano Piserà as of Aug. 18^th, 2023 (#22): “We base our analysis on a sample of 112 European listed banks observed from 2005 to 2021. Our results … provide evidence that banks with a stronger and more sophisticated risk management are more likely to implement a better climate change risk strategy. … Our findings underline that bank providing their employees and managers with specific training programs on environmental topics, or availing of the presence of a CSR committee, or adopting environmental-linked remuneration scheme, stand out for a greater engagement towards C&E risks and opportunities and a sounder C&E strategy” (p. 16).

Generic ESG Research (investor perspective)

ESG dissected: It’s All in the Detail: Individual ESG Factors and Firm Value by Ramya Rajajagadeesan Aroul, Riette Carstens and Julia Freybote as of Aug. 25^th, 2023 (#29): “We disaggregate ESG into its individual factors (E, S and G) and investigate their impact on firm value using publicly listed equity real estate investment trusts (REITs) as a laboratory over the period of 2009 to 2021. … We find that the environmental factor (E) and governance factor (G) positively predict firm value while the social factor (S) negatively predicts it. … Further analysis into antecedents of firm value suggests that our results are driven by 1) E reducing cost of debt and increasing financial flexibility, operating efficiency, and performance, 2) S leading to a higher cost of debt as well as lower financial flexibility and operating performance, and 3) G increasing operating efficiency. … We also find evidence for time-variations in the relationships of E, S and G with firm value and its determinants” (abstract). My comment: This is not really new as one can see in my publication from 2014: 140227 ESG_Paper_V3 1 (naaim.org)

Greenbrown valuations: The US equity valuation premium, globalization, and climate change risks by Craig Doidge, G. Andrew Karolyi, and René M. Stulz as of Sept. 15^th, 2023 (#439): “It is well-known that before the GFC (Sö: Global Financial Crisis of 2008), on average, US firms were valued more highly than non-US firms. We call this valuation difference the US premium. We show that, for firms from DMs (Sö: Developed Markets), the US premium is larger after the crisis than before. By contrast, the US premium for firms from EMs (Sö: Emerging Markets) falls. In percentage terms, the US premium for DMs increases by 27% while the US premium for EMs falls by 24%. … the differing evolution of the US premium for DM firms and for EM firms is concentrated among old economy firms – older firms in industries that have a high ratio of tangible assets to total assets. … We find that the valuations of firms in brown industries in non-US DMs fell significantly relative to comparable firm valuations in the US and this decline among brown industries in EMs did not take place. Though this mechanism does not explain the increase in the US premium for firms in DMs fully, it explains much of that increase. It follows from this that differences across countries in the importance given to sustainability and ESG considerations can decrease the extent to which financial markets across the world are integrated“ (p. 28).

Sin ESG: Does ESG impact stock returns for controversial companies? by Sonal and William Stearns as of Sept. 2^nd, 2023 (#35): “We find that the market perception of ESG investments of controversial firms have changed over time. For the 2010-2015 period, ESG investments made by sinful firms are rewarded positively by increasing stock prices. However, for the sample period post 2015, increases in ESG no longer result in positive stock returns. We further find the maximum change for the oil and gas industry“ (p. 11/12). My comment see ESG Transition Bullshit? – Responsible Investment Research Blog (prof-soehnholz.com)

Portfolio ESG effects: Quantifying the Impacts of Climate Shocks in Commercial Real Estate Market by Rogier Holtermans, Dongxiao Niu, and Siqi Zheng as of Sept. 7^th, 2023 (#251): “We focus on Hurricanes Harvey and Sandy to quantify the price impacts of climate shocks on commercial buildings in the U.S. We find clear evidence of a decline in transaction prices in hurricane-damaged areas after the hurricane made landfall, compared to unaffected areas. We also observe that …. Assets in locations outside the FEMA floodplain (with less prior perception about climate risk) have experienced larger price discounts after the hurricanes. … Moreover, the price discount is larger when the particular buyer has more climate awareness and has a more geographically diverse portfolio, so it is easier for her to factor in this risk in the portfolio construction” (abstract).

ESG investors or traders? Do ESG Preferences Survive in the Trading Room? An Experimental Study by Alexander Bassen, Rajna Gibson Brandon, Andreas G.F. Hoepner, Johannes Klausmann, and Ioannis Oikonomou as of Sept. 19^th, 2023 (#12): “This study experimentally tests in a competitive trading room whether Socially Responsible Investors (SRIs) and students are consistent with their stated ESG preferences. … The results suggest that all participants who view ESG issues as important (ESG perception) trade more aggressively irrespective of whether the news are related to ESG matters or not. … More importantly, SRIs trade on average much less aggressively than students irrespective of their ESG perceptions and behaviors” (abstract). … “Investors mostly consider macroeconomic and id[1]iosyncratic financial news in their investment decisions. Updates on the ESG performance of a firm are perceived as less likely to move prices by the participants. In addition to that, we observe a stronger reaction to positive news compared to negative news” (p. 26). My comment: I prefer most-passive rules based to active investments, compare Noch eine Fondsboutique? – Responsible Investment Research Blog (prof-soehnholz.com) or Active or impact investing? – (prof-soehnholz.com)

Supplier ESG research (also see Supplier engagement – Opinion post #211)

Supplier ESG shocks: ESG Shocks in Global Supply Chains by Emilio Bisetti, Guoman She, and Alminas Zaldokas as of Sept. 6^th, 2023 (#38): “We show that U.S. firms cut imports by 29.9% and are 4.3% more likely to terminate a trade relationship when their international suppliers experience environmental and social (E&S) incidents. These trade cuts are larger for publicly listed U.S. importers facing high E&S investor pressure and lead to cross-country supplier reallocation …. Larger trade cuts around the scandal result in higher supplier E&S scores in subsequent years, and in the eventual resumption of trade” (abstract).

Sustainable supplier reduction: A Supply Chain Sourcing Model at the Interface of Operations and Sustainability by Gang Li and Yu A. Xia as of Aug. 25th, 2023 (#204): “This research investigates … how to integrate sustainability with sourcing planning decisions and how to address the challenges associated with the integration, such as the balance between operational factors and sustainability factors and the quantitative evaluation of sustainability performance. … Our model suggests that while increasing the number of suppliers may cause additional sustainability risk in supply chain management, decreasing the supply base will decrease the production capacity and increase the risk of delivery delay. Therefore, a firm should carefully set up its global sourcing network with only a limited number of selected suppliers. This finding is particularly true when the focus of sourcing planning gradually moves away from decisions based solely on cost to those seeking excellence in both supply chain sustainability and cost performance“ (p. 32).

Empowering stakeholders: Stakeholder Governance as Governance by Stakeholders by Brett McDonnell as of August 31^st, 2023 (#64): “… American stakeholder engagement is limited to soliciting (and on occasion responding to) the opinions of employees, customers, suppliers, and others. True stakeholder governance would involve these groups in actively making corporate decisions. I have suggested various ways we could do this. The focus should be on employees, who could be empowered via board representation, works councils, and unions. Other stakeholders could be less fully empowered through councils, advisory at first but potentially given power to nominate or even elect directors” (p. 19).

Impact investment research (supplier ESG)

Anti-climate concert: Rethinking Acting in Concert: Activist ESG Stewardship is Shareholder Democracy by Dan W. Puchniak and Umakanth Varottil as of Sept. 13^th, 2023 (#187): “… the legal barriers posed by acting in concert rules in virtually all jurisdictions prevent institutional investors from engaging in collective shareholder activism with the aim or threat of replacing the board (i.e., “activist stewardship”). Perversely, the current acting in concert rules effectively prevent institutional investors from replacing boards that resist (or even deny) climate change solutions – even if (or, ironically, precisely because) they collectively have enough shareholder voting rights to democratically replace the boards of recalcitrant brown companies. This heretofore hidden problem in corporate and securities law effectively prevents trillions of dollars of shareholder voting rights that institutional investors legally control from being democratically exercised to change companies who refuse to properly acknowledge the threat of climate change” … (abstract).

Other investment research

AI investment risks: Artificial Intelligence (AI) and Future Retail Investment by Imtiaz Sifat as of Sept. 12^th, 2023 (#20): “I have analyzed AI’s integration in retail investment. … The benefits spring from access to sophisticated strategies once exclusive to institutional investors. The downside is that the opaque models which facilitate such strategies may aggravate risks and information asymmetry for retail investors. To stop this gap from widening, proper governance is essential. Similarly, the ability to ingest copious alternative data and instantaneous portfolio optimization incurs a tradeoff—too much dependence on historical data invokes modelling biases and data quality cum privacy concerns. It is also likely that AI-dominated markets of the future will be more volatile, and new forms of speculation would emerge as trading platforms incentivize speculation and gamification. The combined forces of these concurrent challenges put a heavy stress on orthodox finance theories …“ (p. 16/17). Maybe interesting: AI: Wie können nachhaltige AnlegerInnen profitieren? – Responsible Investment Research Blog (prof-soehnholz.com)

Venture careers: Failing Just Fine: Assessing Careers of Venture Capital-backed Entrepreneurs via a Non-Wage Measure by Natee Amornsiripanitch, Paul A. Gompers, George Hu, Will Levinson, and Vladimir Mukharlyamov as of Aug. 30^th, 2023 (#131): “Would-be founders experience accelerated career trajectories prior to founding, significantly outperforming graduates from same-tier colleges with similar first jobs. After exiting their start-ups, they obtain jobs about three years more senior than their peers who hold (i) same-tier college degrees, (ii) similar first jobs, and (iii) similar jobs immediately prior to founding their company. Even failed founders find jobs with higher seniority than those attained by their non-founder peers“ (abstract).

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Sponsor my research by investing in and/or recommending my global small/midcap mutual fund (SFDR Art. 9). The fund focuses on social SDGs and uses separate E, S and G best-in-universe minimum ratings and broad shareholder engagement with currently 30 of 30 engaged companies: FutureVest Equity Sustainable Development Goals R – DE000A2P37T6 – A2P37T; also see Active or impact investing? – (prof-soehnholz.com)

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Supplier engagement – Opinion post #211

Supplier engagement is my term for shareholder engagement with the goal to address suppliers either directly or indirectly. I provide an overview of current scientific research regarding supplier engagement. I also explain my respective recommendations to the companies I am invested in. Supplier engagement can be very powerful.

The other two stakeholder groups which I address with my “leveraged shareholder engagement” are customers and employees (compare HR-ESG shareholder engagement: Opinion-Post #210 – Responsible Investment Research Blog (prof-soehnholz.com)).

Supplier emissions can be very high

Supplier relations have become much talked about in recent years. Climate change is one of the reasons. Greenhouse gas (GHG) emissions are one of the prime shareholder concerns if they are interested in environmental topics. To compare more or less vertically integrated companies with their competitors, evaluating GHG emissions of suppliers is important. Often, GHG emissions of suppliers (part of so-called scope 3) are much higher than the (scope 1 and 2) emissions of the analyzed company itself.

Relevant research (1): Managing climate change risks in global supply chains: a review and research agenda by Abhijeet Ghadge, Hendrik Wurtmann and Stefan Seuring as of June 13^th, 2022: “The research … captures a comprehensive picture of climate change and associated phenomenon in terms of sources, consequences, control drivers, and mitigation mechanisms. … The study contributes to practice by providing visibility into the industry sectors most likely to be impacted; their complex association with other supply chain networks. The drivers, barriers, and strategies for climate change mitigation are particularly helpful to practitioners for better managing human-induced risks …” (p. 59).

