Responsible investment research: ESG confusion
Good PRI: Investor Commitment to Responsible Investing and Firm ESG Disclosure by Dirk E. Black, Helena Isidro and Ana Marques as of Oct. 12th, 2022 (#161): “We find that following institutional investors’ commitment to the PRI agreement, the quantity of investee ESG disclosure in SEC Forms 10-K and 10-Q increases with the PRI institutional ownership. Thus, the sensitivity of ESG disclosure to socially responsible institutional ownership is increasing in a public signal of investor commitment to socially responsible investment. …. We also find that the improvement in firm ESG disclosure is attributable primarily to PRI institutional investors from Europe …” (p. 21).
More ESG control: D&O Insurers as ESG Monitors by Amelia Miazad as of Sept. 28th, 2022 (#326): Directs and Officers “D&O insurers are beginning to monitor their insureds‘ environmental, social, and governance (ESG) risks. … this trend is likely to continue, not only for the obvious reason that D&O claims relating to ESG are increasing, but also because both insurers and insureds benefit from reducing their ESG harms. … This Article argues that D&O insurers should have a greater role to play in monitoring the monitors”.
ESG credit effects: The role of Environmental, Social, and Governance rating on corporate debt structure by Stylianos Asimakopoulos and Panagiotis Asimakopoulos as of Sept. 20th, 2022 (#42): “… we focus on the impact of ESG rating on firm leverage ratios and debt components … for U.S. firms for the period 2002-2019. … We find that when firms become ESG rated they tend to reduce their target (optimal) market and book leverage ratios. … on average, ESG rated firms do not significantly alter their current market and book leverage ratios. … we find that ESG rated firms redistribute their funding towards more internal sources (according to pecking order theory), from bonds debt to bank loans. This result is more pronounced for firms with high financial pressure, low growth opportunities, and fewer alternative uses of assets. … Overall, these results support the fact that an ESG rating conveys information to the public leading to lower information asymmetry between the lender and the owner. It also appears that the higher is the obtained ESG rating the better would be the access to “safer” sources of financing” (p. 32).
ESG confusion? Financial return and environmental impact information promotes ESG investments: Evidence from a large, incentivized online-experiment by Marcel Seifert, Katharina Gangl, Florian Spitzer, Simone Haeckl, Alexia Gaudeul, Erich Kirchler, and Stefan Palan as of Dec. 6th, 2022 (#46): “We run an incentivized online experiment with experienced retail investors and a representative sample of the Austrian population (N = 2,254 in total). We find that information on financial returns and information on environmental impact both stimulate sustainable investments. However, presenting the two types of information in combination yields no greater effect than presenting one of them alone. Furthermore, we find no evidence that investment decisions are affected by whether sustainability preferences are elicited generally or in a more detailed format. Results also show that sustainable investments are positively correlated with investors’ biospheric values and their financial literacy” (abstract).
ESG confusion: The Confusion of Taste and Consumption: Evidence from a Stated-Choice Experiment by Philipp Kleffel and Matthias Muck as of Dec. 6th, 2022 (#198): “… we conduct a stated choice experiment with German retail investors … We find that there are market participants who are not able to distinguish between information related to sustainability and financial performance. In particular, investors seem to overreact to bad financially material sustainability information. Others seem to be prone to affect as they are intrinsically motivated to “do good” and erroneously project sustainability information onto future dividends, regardless of materiality. Our results highlight the importance of establishing appropriate classification systems for sustainability reporting” (abstract).
Net zero manipulation: Fixing Net Zero Leakage by Albert C. Lin as of Sept. 23rd, 2022 (#57):“Net zero leakage reflects the potential for private actors’ actions under net zero pledges to displace rather than reduce carbon emissions. Just as carbon regulation in one jurisdiction can lead to carbon leakage, action by a private actor under a net zero pledge can result in greater emissions by another actor. Overall emissions may even increase … This Article explores strategies to prevent or limit net zero leakage. These strategies include: extending net zero pledges to cover more activities and entities, amending carbon accounting rules to account for actual carbon impacts, incorporating safeguards against leakage into asset sales agreements, and establishing investment vehicles aimed at purchasing and retiring fossil fuel assets“ (abstract).