Supply chain becomes more important for ESG-analyses

COVID and geopolitical changes such as the Russian attack on the Ukraine also showed that the management of supply chains is crucial for many companies. Even before, many supplier related incidents such as the Foxconn/Apple discussions had significant effects on company ESG perceptions and potentially also on ESG-ratings. Also, supply chains are becoming more in many countries.

Relevant research (2): ESG Shocks in Global Supply Chains by Emilio Bisetti, Guoman She, and Alminas Zaldokas as of Sept. 6^th, 2023: “We show that U.S. firms cut imports by 29.9% and are 4.3% more likely to terminate a trade relationship when their international suppliers experience environmental and social (E&S) incidents. These trade cuts are larger for publicly listed U.S. importers facing high E&S investor pressure and lead to cross-country supplier reallocation …. Larger trade cuts around the scandal result in higher supplier E&S scores in subsequent years, and in the eventual resumption of trade” (abstract).

On the positive side, many suppliers have great knowhow and can help their clients to become better in ESG-terms.

Relevant research (3): Stakeholder Engagement by Brett McDonnell as of Nov. 1^st, 2022^t: “Suppliers, like employees, also provide inputs to the production process of companies. Retaining the loyalty of suppliers may be important for companies, depending in part on how firm-specific inputs are. Where inputs are fungible, they can be bought on the market for the prevailing market price, but where they are firm-specific, the buying firm will have more trouble replacing a supplier that decides to withdraw. Suppliers have information about the quality of what they supply, and about conditions which may affect future availability and prices” (p. 8).

Supplier engagement: How investors can indirectly engage

Investors in publicly listed companies do probably not want to directly with the often many important suppliers of their portfolios companies. But they can indirectly leverage the knowhow and energy of suppliers. Here is what Brett McDonnell suggests:

Relevant research (4): Stakeholder Governance as Governance by Stakeholders by Brett McDonnell as of August 31^st, 2023: “… American stakeholder engagement is limited to soliciting (and on occasion responding to) the opinions of employees, customers, suppliers, and others. True stakeholder governance would involve these groups in actively making corporate decisions. I have suggested various ways we could do this. The focus should be on employees, who could be empowered via board representation, works councils, and unions. Other stakeholders could be less fully empowered through councils, advisory at first but potentially given power to nominate or even elect directors” (p. 19).

In my opinion, too, advisory councils of suppliers could be helpful to improve listed companies. I prefer other forms of ESG engagement with suppliers, though. First, companies could regularly survey most of their direct and even some important indirect suppliers in a regular way regarding ESG topics. With regular surveys companies can find out how happy their suppliers are with the companies ESG activities and ESG-improvement ideas by suppliers can be collected.

Example (1): Surveys from Stakeholders Make Good Business Sense by Terrie Nolinske from the National Business Research Institute (no date) mentions The Body Shop and Michelin who use supplier surveys.

Example (2): AA1000 Stakeholder Engagement Standard from Accountability as of 2015 “provides a … practical framework to implement stakeholder engagement and … Describes how to integrate stakeholder engagement with an organization’s governance, strategy, and operations”.

I specifically suggest to regularly ask suppliers the following questions: 1) “How satisfied are you with the environmental, social and corporate governance activities of company XYZ?” and 2) “Which environmental, social and corporate governance improvements do you suggest to company XYZ?”.

Systematic supplier engagement using ESG evaluations

In my view, even more important to improve the full supply chain ESG-profile is that companies regularly, broadly and independently evaluate the ESG-quality of their suppliers. Independent ESG-ratings can be very useful for that purpose, since they systematically cover many environmental, social and governance aspects.

I try to invest in the 30 most sustainable publicly listed companies globally (see Active or impact investing? – (prof-soehnholz.com)), but even most of these companies do not have such a supplier ESG evaluation process. Here are the two best examples of my portfolios companies:

Supplier ESG evaluation (1): Watts Water Sustainability Report 2022 p. 63: “In 2022, we met our goal of reviewing suppliers representing approximately 30% of our global annual spend using the Dun & Bradstreet (D&B) ESG Rating Service. The service is a web-based ratings platform that assesses the ESG operations of suppliers across 70 key topics, including through peer benchmarking and using leading sustainability frameworks …. Through our expanded use of this tool, we gained increased insight into our suppliers’ sustainability practices, including that suppliers making up one-sixth of the global spend we assessed already have advanced ESG systems in place”.

Supplier ESG evaluation (2): CAFs 2022 Sustainability Report: “… the evaluation effort focuses on 349 target suppliers out of a total of approximately 6,000 suppliers. The evaluations are carried out by Ecovadis …. Ecovadis adapts the evaluation questionnaire to each supplier based on the locations in which it operates, its sector and its size to evaluate 21 aspects of sustainability alligned with the most demanding international norms, regulations and standards …. Suppliers‘ responses are evaluated by specialised analysts … This analysis results in a general rating with a maximum score of 100 points …. If the result of an evaluation does not meet the requirements established by CAF (a general score of 45 out of 100 in sustainability management), the supplier is required to implement an action plan to improve the weaknesses identified. If the supplier does not raise its assessment to acceptable levels or does not show a commitment to improve, it is audited by experts in the field” (p. 83).

“By the end of 2022, the activities … have assessed … 78% of the prioritised suppliers (118 business groups) …. The assessed suppliers have an average overall rating of 58.6 out of 100 … which is 13 percentage points higher than the average of all suppliers assessed by Ecovadis worldwide (45/100). In addition, 71% of CAF suppliers reassessed in the last year improved their general rating … As a result of these assessments it has also been identified that 2% of the Group’s total purchases are made from suppliers with average or lower sustainability management and an improvement plan has been agreed with all of them”(p. 84).

The picture of my blogpost summarises the results of the 2022 supplier assessment campaign of one of my portfolio companies: Construcciones y Auxiliar de Ferrocarriles (CAF Sustainability Report 2022, p. 85):

But even Watts Water and CAF currently only cover a relatively small share of their suppliers with these evaluations.

Better fewer suppliers?

Such a sustainability-oriented supplier evaluation approach could result in fewer and therefore more important suppliers.

Relevant research (5): A Supply Chain Sourcing Model at the Interface of Operations and Sustainability by Gang Li and Yu A. Xia as of Aug. 25th, 2023: “This research investigates … how to integrate sustainability with sourcing planning decisions and how to address the challenges associated with the integration, such as the balance between operational factors and sustainability factors and the quantitative evaluation of sustainability performance. … Our model suggests that while increasing the number of suppliers may cause additional sustainability risk in supply chain management, decreasing the supply base will decrease the production capacity and increase the risk of delivery delay. Therefore, a firm should carefully set up its global sourcing network with only a limited number of selected suppliers. This finding is particularly true when the focus of sourcing planning gradually moves away from decisions based solely on cost to those seeking excellence in both supply chain sustainability and cost performance“ (p. 32).

Supplier engagement: Powerful supplier ESG disclosures

I think that is very important to make the supplier engagement activities transparent. Only transparent activities can be controlled by stakeholders. It is very useful for stakeholders, too, to know the identities of the major suppliers.

Relevant research (6): Green Image in Supply Chains: Selective Disclosure of Corporate Suppliers by Yilin Shi, Jing Wu, and Yu Zhang as of Sept. 9^th, 2022 (#2015): “We uncover robust empirical evidence showing that listed firms selectively disclose environmentally friendly suppliers while selectively not disclosing suppliers with poor environmental performance, i.e., they conduct supply chain greenwashing. This is a prevalent behavior in the sample of more than 40 major countries or regions around the world that we study. … we find that customer firms that face more competitive pressure, care more about brand image and reputation, and have larger shares of institutional holdings are more likely to conduct such selective disclosure. … we find that information transparency reduces such behavior. Finally, we study the outcomes of selectively disclosing green suppliers and find that customers benefit from the practice in terms of sales, profitability, and market valuation“ (p. 22/24).

A supplier engagement proposal and first engagement experiences

Based on my engagement policy (Shareholder engagement: 21 science based theses and an action plan – (prof-soehnholz.com)), I try to make it as simple as possible for my portfolio companies to implement my suggestions. Comprehensive and regular supplier ESG surveys would be a rather simple and low-cost approach and I certainly encourage them.

Given the importance of the supply chain for ESG-topics and the risks of greenwashing, I especially recommend a more demanding supplier ESG-rating approach to all my portfolio companies. Specifically, I tell them: “Favoring suppliers with better overall/comprehensive ESG scores is probably the way to go. Reporting aggregated information such as percentage of suppliers with XYZ ESG-scores can be one first step regarding transparency”. I also inform them about current relevant research and the two examples mentioned above.

No supplier engagement results yet

I started my respective engagement activities only at the end of 2022. Some companies answered that they like my suggestions and plan to analyze them, but I cannot report implementations so far (compare 230831_FutureVest_Engagementreport-2830ab605a502648339b4f8f58fa2ee2dce539ef.pdf).

I am only a small investors and cooperative engagement can me more powerful. Unfortunately, my attempts for cooperative engagement with other investors have not been fruitful yet. One reason is that I could only find very few sustainable investment funds with a dedicated small-and midcap focus such as mine. With the few such funds I have typically very little company overlap. The asset managers and the shareholder organizations which I have asked so far want to cooperate with larger asset managers and not with such a small entity as mine.

Nevertheless, I will continue to ask my portfolio companies for such stakeholder engagements and the publication of their results. I am confident, that at least a few companies will adopt such surveys and evaluations and thus position themselves even more as ESG-leaders. Research such as “A Test of Stakeholder Governance” by Stavros Gadinis and Amelia Miazad as of Aug. 25^th, 2021 is one of the reasons for optimism on my part. And, maybe, with publications such as this blog post, I can encourage other companies, investors etc. to support such broad stakeholder engagement activities as well.

HR-ESG shareholder engagement: Opinion-Post #210

HR-ESG is attractive: Environmental, Social and Governance (ESG) aspects are becoming more important for companies who need additional capital, for those who want to increase sales, and also for hiring and keeping good employees (HR for “human resources”)[1].

In addition, employees can help companies to become more sustainable[2]. The Boston Consulting Group, for example, published recently that new ideas generated by employees helped to “overcome roadblocks in reducing Scope 3 emissions”[3].

Little scientific HR-ESG and employee engagement research

Unfortunately, I find very little comprehensive scientific research on HR-ESG[4]. A study by Hoa Briscoe-Tran from the University of Alberta[5] is one of the rare exceptions. Briscoe-Tran writes: “I analyze 10.4 million anonymous employee reviews and find that employees have useful information about firms’ environmental, social, and governance (ESG) practices. Employees discuss ESG topics in 43% of reviews, thereby providing substantial information about firms’ ESG practices. The employees’ inside view predicts various indicators of a firm’s future ESG-related outcomes, beyond the existing ESG ratings, particularly on the S and G dimensions. Using the inside view, I show that a firm’s stated ESG policies often differ from its employees’ view of its practices. … ESG rating agencies could consider incorporating employee reviews into their rating methodology more broadly” (p. 33).

Companies should use the broad employee interest for ESG in a systematic way. And Shareholders should address this change potential when they engage with their portfolio companies.

Even though I have studied scientific publications regarding shareholder engagement quite thoroughly[6], I have found very little engagement with a broad HR-ESG perspective going significantly beyond rather limited diversity, equality, and inclusion (DEI) issues.

Broad HR-ESG activation is easy

With my mutual fund I try to invest in 30 of the most sustainable companies worldwide. Most of these companies actively address the typical HR-ESG-topics such as DEI, workplace safety etc.. I read their sustainability reports and also directly asked them, but I could not find one single company which tries to broadly engage its employees regarding ESG topics[7].