Impact (engagement) research: ESG confusion
Engagement theory: Advising the Management: A Theory of Shareholder Engagement by Ali Kakhbod, Uliana Loginova, Andrey Malenko and Nadya Malenko as of Nov. 28th, 2022 (#585): “Shareholder engagement, that is, shareholders communicating their views about the firms policies to management, has become increasingly important in recent years. … We show that when shareholders and management have different beliefs, shareholders have incentives to misrepresent their information, which makes shareholder engagement less effective. However, since differences in beliefs decrease as more shareholders convey their views to management, the engagement of each individual shareholder is more effective when more other shareholders engage with management as well. … both communication frictions and a limited shareholder base inhibit managerial learning from shareholders and these inefficiencies amplify each other. We show that the presence of passively managed institutional investors, who become shareholders even if they disagree with management, can counteract these effects and enhance shareholder engagement” (p. 32/33). My comment: I am somewhat skeptical on shareholder engagement effects compare Engagement test (Blogposting #300) – Responsible Investment Research Blog (prof-soehnholz.com)
Effective engagement: How Does Board-Shareholder Engagement Really Work? Evidence from a Survey of Corporate Officers and from Disclosure Data by Matteo Gatti, Giovanni Strampelli, and Matteo Tonello as of Jan. 16th, 2023 (#194): “… understanding the details of board-shareholder engagement–in terms of its frequency, content, process, and outcome–is not easy, as engagement consists of private interactions and, as a result, very few details are reported. … First, we show that corporate shareholder engagement is on the rise and is a phenomenon that is no longer limited to larger companies. … roughly 60 percent of the companies surveyed experienced confrontational engagement … As the role played by activists is more relevant at smaller companies, the larger the company, the less the confrontation. Third, we find that shareholder engagement is effective in terms of outcomes. Almost half of our survey respondents stated that engagement led to a change in the corporate practice. We also find that engagement closely affects voting behavior. Based on responses to our survey, engagement often led investors to withdraw a shareholder proposal submitted, and/or to change the proxy vote previously announced” (p. 29/30).
Pay gap reduction effects: The Effect of Voluntary Managerial Pay Cuts on Employee Effort by Christoph Feichter and Martin Wiernsperger as of Sept. 6th, 2022 (#149): “Voluntary managerial pay cuts are commonly observed during crises and regular times. … we find that when managers voluntarily give up their own salaries to simply reduce vertical pay dispersion, this is seen as an act of kindness to which employees respond with additional effort. However, the positive motivational effect on employee effort is even stronger when managers cut their own salaries and use their forgone salaries to benefit others (i.e., indirect reciprocity) or their own employees (i.e., direct reciprocity). Moreover, we show that the effect of a voluntary managerial pay cut is substantially larger than the effect of a mandated pay cut, despite outcomes being identical“ (p. 29). My comment: I enclude “pay gap” disclosure in my shareholder engagements, see also Wrong ESG bonus math? Content-Post #188 – Responsible Investment Research Blog (prof-soehnholz.com)
Government engagement: Sustainability Integration for Sovereign Debt Investors: Engaging with Countries on the Sustainable Development Goals (SDGs) by Jan Anton van Zanten, Bhavya Sharma and Malene Christensen from Robeco as of June 16th, 2021 (#86): “…We conducted interviews with an investor and studied a recent case that saw a collective of investors engage with the government of Brazil on the topic of halting deforestation. On this basis, we created a framework that helps investors answer three questions that collectively guide the sovereign engagement process: (i) who to engage with; (ii) what to engage on; and (iii) how to engage. The first question identifies relevant countries to engage with based on the investor’s (public and private) investment exposure to that country, as well as the overall level of progress that the country is making on the SDGs. The second question defines which SDGs and sub-targets are most relevant to engage on by, among others, assessing how a country is progressing on each of the goals, and by leveraging the investor’s experience with those SDGs. Finally, the third question lays out a detailed roadmap that investors can use to start engaging with the defined countries on the selected SDGs – from the initial ‘knock on the door’ to the final reporting“ (p. 13/14).