In my shareholder engagement strategy[8] I propose a very simple and efficient approach to activate employees for ESG-issues. Specifically, I write to all my portfolio companies:

“I think that regular and broad questions such as “How satisfied are you with the environmental, social and corporate governance activities of your company?” and “Which environmental, social and corporate governance improvements do you suggest to your company?” plus the (anonymous) publication of the main results of the answers in the sustainability report would be very helpful in seriously engaging employees and getting valuable structured feedback”.

Leveraged shareholder or stakeholder engagement

Most of these companies use regular broad as well as specific pulse employee surveys and typically have high participation rates. Implementation of my questions therefore should be simple and cost-efficient.

In addition, I suggest asking the same questions to customers and they also could be asked to suppliers. Interestingly, “surveys are already very common among employees, but many companies do not yet use them for customers (or at least, they don’t report on it if they do) and surveys of suppliers may be worth adopting as well“[9]. Therefore, the implementation of my suggested regular ESG surveys of customers and suppliers might be somewhat more time-consuming and expensive than employee surveys. But I think that it may well be worth the effort.

If companies regularly ask these questions to employees, customers and suppliers, shareholders can leverage their engagement activities to several stakeholder groups.

I started my respective engagement activities only at the end of 2022. Some companies answered that they like my suggestions and plan to analyze them, but I cannot report implementations so far.

I am only a small investors and cooperative engagement can me more powerful. Unfortunately, my trials for cooperative engagement with other investors have not been fruitful yet. One reason is that I could only find very few sustainable investment funds with a dedicated small-and midcap focus such as mine. With the few such funds I have typically very little overlap. The asset managers and shareholder organizations which I have asked so far want to cooperate with larger asset managers and not with such as small entity as mine.

But I will continue to ask for such surveys and the publication of their results. I am confident, that at least a few companies will adopt such surveys and position themselves even more as ESG-leaders[10]. And, maybe, with publications such as this one, I can encourage other companies, investors etc. to support such broad and easy to implement HR-ESG activities as well.

[1] see Effect of Corporate Environment Social and Governance Reputation on Employee Turnover by Ming Leung, Chuchu Liang, Ben Lourie and Chenqi Zhu as of August 20th, 2023

[2] see Engaging your people as the advocates and enablers of ESG change by Jessica Norton and Hannah Summers from Willis Towers Watson as of July 13, 2020

[3] see People Make the Difference in Green Transformations by Alice Bolton, Marjolein Cuellar, Kristy Ellmer, Elina Ibounig, Camila Noldin, Nick South and Astrid Vikström from The Boston Consulting Group as of August 23^rd, 2023

[4] For a broad overview see e.g. Stakeholder Engagement by Brett McDonnell – SSRN as of Oct. 31^st, 2022

[5] Do Employees Have Useful Information About Firms’ ESG Practices? by Hoa Briscoe-Tran – SSRN as of Aug. 2nd, 2023

[6] see for example Stakeholder engagement and ESG (Special Edition Researchposting 115) by Dirk Soehnholz as of Feb. 3, 23

[7] compare Active or impact investing? By Dirk Soehnholz as of July 21^st, 2023 and 230831_FutureVest_Engagementreport-2830ab605a502648339b4f8f58fa2ee2dce539ef.pdf

[8] see Shareholder engagement: 21 science based theses and an action plan by Dirk Soehnholz as of Feb. 8^th, 2023

[9] see Stakeholder Engagement by Brett McDonnell – SSRN as of Oct. 31^st, 2022, p. 48

[10] this study is one of the reasons for optimism on my part: A Test of Stakeholder Governance by Stavros Gadinis and Amelia Miazad as of Aug. 25^th, 2021

Impact strategies: Researchpost #142

Impact strategies: 12x new research on AI, education, diversity, insiders, compensation, impact investing, collaborative engagement, voting and analysts by Olaf Weber and many more (#: SSRN downloads as of Sept. 7^th, 2023)

Social and ecological research (Impact strategies)

Good and bad AI: How We Learned to Stop Worrying and Love AI: Analyzing the Rapid Evolution of Generative Pre-Trained Transformer (GPT) and its Impacts on Law, Business, and Society by Scott J. Shackelford, Lawrence J. Trautman, and W. Gregory Voss as of Sept. 6^th, 2023 (#108): “There is ample reason to believe that novel AI-driven capabilities hold considerable potential to drive practical solutions to address many of the world’s major challenges such as cancer, climate change, food production, healthcare, and poverty. … Even so, there are equally significant warning signs of serious consequences, including the threat of eliminating humanity. These warnings should not be ignored“ (p. 94). My comment: For responsible investing see How can sustainable investors benefit from artificial intelligence? – GITEX Impact – Leading ESG Event 2023

Educational tools: The Emergence of An Educational Tool Industry: Opportunities and Challenges For Innovation in Education by Dominique Foray and Julio Raffo as of May 4^th, 2023 (#16): “… an educational tool industry has emerged; that is to say a population of small firms is inventing and commercialising instruction (mainly ICT-based) technologies. … However the main commercial target of these companies is not the huge K12 public school system. This market does not satisfy most conditions for attracting and sustaining a strong entrepreneurial activity in the tool business. … But other “smaller” markets seem to be sufficiently attractive for entrepreneurs and this connection explains to a certain extent why we have observed the patent explosion and some increase in the number of firms specialised in the tool business“ (p. 19/20).

ESG investment research (Impact strategies)

Unflexible Diversity? Are Firms Sacrificing Flexibility for Diversity and Inclusion? by Hoa Briscoe-Tran as of Aug.14^th, 2023 (#181): “I analyze data from thousands of companies dating back to 2008 and find that diverse and inclusive firms (D&I firms) tend to have lower operating flexibility. Exploration of mechanisms suggest that D&I firms have lower operating flexibility due to their slower operating efficiency in their response to unexpected economic shocks“ (p. 25).

Bad competition? Competitive Pressure and ESG by Vesa Pursiainen, Hanwen Sun, and Yue Xiang as of Sept. 1^st, 2023 (#95): “… Our results suggest that a firm’s exposure to competition is negatively associated with its ESG performance. … The effect of product market competition on ESG performance is higher for firms that are more financially constrained and in more capital-intensive industries. Taken together, our findings suggest that companies face a trade-off in investing in ESG versus other investment needs …” (p. 18).

Bad insiders: Executive Ownership and Sustainability Performance by Marco Ghitti, Gianfranco Gianfrate, and Edoardo Reccagni as of Oct. 19^th, 2022 (#167): “Our results indicate that executive shareholding is negatively associated with corporate E&S (Sö: Environmental and social) performance, indicating that the pursuit of non-financial returns is penalized when executives are more financially vested in the company. … We analogously observe that inside trading intensity is inversely associated with the sustainability footprint, thus confirming that when executives’ primary focus is on financial gains, E&S activities diminish. … we use an exogenous shock in capital gains taxation that specifically affected executive ownership in US public companies. The quasi-natural experiment confirms that it is the degree of executive ownership that affects the E&S footprint“ (p. 12).

CSR compensation: Empirical Examination of the Direct and Moderating Role of Corporate Social Responsibility in Top Executive Compensation by Mahfuja Malik and Eunsup Daniel Shim as of Aug. 9^th, 2023 (#18): “Using a sample of 4,193 firm-year observations and 1,318 public U.S. firms, we find that CSR (Sö: Corporate social responsibility) performance positively moderates the relationship between firms’ total and long-term compensation, along with its direct association with CEO compensation. However, firms’ separate CSR report disclosures are not associated with CEO compensation. … we find that CSR has no moderating role in the relationship between CEO compensation and accounting-based performance. Interestingly, we find that CSR performance plays a moderating role in weakening the positive relationship between executive compensation and firm size“ (p. 18/19). My comment: see Wrong ESG bonus math? Content-Post #188 – Responsible Investment Research Blog (prof-soehnholz.com)

Costly greenwashing: Does Greenwashing Pay Off? Evidence from the Corporate Bond Market by Nazim Hussain, Shuo Wang, Qiang Wu, and Cheng (Colin) Zeng as of Sept. 7^th, 2023 (#127): “Using 3,810 public bonds issued by U.S. firms, we find a positive relationship between greenwashing and the cost of bonds. We identify the causal relation by using the Federal Trade Commission’s 2012 regulatory intervention to curb misleading environmental claims as an exogenous shock to greenwashing. We also find a more pronounced relation between greenwashing and the cost of bonds for firms whose credit rating is adjacent to the investment/speculative borderline, firms within environmentally sensitive industries, and firms with opaque information environments. Moreover, we show that greenwashing leads to higher environmental litigation costs and a higher chance of rating disagreements among credit rating agencies … “ (abstract).

Impact strategies research

Green claims: Market review of environmental impact claims of retail investment funds in Europe by Nicola Stefan Koch, David Cooke, Samia Baadj, and Maximilien Boyne from the 2 Degree Investing Initiative as of August 2023: “27% of all in scope funds were associated with environmental impact claims. No fund with an environmental impact claim could sufficiently substantiate its claim according to the updated UCPD Guidance indicating a substantial potential legal risk. … Of the environmental impact claims deemed to be false or generic, there were 3x more appearing in Art 9 fund marketing materials compared to Art 8 fund marketing materials. … Most environmental impact claims deemed false equated “company impact” with “investor impact”, most environmental impact claims deemed unclear were not substantiated by sufficient information and most environmental impact claims deemed generic were fund names including the term “impact” with insufficient additional information” (p. 3). My comment: see Shareholder engagement: 21 science based theses and an action plan – (prof-soehnholz.com)

Impact strategies? New bottle or new label? Distinguishing impact investing from responsible and ethical investing by Truzaar Dordi, Phoebe Stephens, Sean Geobey, and Olaf Weber as of July 27^th, 2023: “… how does the subfield of impact investing differentiate itself from more established ethical and responsible investing … Adopting a combination of bibliometric and content analyses, we identify four distinct features of impact investing – positive impact targeting, novelty of governance structures, long time horizons, and the importance of philanthropy” (abstract). … “This differs from responsible investing, which mainly relies on modern portfolio theory and capital pricing models for research …” (p. 22). My comment: see No engagement-washing! Opinion-Post #207 – Responsible Investment Research Blog (prof-soehnholz.com)

Engagement impact strategies: Tailor-to-Target: Configuring Collaborative Shareholder Engagements on Climate Change by Rieneke Slager, Kevin Chuah, Jean-Pascal Gond, Santi Furnari, and Mikael Homanen as of June 15^th, 2023: “We study collaborative shareholder engagements on climate change issues. These engagements involve coalitions of investors pursuing behind-the-scenes dialogue to encourage target firms to adopt environmental sustainability practices. … we investigate how four coalition composition levers (coalition size, shareholding stake, experience, local access) combine to enable or hinder engagement success. We find that successful coalitions use four configurations of coalition composition levers that are tailored to target firms’ financial capacity and environmental predispositions, that is, target firms’ receptivity. Unsuccessful configurations instead emphasize single levers at the expense of others. Drawing on qualitative interviews, we identify three mechanisms (synchronizing, contextualizing, overfocusing) that plausibly underly the identified configurations and provide investor coalitions with knowledge about target firms and their local contexts, thus enhancing communication and understanding between investor coalitions and target firms” (abstract).

Other investment research

Bad delegation? Voting Choice by Andrey Malenkoy and Nadya Malenko as of Aug. 27^th, 2023 (#346): “Under voting choice, investors of the fund can choose whether to delegate their votes to the fund or to exercise their voting rights themselves. … If the reason for offering voting choice is that investors have heterogeneous preferences, but investors are uninformed about the value of the proposal, then the equilibrium under voting choice is generally inefficient: it features either too little or too much delegation. … In contrast, if the reason for offering voting choice is that investors have information about the proposal that the fund manager does not have, but all investors preferences are aligned, then voting choice is efficient: the equilibrium level of delegation is the one that maximizes investor welfare. … However, if information acquisition is costly, voting choice can also lead to coordination failure: if too few votes are delegated to the fund, the fund has weak incentives to acquire information, which discourages delegation even further and may result in insufficiently informed voting outcomes“ (p. 28/29).

Analyst advantage: Behavioral Machine Learning? Computer Predictions of Corporate Earnings also Overreact by Murray Z. Frank, Jing Gao, and Keer Yang as of May 24^th, 2023 (#184): “We study the predictions of corporate earnings from several algorithms, notably linear regressions and a popular algorithm called Gradient Boosted Regression Trees (GBRT). On average, GBRT outperformed both linear regressions and human stock analysts, but it still overreacted to news and did not satisfy rational expectation as normally defined. … Human stock analysts who have been trained in machine learning methods overreact less than traditionally trained analysts. Additionally, stock analyst predictions reflect information not otherwise available to machine algorithms” (abstract).

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Advert for German investors:

Sponsor my research by investing in and/or recommending my global small/midcap mutual fund (SFDR Art. 9). The fund focuses on social SDGs and uses separate E, S and G best-in-universe minimum ratings and broad shareholder engagement with currently 29 of 30 engaged companies: FutureVest Equity Sustainable Development Goals R – DE000A2P37T6 – A2P37T; also see Active or impact investing? – (prof-soehnholz.com)

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Noch eine Fondsboutique?

(„Noch eine Fondsboutique“ ist am 15. August 2023 zuerst auf LinkedIn veröffentlicht worden).

Es gibt schon so viele Fonds und Fondsboutiquen. Noch eine Fondsboutique zu gründen, scheint wenig Sinn zu machen. Trotzdem habe ich das im August 2021 auf Wunsch eines Geschäftspartners gemacht, nachdem ich ursprünglich nur Modellportfolios anbieten wollte. Ziel war es einen Fonds zu starten, der sowohl besonders gut auf ökologische aber auch auf soziale Entwicklungsziele der Vereinten Nationen (SDG) ausgerichtet ist und der zudem besonders geringe Umwelt-, Sozial- und Unternehmensführungsrisiken aufweist.

Nachhaltigkeit wichtiger als Überrendite

Ich habe viele Jahre als Fondsselekteur gearbeitet und weiß, wie schwer es ist, passive Benchmarks zu schlagen. Ich werbe auch bewusst nicht damit, Outperformance liefern zu können. Mein Ziel ist es, so nachhaltig wie möglich zu investieren. Damit strebe ich eine aktienmarkttypische Performance an. Das Modellportfolio, auf dem der Fonds basiert, hat das seit dem Start Ende 2017 weitgehend erreicht. Im Vergleich zu aktiv gemanagten Fonds funktioniert das trotz einer relativ schlechten Rendite im ersten Halbjahr 2023 durch das gute Jahr 2022 bisher auch für den Fonds.

Mein Ansatz ist sehr untypisch: Ich selektiere meine Aktien fast nur anhand von Nachhaltigkeitsinformationen. Die Diversifikation beschränke ich bewusst auf 30 Aktien, weil eine höhere Diversifikation meine Nachhaltigkeitsanforderungen verwässern würde. Trotzdem sind die Risikokennzahlen des Fonds gut.

Konsequente Nachhaltigkeit ist leichter von Small- und Midcaps erfüllbar (noch eine Fondsboutique)

Mein Fonds ist auf Unternehmen fokussiert, deren Produkte und Services möglichst gut mit mindestens einem SDG vereinbar sind. Das trifft eher auf kleinere als auf größere Unternehmen zu. Auch meine zahlreichen konsequenten Ausschüsse sind eher von spezialisierteren als von diversifizierten Unternehmen erfüllbar, so dass der Fonds überwiegend Small- und Midcaps enthält.

Unternehmen mit Hauptsitz in Ländern, die meinen Anforderungen an Gesetzmäßigkeit nicht entsprechen, bleiben unberücksichtigt. In meinem Fonds haben die USA aktuell einen Anteil von leicht über 50%. Der Eurolandanteil liegt ebenso wie der Australien-Anteil derzeit bei etwa 10%. Gesundheits- und Industrieunternehmen machen den Hauptbestandteil aus und auch (Sozial-) Immobilien und (nachhaltige) Infrastruktur sind überdurchschnittlich vertreten. Technologieunternehmen sind dagegen unterrepräsentiert im Vergleich zu traditionellen Aktienbenchmarks.

Große Unterschiede zu anderen Fonds

In Deutschland werden nur wenige global investierende Fonds mit Small- und/oder Midcap-Fokus angeboten. Im Juni habe ich mir die Portfolios potenzieller Wettbewerber angesehen und maximal vier Aktien Überscheidung gefunden.

Unterschiede zu anderen Fonds gibt es vor allem in Bezug auf das Nachhaltigkeitskonzept. Ich kenne keinen anderen Fonds mit so strengen und so vielen Ausschlüssen. Ich kenne auch keinen anderen branchendiversifizierten Fonds, der strenge Best-in-Universe ESG-Ratings nutzt. Dabei werden nur Unternehmen mit besonders geringen absoluten ESG-Risiken ausgewählt. Fast alle anderen Fonds nutzen einen laxeren Best-in-Class ESG-Ratingansatz, bei dem – abhängig vom jeweiligen Marktsegment – relativ gute ESG-Risiken ausreichen.

Viele Fonds haben zudem nur Mindestanforderungen an aggregierte ESG-Ratings und nicht explizit separate Mindestanforderungen an Umwelt-, Sozial- und Unternehmensführungsratings, wie es bei meinem Fonds der Fall ist. Auf Basis eines detaillierten Nachhaltigkeits-Engagementkonzeptes, das auch auf andere Stakeholder wie Mitarbeiter einbezieht, bin ich zudem aktuell mit 28 von 30 Unternehmen in einem aktiven Dialog.

Für die meisten Fondsselekteure ist mein Fonds aber noch zu jung und mit knapp über 10 Millionen Fondsvermögen noch zu klein. Durch meinen regelbasieren Ansatz kann ich aber auch als Ein-Personen Fondsboutique gemeinsam mit meinen Fondspartnern Deutsche Wertpapiertreuhand und Monega sowie mit meinem Beratungs- und IT-Partner QAP Analytic Solutions und meinem Datenlieferanten Clarity.ai alle Anforderungen gut erfüllen.

Ich bin sehr zuversichtlich, dass mein Fonds eine gute Zukunft hat und möchte dauerhaft in großem Umfang im Fonds investiert bleiben.

Weiterführende Informationen siehe www.futurevest.fund und z.B. Active or impact investing? – (prof-soehnholz.com)

Disclaimer zu „Noch eine Fondsboutique)

Dieser Beitrag ist von der Soehnholz ESG GmbH erstellt worden. Die Erstellerin übernimmt keine Gewähr für die Richtigkeit, Vollständigkeit und/oder Aktualität der zur Verfügung gestellten Inhalte. Die Informationen unterliegen deutschem Recht und richten sich ausschließlich an Investoren, die ihren Wohnsitz in Deutschland haben. Sie sind nicht als Verkaufsangebot oder Aufforderung zur Abgabe eines Kauf- oder Zeichnungsangebots für Anteile des in dieser Unterlage dargestellten Fonds zu verstehen und ersetzen nicht eine anleger- und anlagegerechte Beratung. Anlageentscheidungen sollten nur auf der Grundlage der aktuellen gesetzlichen Verkaufsunterlagen (Wesentliche Anlegerinformationen, Verkaufsprospekt und – sofern verfügbar – Jahres- und Halbjahresbericht) getroffen werden, die auch die allein maßgeblichen Anlagebedingungen enthalten. Die Verkaufsunterlagen werden bei der Kapitalverwaltungsgesellschaft (Monega Kapitalanlagegesellschaft mbH), der Verwahrstelle (Kreissparkasse Köln) und den Vertriebspartnern zur kostenlosen Ausgabe bereitgehalten. Die Verkaufsunterlagen sind zudem im Internet unter www.monega.de erhältlich. Die in dieser Unterlage zur Verfügung gestellten Inhalte dienen lediglich der allgemeinen Information und stellen keine Beratung oder sonstige Empfehlung dar. Die Kapitalanlage ist stets mit Risiken verbunden und kann zum Verlust des eingesetzten Kapitals führen. Vor einer etwaigen Anlageentscheidung sollten Sie eingehend prüfen, ob die Anlage für Ihre individuelle Situation und Ihre persönlichen Ziele geeignet ist. Diese Unterlage enthält ggf. Informationen, die aus öffentlichen Quellen stammen, die die Erstellerin für verlässlich hält. Die dargestellten Inhalte, insbesondere die Darstellung von Strategien sowie deren Chancen und Risiken, können sich im Zeitverlauf ändern. Einschätzungen und Bewertungen reflektieren die Meinung der Erstellerin zum Zeitpunkt der Erstellung und können sich jederzeit ändern. Es ist nicht beabsichtigt, diese Unterlage laufend oder überhaupt zu aktualisieren. Sie stellt nur eine unverbindliche Momentaufnahme dar. Die Unterlage ist ausschließlich zur Information und zum persönlichen Gebrauch bestimmt. Jegliche nicht autorisierte Vervielfältigung und Weiterverbreitung ist untersagt.

Impact impact? Researchpost #137

Impact impact? 18x new research on pension taxes, food carbon labels, sector investing, brown divestments, biodiversity, ESG fund flows, governance washing, impact investing, stewardship, shareholder engagement, divestments, social bonds, article 9 funds and asset allocation (# of SSRN downloads on August 3^rd, 2023) by Marco Becht, Tobias Berg, Timo Busch, Thierry Roncalli, Laurens Swinkels and many more

Social and ecological research

Pension taxes: Does a Decrease in Pension Taxes Increase Retirement Savings? An Experimental Analysis by Kay Blaufus, Michael Milde, and Alexandra Spaeth as of June 12^th, 2023 (#34): “Many countries use tax incentives to promote retirement savings. … Using a series of experiments, we demonstrate that decreasing pension tax rates does not encourage retirement savings. … In contrast, an increase in the tax refund rate, i.e., the rate at which individuals can deduct their retirement savings, increases savings. … all subjects were fully informed about the tax rules and passed comprehension tests on these rules. Nevertheless, we observe significant misperceptions regarding taxes on pension income. … an instrument that increases current tax benefits is more effective than one that decreases future tax burdens even if both instruments are economically equivalent. … we show that substituting deferred taxation with economically equivalent immediate taxation increases the (effective) savings rate by 7.2 percentage points without changing tax revenue” (p. 28/29).

Food carbon labels: Should Carbon Footprint Labeling be Mandatory for all Food Products? RCT Shows no Benefit beyond Labeling the Top Third by Pierre Chandon, Jad Chaaban, and Shemal Doshi as of June 12^th, 2023 (#26): “Carbon footprint labels have been shown to lead consumers to choose food products with lower CO2 emissions … We asked 1,081 American consumers to shop in an experimental online grocery store and choose one frozen meal among the full assortment of a major American grocer … A 16.5% reduction in emissions was achieved by labeling the top third of products, with no statistically significant improvement gained by further increasing the proportion of labeled products” (abstract).