Traditional investment research
Allocation dynamics: A Century of Asset Allocation Crash Risk by Mikhail Samonov and Nonna Sorokina as of Jan. 6th, 2023 (#390): “We extend proxies of the main asset allocation approaches back to 1926 using long-run return data for a variety of sub-asset classes and factors and test the long-term performance of U.S. and Global 60/40, Diversified Multi-Asset, Risk Parity, Endowment, Factor-Based and Dynamic Asset Allocation portfolios. While Factor-Based and Risk-Parity portfolios exhibit best risk-adjusted returns in the long run, the Dynamic Asset Allocation reduces the abandonment risk due to its lower expected drawdown. Across all strategies, risk-tolerant investors that rely on the longer history for setting their expectations, experience significantly better outcomes, particularly if their investment horizon includes times of crisis” (abstract). My comment: Especially factor-based and dynamic strategies can vary very much depending on the specifications. My “most-passive” approach see Das-Soehnholz-ESG-und-SDG-Portfoliobuch.pdf (soehnholzesg.com)
Stable cash holdings: Five Facts About the Money Holdings of Individuals and Firms by Sebastien Betermier, Laurent E. Calvet, and Jens Kvaerner as of Sept. 28th, 2022 (#73): “Our main result is that the cash share has remained constant for individuals and firms in the bottom 90% of the distribution of financial wealth, while the cash share has decreased significantly in the top 10%. Our findings suggest that most firms and individuals use cash for daily financial management, so that their cash share is insensitive to changes in interest rates and investment opportunities. In stark contrast, the wealthiest hold elastic shares of M2, which respond positively to interest rates” (p. 19).
Trading fee effects: Fee the People: Retail Investor Behavior and Trading Commission Fees by Omri Even-Tov, Kimberlyn George, Shimon Kogan and Eric So as of Jan. 21st, 2023 (#276): “We study the implications of removing commission fees for trading activity among retail investors. We do so by leveraging the selective removal of trading commission fees on eToro, which primarily caters to retail investors. Our findings suggest that commission fees deter retail investor participation, trading activity, and diversification. …. we also show removing fees disproportionately affected inexperienced investors with lower deposit amounts and lesser technological sophistication … we find no discernible change in retail investors’ gross investment performance or holdings of small, lottery-like stocks following the removal of fees, indicating retail investors are not necessarily worse off when trading more often” (p. 31).
Alternative investment research
Good private equity? Private equity buyouts and portfolio company performance post-exit by Paul Lavery and Nick Wilson as of Dec. 13th, 2022 (#86): “… we examine the long-term impact of PE investment on target firms using a sample of over 1,200 realized PE buyouts of UK companies. … We find that while portfolio company growth slows considerably during the postexit period relative to the PE holding period, the outperformance of PE-backed companies relative to matched control companies persists in the long run after the PE investor has exited the company. The effect is found to be driven by smaller and younger PE portfolio companies. … we do find evidence that gains to productivity, investment, and debt issuance increase in the long run relative to the holding period. … we document an increased likelihood of PE-backed companies filing for insolvency in the post-exit period, relative to the PE holding period (and relative to matched control firms). Consistent with our performance results, insolvency risk is found to be stronger for larger and older portfolio firms rather than smaller and younger firms“ (p. 33/34).
Bad cryptos: Putting Cryptocurrency in Its Place: The Case for Why ESG Funds Should Exclude Cryptocurrency Investments by Michael Conklin and Jason Malone as of Jan. 15th, 2023 (#31): “The significant societal harms from cryptocurrencies include environmental harms; facilitation of illegal transactions; the diversion away from traditional stocks and bonds, which produce positive externalities; and the harm from providing an alternative to those who hold the U.S. dollar internationally. The alleged benefits of cryptocurrency use, properly understood, fail to outweigh these harms. The decentralized nature of cryptocurrencies potentially do more harm than good, benefits to refugees are exaggerated due to their limited access to secure internet connections and venders who accept cryptocurrencies in the places they flee to, there are better alternatives to using cryptocurrencies as investment portfolio diversification, cryptocurrencies are not an attractive alternative for avoiding currency conversion fees, and cryptocurrencies are not effective for large-scale payment processing” (abstract). My comment: Here is a recent summary of the positive social and governance aspects of Bitcoin (which is too optimistic in my opinion): Is Bitcoin ESG-Compliant? A Sober Look by Juliane Proelss, Denis Schweizer, Stephane Sevigny :: SSRN as of Jan 23rd, 2023 (#200)