ESG and internal control: Corporate Environmental, Social, and Governance (ESG) Performance and the Internal Control Environment by Jacquelyn Sue Moffitt, Jeanne-Claire Alyse Patin, and Luke Watson as of June 15^th, 2023 (#59): “We find that ESG performance is negatively related to the likelihood of general internal control weaknesses, consistent with transparent reporting. We also find that ESG performance is negatively related to company-level internal control weaknesses, which are considered relatively severe. Further, we find that ESG performance is negatively associated with specific internal control weaknesses that indicate a lack of ethical tone at the top. … Overall, our results suggest that ESG performance is positively associated with the strength of the internal control environment“ (abstract).

ESG investing research: Impact impact?

Environmental sector investing: Environmental Preferences and Sector Valuations by Tristan Jourde and Arthur Stalla-Bourdillon as of July 7^th, 2023 (#75): “… we explore the dynamic nature of pro-environmental preferences among investors through the lens of sector valuations in global equity markets from 2018 to 2021. … we find that firms’ green and brown sector affiliations are significantly priced in the global equity market, positively for green sectors and negatively for brown sectors. Furthermore, companies operating in green sectors have become increasingly overvalued relative to the rest of the market between 2018 and 2021, and vice versa for those operating in brown sectors … In addition, the turnover rate of both green and brown companies has increased over the last years …“ (p. 19). My comment: An update of the study after the 2022 market development would be interesting.

Brown divestments: Climate risk and strategic asset reallocation by Tobias Berg, Lin Ma, and Daniel Streitz as of Feb. 28^th, 2023 (#128): “We document that large emitters, i.e., firms that are part of the Climate Action 100+ scheme, started to reduce their combined Scope 1 and 2 emissions by around 12% in the years after the 2015 Paris Agreement relative to other public firms with positive carbon emission levels. … There is no evidence for increased engagements in other emission reduction activities. … we find that buyers of large asset sales tend to be private, financial, and other firms that do not disclose emissions to the Carbon Disclosure Project. … We provide evidence that is consistent with increased regulatory risk being a main driver of the effects“ (p. 25/26). My comment: I am skeptical regarding Transition investments see ESG Transition Bullshit? – Responsible Investment Research Blog (prof-soehnholz.com)

Biodiversity premium: A closer look at the biodiversity premium by Guillaume Coqueret and Thomas Giroux as of Juy 21^st, 2023 (#163): “… while this (Sö: biodiversity) premium is not unconditionally strong, there are dimensions along which it may prove substantial. For instance, air pollution is priced significantly more than land use, even though the latter has a more decisive impact on the environment. Another important subtlety lies in the distinction between realized versus expected returns (from investors). Our results show more pronounced effects on expected returns. … Lastly, like all other premia, the biodiversity factor experiences fluctuating returns. The recent period is associated with largely negative premia, especially for expected returns. Our analysis shows that a few variables are able to explain some time-variations, notably attention to biodiversity and climate, oil prices, and consumer sentiment” (p. 17).

Good ESG capital: ESG Capitals and Corporate Value Creation by Banita Bissoondoyal-Bheenick, Scott Bennett, and Angel Zhong as of June 12^th, 2023 (#110): “Our paper has documented that investing in ESG capital … can lead to better short-term and long-term shareholder wealth … In the short term, the ESG capital triggers sharp financial return improvement for a firm to improve their ESG capital from a very low point (i.e., a firm that seldom considers ESG activities and culture) to an average ESG performance. Such positive effects are small but still positive if the firm continues to enhance its ESG capital from the middle range towards the top level in the market. We also find that investment in ESG capital can positively and interactively influence other capitals, such as financial, innovation and manufacturing capitals, to improve financial returns. Under a good ESG environment, more holding of the other capitals could lead to more significant financial returns than each capital could achieve individually“ (p. 23/24).

Provider-friendly ESG? Machine-Learning about ESG Preferences: Evidence from Fund Flows by George O. Aragon and Shuaiyu Chen as of July 29^th, 2023 (#36): “We first construct a broad dataset of ESG scores for active equity mutual funds based on funds’ stock holdings and stock-level scores from six prominent ESG data providers. We document substantial dispersion in scores across providers, but that many scores nevertheless have predictive power for flows. … Over our 2010–2020 sample period, we find that funds with higher ESG benefits subsequently realize higher flows, lower net returns against the benchmark, lower value-added from net returns, and hold stocks that underperform other stocks. We estimate that investors pay an annual premium of $11 million to invest in a fund with ESG benefits in the top decile. Overall, our findings shed new light on the relevance of ESG scores and the ESG preferences of investors“ (p. 23). My comment: The fund flows should be positive for my pure ESG fund and portfolios, see e.g. Artikel 9 Fonds: Kleine Änderungen mit großen Wirkungen? – (prof-soehnholz.com)

Governance-washing: The G-pillar in ESG: how to separate the wheat from the chaff in comply-or-explain approach? by Daniela Venanzi as of June 26^th, 2023 (#24): “This study tries to verify if a gap exists between apparent and real compliance to CG (Sö; Corporate Governance) Code requirements in a sample of Italian listed financial companies (mostly banks), with reference to two areas (independence of board members and transparency) that mostly make decision-making unbiased by conflicts of interests and are therefore crucial for corporate sustainability. We find opacity/obfuscation in CG narrative and avoidance/concealment strategies also in banks considered “CG champions”, more rarely non-compliance clearly declared and appropriately explained” (abstract).

ESG predictions: Are ESG ratings informative to forecast idiosyncratic risk? by Christophe Boucher, Wassim Le Lann, Stéphane Matton, and Sessi Tokpavi as of July 11^th, 2023 (#71): “The contribution of this article is to propose a formal statistical procedure for assessing the informational content in ESG ratings. … We apply our procedure to evaluate two leading ESG rating systems (Sustainalytics and Asset4) in three investment universes (Europe, North America, and the Asia-Pacific region). The results show that the null hypothesis of a lack of informational content in ESG ratings is strongly rejected for Europe, while the results are mixed and predictive accuracy gains are lower for the other regions. Furthermore, we find that the predictive accuracy gains are higher for the environmental dimension of the ESG ratings. Importantly, we find that the predictive accuracy gains derived from ESG ratings increase with the level of consensus between rating agencies in all three universes, while they are low for firms over which there is a high level of disagreement“ (p. 31).

Risk-reducing disclosure: ESG Disclosure, CEO Power and Incentives and Corporate Risk-taking by Faek Menla Ali, Yuanyuan Wu, and Xiaoxiang Zhang as of July 25^th, 2023 (#19): “… we analyze the impact of ESG disclosure on firm risk-taking within US companies. … the reduction in corporate risk-taking due to ESG disclosure mitigates excessive risk-taking rather than leading to risk avoidance“ (p. 26).

Impact investing research: Impact impact?

Impact impact? Missing the Impact in Impact Investing Research – A Systematic Review and Critical Reflection of the Literature by Deike Schlütter, Lena Schätzlein, Rüdiger Hahn, and Carolin Waldner as of July 6^th, 2023: “Impact investing (II) aims to achieve intentional social impact in addition to financial return. … the growing academic literature on II is scattered across a variety of disciplines and topics, with inconsistencies in terminology and concepts and a paucity of theoretical explanations and frameworks. … Despite the fact that II aims to create a measurable societal impact, this impact of II, its raison d’être, is not scrutinized in the literature“ (abstract).

Stewardship overview: Investor Stewardship: The State of the Art and Future Prospects by Dionysia Katelouzou as of June 22^nd, 2023 (#46): “Within less than fifteen years fifty-five soft-law stewardship codes have been developed across 23 jurisdictions on six continents and investor stewardship became the standard term of reference for the role of institutional investors in addressing not only corporate governance but also environmental and social issues. … Nevertheless, there is still a continuing lack of clarity or consensus over what regulators and investors deem to be a good investor steward. … Institutional investors acting as stewards are expected to exercise power and influence over their assets, on behalf of others, and for others. … Finally, I look at the future of investor stewardship, focusing specifically on two ongoing trends, that of green stewardship and disintermediated stewardship“ (abstract).

ESG engagement: Does Paying Passive Managers to Engage Improve ESG Performance? by Marco Becht, Julian R. Franks, Hideaki Miyajima and Kazunori Suzuki as of July 26^th, 2023 (#283): “… the Japanese Government Pension Investment Fund (GPIF), the largest public pension fund in the world … gave its largest passive manager a remunerated mandate to improve the environmental (E), social (S) and governance (G) performance of portfolio companies. … engagement by the asset manager has resulted in improvements in some of the ESG scores for mid- and large cap companies; small-cap companies were rarely engaged. … we find evidence that GPIF’s portfolio tilt towards ESG indexes has created financial incentives to improve ESG scores” (abstract).

Career first? Exit or Voice? Divestment, Activism, and Corporate Social Responsibility by Victor Saint-Jean as of June 21^st, 2023 (#80): “Using a classification framework based on US mutual funds’ portfolio holdings and votes on S-related shareholder proposals, I show that voice funds generally do better than exit funds when it comes to curtailing firms’ anti-social behavior. The exit strategy relies on the threat of lower stock prices and is effective only at firms with high CEO wealth-performance-sensitivity. Voice funds threaten directors’ reelection, and are thus more effective in general, especially when elections are approaching. Taken together, my results point to the career concerns of the leadership as driving pro-social change when shareholders demand it” (abstract).

No social premium: Green vs. Social Bond Premium by Mohamed Ben and Thierry Roncalli from Amundi as of May 21^st, 2023 (#102): “Between 2019 and 2022, the greenium is about −3 bps on average, meaning that, all else being equal, investors are willing to forsake a small share of returns in exchange for environmental benefits. … For the social bond premium, we notice fragmented estimates of the premium in the secondary market. In the long run, the premium is close to zero and equal to −0.3 bps on average. … we notice that the social bond premium is not positively correlated with the greenium. … non-euro projects are subject to a higher premium“ (p. 26/27).

Article 9 segments: SFDR Article 9: Is it all about impact? by Lisa Scheitza and Timo Busch as of July 17^th, 2023 (#235): “We investigate more than 1,000 investment funds that are classified under Article 9 of the EU Sustainable Finance Disclosure Regulation (SFDR). … while 60% of funds follow an impact-oriented investment strategy, we identify 40% that are not impact-related but rather pursue an Environment, Social, and Governance (ESG) investment strategy. Generally, we do not find significant differences in ESG scores and returns between ESG-related and impact-related funds. Yet, impact-related funds have higher SDG impact scores and higher management fees than ESG-related funds. Downgraded Article 9 funds, i.e., funds that changed SFDR status by January 2023, however, tend to follow less ambitious investment approaches and realize lower returns than funds that maintained their SFDR statuses“ (abstract). “ …. we find no significant differences in risk-adjusted returns between ESG-related investments and impact-related investments among Article 9 funds” (p. 16). My comment: My impact approach see Active or impact investing? – (prof-soehnholz.com)

Other investment research

Asset allocation problem? Empirical evidence on the stock-bond correlation by Roderick Molenaar, Edouard Sénéchal, Laurens Swinkels, and Zhenping Wang as of July 26^th, 2023 (#377): “Our historical data starting in 1875 indicates that a positive stock-bond correlation has been more common than a negative one, even though the latter has been observed mostly in the past two decades. Our overarching finding is that for the post-1952 period with independent central banks, a positive stock-bond correlation is observed during periods with high inflation and high real returns on Treasury bills. … Historical regimes with positive stock-bond correlation are associated with higher volatility risk of a 60/40 portfolio and lower Sharpe ratios“ (p. 25/26). My comment: My most-passive allocation approach see Microsoft Word – 230720 Das Soehnholz ESG und SDG Portfoliobuch

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Impact impact? Advert for German investors:

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Active ESG share: Researchpost #136

Active ESG share: 26x new research on SDG, climate automation, family firms, greenium and green liquidity, anti-ESG, ESG-ratings, diversity, sustainability standards, disclosure, ESG pay, taxes, impact investing, and financial education by Martijn Cremers and many more (#: SSRN downloads as of July 27^th, 2023)

Ecological and social research: Active ESG share

SDG deficits: The Sustainable Development Goals Report Special edition by the United Nations as of July 10^th, 2023: “At the midpoint on our way to 2030, the Sustainable Development Goals are in deep trouble. An assessment of the around 140 targets for which trend data is available shows that about half of these targets are moderately or severely off track; and over 30 per cent have either seen no movement or regressed below the 2015 baseline. Under current trends, 575 million people will still be living in extreme poverty in 2030, and only about one third of countries will meet the target to halve national poverty levels. Shockingly, the world is back at hunger levels not seen since 2005, and food prices remain higher in more countries than in the period 2015–2019. The way things are going, it will take 286 years to close gender gaps in legal protection and remove discriminatory laws. And in education, the impacts of years of underinvestment and learning losses are such that, by 2030, some 84 million children will be out of school and 300 million children or young people attending school will leave unable to read and write. … Carbon dioxide levels continue to rise – to a level not seen in 2 million years. At the current rate of progress, renewable energy sources will continue to account for a mere fraction of our energy supplies in 2030, some 660 million people will remain without electricity, and close to 2 billion people will continue to rely on polluting fuels and technologies for cooking. So much of our lives and health depend on nature, yet it could take another 25 years to halt deforestation, while vast numbers of species worldwide are threatened with extinction” (p. 4).

Climate automation: Labor Exposure to Climate Change and Capital Deepening by Zhanbing Xiao as of June 21^st, 2023 (#31): “This paper looks into these risks and calls for more attention to the health issues of outdoor workers in the transition to a warmer era. … I find that high-exposure firms have higher capital-labor ratios, especially when their managers believe in climate change or when jobs are easy to automate. After experiencing shocks to physical (abnormally high temperatures) or regulatory (the adoption of the HIPS in California) risks, high-exposure firms switch to more capital-intensive production functions. …I also find that high-exposure firms respond to the shocks by innovating more, especially in technologies facilitating automation and reducing labor costs. … industry-wide evidence that labor exposure to climate change negatively affects job creation and workers’ earnings“ (p. 34/35).

Open or private data? Opening Up Big Data for Sustainability: What Role for Database Rights in the Fourth Industrial Revolution? by Guido Noto La Diega and Estelle Derclaye as of Nov. 8^th, 2022 (#159): “… the real guardians of big data – the private corporations that are the key decision-makers in the 4IR (Sö: 4th Industrial Revolution) – are not doing enough to facilitate the sharing and re-use of data in the public interest, including the pursuit of climate justice. … While there may be instances where Intellectual Property (IP) reasons may justify some limitations in the access to and re-use of big data held by corporations, it is our view that, in general, IP should not be used to hinder re-use of data to pursue the SDGs. … First, we will illustrate the triple meaning of ‘data sustainability.’ Second, we will critically assess whether the database right (or ‘sui generis right’) can play a role in opening up corporate big data. Third, will imagine how a sustainable framework for sustainable data governance may look like. This focus is justified by the fact that the Database Directive, often accused of creating an unjustified monopoly on data, is in the process of being reformed by the yet-to-be-published Data Act” (abstract).

Clean family firms: Family Ownership and Carbon Emissions by Marcin Borsuk, Nicolas Eugster, Paul-Olivier Klein, and Oskar Kowalewski as of April 13^th, 2023 (#159): “Family firms exhibit lower carbon emissions both direct and indirect when compared to non-family firms, suggesting a higher commitment to environmental protection by family owners. When using the 2015 Paris Agreement as a quasi-exogeneous shock, results show that family firms reacted more to the Agreement and recorded a further decline in their emissions. … Firms directly managed by the family experience a further reduction in their emissions. On the contrary, family firms with hired CEOs see an increase in emissions. We show that family firms record a higher level of R&D expenses, suggesting that they invest more in new technologies, which might contribute to reducing their environmental footprint. … Compared with non-family firms, family firms commit less to a reduction in their carbon emissions and display lower ESG scores“ (p. 26).

Green productivity: Environmental Management, Environmental Innovation, and Productivity Growth: A Global Firm-Level Investigation by Ruohan Wu as of June 18^th, 2023 (#5): “… overall, environmental management and innovation both increase firm productivity but substitute for each other’s positive effects. Environmental management significantly increases productivity of firms that do not innovate, while environmental innovation significantly increases productivity of those without environmental management” (p. 30).

Good governance: Governance, Equity Issuance and Cash: New International Evidence by Sadok El Ghoul, Omrane Guedhami, Hyunseok Kim, and Jungwon Suh as of May 9^th, 2023 (#18): “… we hypothesize that equity issuance is more frequent and growth-inducing under strong governance than under weak governance. We also hypothesize that cash added to or held by equity issuers creates greater value for shareholders under strong governance than under weak governance. Our empirical results support these hypotheses. Most remarkably, under weak governance, cash assets not only fail to create but destroy value for shareholders if they are in the possession of equity issuers instead of non-equity-issuers. Overall, strong institutions help small growth firms unlock their value through active equity issuance. On the flip side, weak institutions render an economy’s capital allocation inefficient by hindering value-creating equity issuance” (abstract).

ESG Ratings Reearch: Active ESG Share

MSCI et al. criticism? ESG rating agency incentives by Suhas A. Sridharan, Yifan Yan, and Teri Lombardi Yohn as of June 19^th, 2023 (#96): “First, we report that firms with higher (lower) stock returns receive higher (lower) ratings from a rater with high index incentives relative to ratings from a rater with low index incentives. … Second, the rater with high index incentives provides higher ESG ratings for smaller firms with less ESG disclosure. … Third, we show that ESG index inclusion decisions are associated with stock returns. Collectively, our findings suggest that ESG data providers’ index licensing incentives influence their ESG ratings“ (p. 22).

Anti-ESG ESG: Conflicting Objectives of ESG Funds: Evidence from Proxy Voting by Tao Li, S. Lakshmi Naaraayanan, and Kunal Sachdeva as of February 6^th, 2023 (#840): “ESG funds reveal their preference for superior returns by voting against E&S proposals when it is uncertain whether these proposals will pass. … active ESG funds and non-ESG focused institutions are more likely to cast votes against E&S proposals” (p. 26).

Non-ESG ESG? What Does ESG Investing Mean and Does It Matter Yet? by Abed El Karim Farroukh, Jarrad Harford, and David Shin as of June 26^th, 2023 (#77): “… even ESG-oriented funds often vote against shareholder proposals related to E&S issues. When considering portfolio holdings and turnover, firms added to portfolios have better ESG scores than those dropped for both ESG and non-ESG funds. Nevertheless, portfolio additions and deletions do not improve fund scores on a value-weighted basis, and those scores closely track the ESG score of a value weighed portfolio of all public firms. This suggests that while investment filters based on ESG criteria may exist, they rarely bind. … we find that material E&S proposals receive more support, but only a small proportion (4%) of these proposals actually pass. Lastly, unconditional support from funds associated with families that have signed the United Nations Principles for Responsible Investing (UN PRI) would lead to a significant change in the voting outcomes of numerous E&S proposals. Overall, our findings suggest that the effects of ESG investing are growing but remain relatively limited. E&S proposals rarely pass, and the ESG scores of funds declaring ESG preferences are not that different from the rest of funds“ (p. 26).

ESG divergence: ESG Ratings: Disagreement across Providers and Effects on Stock Returns by Giulio Anselmi and Giovanni Petrella as of Jan. 23^rd, 2023 (#237): “This paper examines the ESG rating assigned by two providers, Refinitiv and Bloomberg, to companies listed in Europe and the United States in the period 2010-2020. … Companies with higher ESG scores have the following characteristics: larger size, lower credit risk, and lower equity returns. The ESG dimension does not affect stock returns, once risk factors have been taken into account. The divergence of opinions across rating providers is stable in Europe and increasing in the US. As for the individual components (E, S and G), in both markets we observe a wide and constant divergence of opinions for governance as well as a growing divergence over time for the social component“ (abstract).

Active ESG share: The complex materiality of ESG ratings: Evidence from actively managed ESG funds by K.J. Martijn Cremers, Timothy B. Riley, and Rafael Zambrana as of July 21^st,2023 (#1440): “Our primary contribution is to introduce a novel metric of the importance of ESG information in portfolio construction, Active ESG Share, which measures how different the full distribution of the stock-level ESG ratings in a fund’s portfolio is from the distribution in the fund’s benchmark … We find no predictive relation between Active ESG Share and performance among non-ESG funds and a strong, positive predictive relation between Active ESG Share and performance among ESG funds” (p. 41). My comment: My portfolios are managed independently from benchmarks and typically show significant positive active ESG shares, see e.g. Active or impact investing? – (prof-soehnholz.com)

Responsible investment research: Active ESG share

Stupid ban? Do Political Anti-ESG Sanctions Have Any Economic Substance? The Case of Texas Law Mandating Divestment from ESG Asset Management Companies by Shivaram Rajgopal, Anup Srivastava, and Rong Zhao as of March 16^th,2023 (#303): “Politicians in Texas claim that the ban on ESG-heavy asset management firms would penalize companies that potentially harm the state’s interest by boycotting the energy sector. We find little economic substance behind such claims or the reasoning for their ban. Banned funds are largely indexers with portfolio tilts toward information technology and away from energy stocks. Importantly, banned funds carry significant stakes in energy stocks and hold 61% of the energy stocks held by the control sample of funds. The risk and return characteristics of banned funds are indistinguishable from those of control funds. A shift from banned funds to control funds is unlikely to result in a large shift of retirement investments toward the energy sector. The Texas ban, and similar follow-up actions by Republican governors and senior officials, appear to lack significant economic substance“ (p. 23).

Better proactive: Gender Inequality, Social Movement, and Company Actions: How Do Wall Street and Main Street React? by Angelyn Fairchild, Olga Hawn, Ruth Aguilera, Anatoli Colicevm and Yakov Bart as of May 25^th,2023 (#44): “We analyze reactions to company actions among two stakeholder groups, “Wall Street” (investors) and “Main Street” (the general public and consumers). … We identify 632 gender-related company actions and uncover that Wall Street and Main Street are surprisingly aligned in their negative reaction to companies’ symbolic-reactive actions, as evidenced by negative cumulative abnormal returns, more negative social media and reduced consumer perceptions of brand equity” (abstract)

Less risk? Socially Responsible Investment: The Role of Narrow Framing by Yiting Chen and Yeow Hwee Chua as of Dec. 8^th, 2022 (#54): “Through our experiment, subjects allocate endowments among one risk-free asset and two risky assets. … Relative to the control condition, this risky asset yields additional payments for subjects themselves in one treatment, and for charities in the remaining two treatments. Our results show that additional payments for oneself encourage risk taking behavior and trigger rebalancing across different risky assets. However, payments for charities solely induce rebalancing“ (abstract). My comment: This may explain the typically lower risk I have seen in my responsible portfolios and in some research regarding responsible investments.

Greenium model: Asset Pricing with Disagreement about Climate Risks by Thomas Lontzek, Walter Pohl, Karl Schmedders, Marco Thalhammer, and Ole Wilms as of July 19^th, 2023 (#113): “We present an asset-pricing model for the analysis of climate financial risks. … In our model, as long as the global temperature is below the temperature threshold of a tipping point, climate-induced disasters cannot occur. Once the global temperature crosses that threshold, disasters become increasingly likely. The economy is populated by two types of investor with divergent beliefs about climate change. Green investors believe that the disaster probability rises considerably faster than brown investors do. … The model simultaneously explains several empirical findings that have recently been documented in the literature. … according to our model past performance is not a good predictor of future performance. While realized returns of green stocks have gone up in response to negative climate news, expected returns have gone down simultaneously. In the absence of further exogenous shocks and climate-induced disasters, our model predicts higher future returns for brown stocks. However, if temperatures continue to rise and approach the tipping point threshold, the potential benefits of investments to slow down climate change increase significantly. In this scenario, our model predicts a significant increase in the market share of green investors and the carbon premium“ (p. 39/40).

More green liquidity: Unveiling the Liquidity Greenium: Exploring Patterns in the Liquidity of Green versus Conventional Bonds by Annalisa Molino, Lorenzo Prosperi, and Lea Zicchino as of July 16^th, 2023 (#14): “… we investigate the relationship between liquidity and green bond label using a sample of green bonds issued globally. … our findings suggest that green bonds are more liquid than comparable ordinary bonds. … The difference is large and statistically significant for bonds issued by governments or supranationals, while it is not significantly different from zero for corporates, unless the company operates in the energy sector. … companies that certify their commitment to use the proceeds for green projects or enjoy a strong environmental reputation can also benefit from higher liquidity in the secondary market. … the liquidity of ECB-eligible green bonds improves relative to similar conventional bonds, possibly because they become more attractive to banks with access to ECB funding. Finally, we find that the liquidity of conventional bonds issued by green bond issuers improves significantly in the one-year period following the green announcement“ (p. 18/19).

Impact investment and shareholder engagement: Active ESG share

Standard overload: Penalty Zones in International Sustainability Standards: Where Improved Sustainability Doesn’t Pay by Nicole Darnall, Konstantinos Iatridis, Effie Kesidou, and Annie Snelson-Powell as of June 19^th, 2023 (#17): “International sustainability standards (ISSs), such as the ISO standards, the United Nations Global Compact, and the Global Reporting Initiative framework, are externally certified process requirements or specifications that are designed to improve firms’ sustainability” (p. 1). “Adopting an International Sustainability Standard (ISS) helps firms improve their sustainability performance. It also acts as a credible market “signal” that legitimizes firms’ latent sustainability practices while improving their market value. … However, beyond a tipping point of 2 ISSs, firms’ market gains decline, even though their sustainability performance continues to improve until a tipping point of 3 ISSs“ (abstract).

Good ESG disclosure (1): Mandatory ESG Disclosure, Information Asymmetry, and Litigation Risk: Evidence from Initial Public Offerings by Thomas J. Boulton as of April 7^th, 2023 (#168): “If ESG disclosure improves the information environment or reduces litigation risk for IPO firms, IPOs should be underpriced less when ESG disclosure is mandatory. I test this prediction in a sample of 15,456 IPOs issued in 36 countries between 1998 and 2018. … I find underpricing is lower for IPOs issued in countries that mandate ESG disclosure. From an economic perspective, my baseline results indicate that first-day returns are 15.9 percentage points lower in the presence of an ESG disclosure mandate. The typical IPO firm raises approximately 105.93 million USD in their IPO. Thus, the implied impact of an ESG disclosure mandate is an additional 16.8 million in proceeds. … I find that their impact on underpricing is stronger in countries with lower-quality disclosure environments. … a significant benefit of ESG disclosure mandates is that they lower the cost of capital for the young, high-growth firms that issue IPOs” (p. 27-29).

Good ESG disclosure (2): Environmental, Social and Governance Disclosure and Value Generation: Is the Financial Industry Different? by Amir Gholami, John Sands, and Habib Ur Rahman as of July 18^th, 2023 (#24): “The results show that the overall association between corporate ESG performance disclosure and companies’ profitability is strong and positive across all industry sectors. … All corporate ESG performance disclosure elements (ENV, SOC and GOV) are positively associated with corporate profitability for companies that operate in the financial industry. Remarkably, for companies operating in non-financial sectors, except for corporate governance, there is no significant association between corporate environmental and social elements and a company’s profitability“ (p. 12).

Climate pay effects: Climate Regulatory Risks and Executive Compensation: Evidence from U.S. State-Level SCAP Finalization by Qiyang He, Justin Hung Nguyen, Buhui Qiu, and Bohui Zhang as of April 13^th, 2023 (#131): “Different state governments in the U.S. have begun to adopt climate action plans, policies, and regulations to prepare for and combat the significant threats of climate change. The finalization of these climate action plans, policies, and regulations in a state results in an adaptation plan— the SCAP. … we find that SCAP finalization leads residents in that state to pay more attention to climate-related topics. Also, it leads firms headquartered in that state to have higher perceived climate regulatory risks … Further analyses show a reduction of total CEO pay of about 5% for treated firms headquartered in the SCAP-adopting state relative to control firms headquartered in non-adopting states. The negative treatment effect also holds for non-CEO executive compensation. … the shareholders of treated firms reduce their CEO’s profit-chasing and risk-taking incentives, probably because these activities will likely incur more future environmental compliance costs. Instead, CEO pay is more likely to be linked to corporate environmental performance, that is, the treated firms adopt environmental contracting to redirect CEO incentives from financial gains to environmental responsibility” (p. 27/28).

Stakeholder issues: Corporate Tax Disclosure by Jeffrey L. Hoopes, Leslie Robinson, and Joel Slemrod as of July 17^th, 2023 (#47): “Policies that require, or recommend, disclosure of corporate tax information are becoming more common throughout the world, as are examples of tax-related information increasingly influencing public policy and perceptions. In addition, companies are increasing the voluntary provision of tax-related information. We describe those trends and place them within a taxonomy of public and private tax disclosure. We then review the academic literature on corporate tax disclosures and discuss what is known about their effects. One key takeaway is the paucity of evidence that many tax disclosures mandated with the aim of increasing tax revenue have produced additional revenue. We highlight many crucial unanswered questions …” (abstract). My comment: Nevertheless I suggest to focus on tax disclosure/payment regarding community/government stakeholder engagement see Shareholder engagement: 21 science based theses and an action plan – (prof-soehnholz.com) rather than on donations or other indicators.

Impact investment status quo: Impact Investing by Ayako Yasuda as of July 23^rd, 2023 (#62): “Impact investing is a class of investments that are designed to meet the non-pecuniary preferences of investors (or beneficiaries) and aim to generate a positive externality actively and causally through their ownership and/or governance of the companies they invest in. Impact investing emerged as a new branch of responsible, sustainable or ESG (environmental, social, and governance) investment universe in the last few decades. In this article, we provide a definition of impact investing, review the extant literature, and discuss suggestions for future research” (abstract).

Political engagement: Collaborative investor engagement with policymakers: Changing the rules of the game? by Camila Yamahaki and Catherine Marchewitz as of June 25^th, 2023 (#44): “A growing number of investors are engaging with policymakers on environmental, social and governance (ESG) issues, but little academic research exists on investor policy engagement. … We identify a trend that investors engage with sovereigns to fulfil their fiduciary duty, improve investment risk management, and create an enabling environment for sustainable investments. We encourage future research to further investigate these research propositions and to analyze potential conflicts of interest arising from policy engagement in emerging market jurisdictions” (abstract).

General investment research

Good diversity: Institutional Investors and Echo Chambers: Evidence from Social Media Connections and Political Ideologies by Nicholas Guest, Brady Twedt, and Melina Murren Vosse as of June 26^th, 2023 (#62): “… we measure the ideological diversity of institutional investors’ surroundings using the social media connections and political beliefs of the communities where they reside” (p. 24/25). “Finally, firms whose investors have more likeminded networks exhibit substantially lower future returns. Overall, our results suggest that connections to people with diverse beliefs and information sets can improve the financial decision making of more sophisticated investors, leading to more efficient markets (abstract).

Good education: The education premium in returns to wealth by Elisa Castagno, Raffaele Corvino, and Francesco Ruggiero as of July 6^th, 2023 (#17): “… we define as education premium the extra-returns to wealth earned by college-graduated individuals compared to their non-college graduated peers. We find that the education premium is sizeable … We find that an important fraction of the premium is due to the higher propensity for risk-taking and investing in the stock market of better educated individuals … we document a significantly higher propensity for well-diversified portfolios as well as a higher persistence in stock market participation over time of better educated individuals, and we show that both mechanisms positively and significantly contribute to the education premium” (p. 25).

Finance-Machines? Financial Machine Learning by Bryan T. Kelly and Dacheng Xiu as of July 26^th, 2023 (#12): “We emphasize the areas that have received the most research attention to date, including return prediction, factor models of risk and return, stochastic discount factors, and portfolio choice. Unfortunately, the scope of this survey has forced us to limit or omit coverage of some important financial machine learning topics. One such omitted topic that benefits from machine learning methods is risk modeling. … Closely related to risk modeling is the topic of derivatives pricing. … machine learning is making inroads in other fields such as corporate finance, entrepreneurship, household finance, and real estate“ (p. 132/133). My comment: I do not expect too much from financial maschine learning. Simple approaches to investing often work better than pseudo-optimised ones, see e.g. Pseudo-optimierte besser durch robuste Geldanlagen ersetzen – Responsible Investment Research Blog (prof-soehnholz.com)

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ESG sales impact: Researchpost #135

ESG sales impact: 11x new research on ESG sales effects, governance knowledge deficits and policies, corporate purpose measurement, CSR returns, impact frameworks, bad asset managers, financial advice AI and Bitcoin by Christina Bannier, Lars Hornuf, Judith Stroehle and many more (#: SSRN downloads on July 19th, 2023)

Social and ecological research: ESG sales impact

ESG sales impact (1): Do Consumers Care About ESG? Evidence from Barcode-Level Sales Data by Jean-Marie Meier, Henri Servaes, Jiaying Wei, and Steven Chong Xiao as of July 11^th, 2023 (#266): “… we find that higher E&S ratings positively affect subsequent local product sales. The positive effect of E&S ratings on local product sales is stronger in markets with more Democratic voters and with a higher average income. … revenue also declines after the release of negative E&S news. … we find a significant increase in the sensitivity of local retail sales to firm E&S performance after (Sö: natural and environmental) … disaster events for counties located closer to the events“ (p. 23).

ESG sales impact (2): How Does ESG Shape Consumption? by Joel F. Houston, Chen Lin, Hongyu Shan, and Mo Shen as of June 21^st, 2023 (#280): “Our study explores the effects of more than 1600 negative events captured from the RepRisk database, on 150 million point-of-sale consumption observations … Our baseline findings show that the average negative event generates a 5 – 10 % decrease in sales for the affected product in the six months following the event. … we find that there is considerable heterogeneity in consumer responses, and that the average response varies considerably depending on consumer demographics and the nature of the ESG-related reputation shock“ (p. 23/24).

Governance doubts: Seven Gaping Holes in Our Knowledge of Corporate Governance by David F. Larcker and Brian Tayan as of May 3^rd, 2023 (741): “… we highlight significant “holes” in our knowledge of corporate governance. … While the concepts we review are not exhaustive, each is critical to our understanding of the proper functioning of governance, including board oversight, the recruitment of CEO talent, the size and structure of CEO pay, and the advancement of shareholder and stakeholder welfare” (abstract).

Purpose first: Sustainable Corporate Governance. An Overview and an Assessment by Steen Thomsen as of June 8^th, 2023 (#144): “This paper outlines what could be some of the key elements of sustainable corporate governance 2.0 including company law (director liability), long-term ownership, ESG investment, company purpose, sustainability committees, sustainability competencies, ESG incentives, climate plans, climate risk management, sustainability reporting, and internal carbon pricing. … the current fixation on regulation and ESG is counterproductive and suggest that a better way forward is to start with company purpose and to adjust corporate governance accordingly. Using this approach, I outline a tentative roadmap for sustainable corporate governance 2.0“ (abstract). My comment: I suggest a Roadmap for corporate and stakeholder engagement here Shareholder engagement: 21 science based theses and an action plan – (prof-soehnholz.com)

Responsible investment research: ESG sales impact

Purpose measurement: Through the looking glass: tying performance and materiality to corporate purpose by Judith C. Stroehle, Kazbi Soonawalla, and Marcel Metzner as of June 7^th, 2023 (#18): “The performance principles of corporate purpose suggest that measurement needs to reflect whether companies take into account the growing significance of workers, societies and natural assets both inside and outside a company’s legal boundaries … Purpose without measurement runs the risk of being merely a mirage …. we show that it is not impossible to establish measurement of purpose, in particular when performance in relation to purpose is linked to existing frameworks of measurement and notions of single and double materiality“ (p. 30/31).

Irresponsible returns? The risk‑return tradeoff: are sustainable investors compensated adequately? by Christina E. Bannier, Yannik Bofinger, and Björn Rock as of April 27^th, 2023: “… our results show that low CSR (Sö: Corporate Social Responsibility) is … associated with higher portfolio returns. Interestingly, these higher returns even overcompensate the investor for the amount of risk she has to bear. … from an investor’s perspective, the ‘optimal’ return-to-risk ratio is achieved for a portfolio that invests in the lowest CSR-rated firms” (p. 169/170). My comment see ESG Transition Bullshit? – Responsible Investment Research Blog (prof-soehnholz.com)

Impact frames: How impact investing firms use reference frameworks to manage their impact performance: An industry-level study by Syrus M. Islam and Ahsan Habib as of July 10^th, 2023 (#8): “… we show how impact investing firms use various reference frameworks (e.g., IFC Performance Standards, Impact Management Project framework, UN Sustainable Development Goals) to manage their impact performance throughout the investment lifecycle. … We also discuss … how reference frameworks used in performance management in the impact investing industry differ from those used in some other industries” (abstract). My comment: I use the SDG-Framework see Active or impact investing? – (prof-soehnholz.com)

Bad asset managers? Who’s managing your future? An assessment of asset managers’ climate action by Lara Cuvelier at al. from Reclaim Finance as of June 28^th, 2023: “At the parent (or group) level, the 30 asset managers included in this report invested at least $3.5 billion in 74 newly issued bond securities from companies actively engaged in fossil fuel expansion. … The 30 asset managers analyzed held US$597 bn in bonds and shares in the biggest fossil fuel developers as of January 2023. … the majority of these 30 major asset managers do not currently sanction polluting companies for failing to take the right steps for the climate …After five years of intensive dialogue by investors from the CA100+ initiative, only 20% of the companies from the coal mining and oil and gas sectors that have been engaged have even set an ambition to achieve net zero emissions by 2050. … only two of the companies are working to decarbonize their capital expenditures” (p. 7).

General investment research

AI & investments: Executives vs. Chatbots: Unmasking Insights through Human-AI Differences in Earnings Conference Q&A by John (Jianqiu) Bai, Nicole Boyson, Yi Cao, Miao Liu, and Chi Wan as of June 22th, 2023 (#125): “… we use earnings conference calls as a setting and introduce a novel measure of information content (Human Machine Differences, HAID) by exploiting the discrepancy between answers to questions at earnings conference calls provided by actual corporate CFOs and CEOs and those given by several context-preserving Large Language Models (LLM) including ChatGPT. … HAID has significant predictive power for the absolute cumulative abnormal return around earnings call, stock liquidity, earnings growth, analyst forecast accuracy, as well as management’s propensity to provide guidance. … Overall, we find that HAID provides a unique and previously unidentified source and methodology to help investors uncover new information content” (p. 26).

LLM Advice: Using GPT-4 for Financial Advice by Christian Fieberg, Lars Hornuf, David J. Streich as of July 6^th, 2023 (#250): “GPT-4 can provide financial advice which is on par with the advice provided by professional low-cost automated financial advisory services. While the portfolios suggested by GPT-4 displayed considerable home bias, its historical risk-return profiles are at least on par with … benchmark portfolios. … To investigate GPT-4’s ability to serve clients’ sustainability preferences (ESMA, 2018), we added sustainability preferences to some of our investor profiles. The portfolios suggested for those profiles included ESG-focused versions of the portfolio components such as the iShares ESG Aware MSCI USA ETF. … risk profiling … can currently not be handled by GPT-4. … GPT-4 cannot offer assistance in implementing the portfolio (opening an account, purchasing and rebalancing portfolio components)“ (p. 11/12).

Bitcoin infects: Is Bitcoin Exciting? A Study of Bitcoin’s Spillover Effects by Minhao Leong and Simon Kwok as of July 13^th, 2023 (#16): “… we detect the presence of positive jump spillovers from Bitcoin to risk assets (U.S. equities, developed market equities and emerging market equities) and negative jump spillovers from Bitcoin to defensive assets (gold and emerging market bonds) after COVID-19. … we also find evidence of jump and diffusion spillovers from Bitcoin to U.S. equity sectors, particularly to the financials, technology, consumer discretionary and communication services sectors. … We show that over time, the proportion of blockchain and cryptocurrency exposed U.S. companies (BCEs) has increased in recent years, from 19% during the pre-pandemic period to 28.8%. Specifically, the adoption of blockchain and cryptocurrency related technologies by mega-cap names such as Microsoft (Technology), Amazon (Consumer Discretionary), Alphabet (Communication Services) and Tesla (Consumer Discretionary) has increased the Bitcoin exposures of equity market and sector indices“ (p. 41/42).

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ESG Transition Bullshit?

No impact on secondary markets?

ESG transition approaches suggest making companies more sustainable. Many providers of so-called responsible investments promote ESG transition investments. Typically, the argumentation is: You have to put money into brown companies so that they can finance the transition to become a greener company. That sounds plausible but may be misleading.

In the case of listed investments, securities are bought from other investors. No capital flows to the companies themselves. This is different with capital increases, new bond issues or private equity and credit investments. Not every such investor investment is truly additional because of an often high investor demand (“capital overhang”). In any case, issuers receive additional capital which they could use to finance a green transition. Unfortunately, even in the case of some so-called green, social or sustainability bonds, it cannot be guaranteed that the proceeds are used to finance greener or more social transitions (compare The Economics of Sustainability Linked Bonds by Tony Berrada, Leonie Engelhardt, Rajna Gibson, and Philipp Krueger as of September 14^th, 2022).

ESG Transition? Big Oil throws cash at shareholders, not renewables

According to Nathaniel Bullard from BNN Bloomberg (“Big Oil’s pullback from clean energy matters less than you might think” as of June 25^th, 2023) “The world’s five biggest publicly listed oil and gas companies posted just under $200 billion in total profits last year. Faced with three strategic possibilities for how to use their cash piles — extract oil and gas apace, move their businesses into renewable power and energy transition assets or return money to shareholders — the supermajors have largely sprung for the third option in recent weeks”. They invested in transition in the past, but their overall energy-transition investment share is low with about 3% according to Bullard. “And there is no shortage of capital at the moment — according to the International Energy Agency, more has been invested in clean energy than fossil fuels every year since 2016”.

It seems to make little sense to promote investments in Big Oil stocks or bonds as transition investments. Blackrock, one of the largest asset managers with very large holdings in Big Oil companies, probably disagrees with me. Exxon, Chevron and ConocoPhilipps are among the holding of its U.S. Carbon Transition Readiness ETF. According to Blackrock, the ETF provides a “broad exposure to large- and mid-capitalization U.S. companies tilting towards those that BlackRock believes are better positioned to benefit from the transition to a low-carbon economy” and “harness BlackRock’s thinking in sustainable investing through a strategy utilizing research-driven insights” (BlackRock U.S. Carbon Transition Readiness ETF | LCTU (ishares.com)).

I would rather invest in companies specialized in renewable energies. And even with listed investments, investments could have some positive impact.

Shareholder engagement with the bad or the good companies?

In theory, share- and bondholder engagement can have a positive impact on companies. For Big Oil, that did not work well so far: “Resolutions that would have forced the companies to align with Paris Agreement climate targets failed. BP and Shell have also pulled back on their strategies to cut fossil fuel production” (Bullard).

Shareholder engagement seems to be more fruitful when targeted at already somewhat responsible companies (compare Shareholder Engagement on ESG Performance by Barko et al. (2022)). That is also my experience (see Active or impact investing? – (prof-soehnholz.com)).

ESG Transition: But we still need oil and gas!

Certainly, we still need oil and gas for our economy for a long time. But Big Oil will certainly sell us oil and gas as long as we adequately pay for it. I do not expect that they decide to sell oil and gas only to stock- and bondholders.

Maybe, responsible investors should not invest at all in brown companies or companies with social deficits which distribute dividends instead of investing the available capital in a greener or more social future (see Transitionierer: Dividendenverbot für ESG Sünder? – Responsible Investment Research Blog (prof-soehnholz.com)).

Underdiversification and return risks?

Many investment advisors (and promotors of diversified products) argue, that investors should not deviate much from diversified indices. This would mean to also invest in brown and not very social companies. These advisors and promotors rarely mention the – mostly very low – marginal utility of additional diversification. Also, most likely, you will not hear the argument that if you start with very responsible investments and then diversify, the average responsibility score of the portfolio will shrink. There are very few convincing arguments why investors should invest in all the same countries, industries and companies as broad indices. Focusing investments on few of the most responsible investments can generate attractive returns and risk adjusted performances (see 30 stocks, if responsible, are all I need – Responsible Investment Research Blog (prof-soehnholz.com)).

Some argue that theory proves that brown investment should have high returns in the future. According to them, brown companies have to pay higher interest rates to creditors and higher returns to stockholders than responsible companies. Thus, shareholders of brown companies should have higher returns than shareholders of green companies.

Lower brown risks

There are other arguments, though. Brown companies certainly have more ecological risk than green companies. Therefore, the risk adjusted returns of brown companies may not be so attractive. And if brown companies have to invest instead of distributing dividends, higher returns for stockholders mean that in the future, someone has to pay a relatively high price for the (formerly?) brown stock. Instead, investors can invest in already green companies. Those companies have lower capital investment requirements for transitions. But they can still improve their greenness and/or distribute dividends. That seems to be the more attractive investment case. And given the low current share of truly green and social investments, I expect responsible investments to continue to grow for many years to come.

Since 2017 I try to invest in a limited number of most responsible companies. Since even these companies can still improve significantly in terms of responsibility, I also try to engage with all of them (see Shareholder engagement: 21 science based theses and an action plan – (prof-soehnholz.com)). So far, that approach works well.

Active or impact investing?

Active or impact investing is a valid question, since it often requires a long time to reach shareholder impact. Passive or impact investing is an equally valid question, because passive investors do not want or do not have the resources to impact their investments.

With impact investments, investors try to improve the world. Investing in listed securities does not add capital for the issuers. Therefore, responsible investors typically use voting and engagement to try to improve issuers of securities.

I advise a rules-based mutual fund with a very high active share. Here are some of my shareholder engagement experiences and learnings:

My goal: 100% Engagement

With my mutual fund, I invest in only 30 stocks (see 30 stocks, if responsible, are all I need). According to my definition, they are issued by the most responsible listed companies worldwide (see Artikel 9 Fonds: Kleine Änderungen mit großen Wirkungen?). In 2022, I was positively surprised by my first shareholder engagement test (see Engagement test (Blogposting #300)). Since I try to invest as responsibly as possible, I decided to try to engage with all 30 companies in my portfolio.

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