ESG regulation: Das Bild von Thomas Hartmann zeigt Blumen in Celle

ESG regulation and more (Researchblog #101)

Profitable regulation: Asset-Pricing Evidence of Regulatory Capture by Marc Eskildsen as ofOctober 15th, 2022 (#90): “The empirical analysis reveals that changes in regulation are positively associated with returns in the year following enactment, and this is not explained by risk exposure as specified by common asset pricing models. Instead, I argue that the finding is consistent with changes in cash flows. Newly regulated industries experience significant increases in profits and cash flows relative to deregulated industries, with no observable differences in their development prior to the regulatory changes. I provide evidence that this may be driven by changes in barriers to entry, as regulated industries have significantly lower net entry of new establishments. Further, I find some evidence that lobbying efforts positively impact firm outcomes following changes in regulation” (p. 33).

ESG regulatory cost-benefits: Socially Optimal Sustainability Standards with Non-Consequentialist („Warm Glow“) Investors by Roman Inderst and Markus Opp as of March 25th, 2022 (#57): “… we introduce investors with warm-glow preferences into an equilibrium model of financially constrained firms. When an investment label is introduced, firms that meet the respective sustainability standard can tap into such cheaper financing. In a longer-term perspective, where the sustainability standard is endogenous, more sustainable firms must incur the respective higher per-unit costs. … While the respective investment standard only affects the distribution of more or less sustainable firms in the sector, instead the requirement of a minimum standard for all active firms affects total industry size, given that it raises costs for all firms” (p. 19/20).

Protective regulation: Corporate criminal ESG by J.S. Nelson as of October 11th, 2022 (#68): “The New York Bar Association is already asking for regulation and guidance to help protect its members. .. Some of the most potentially egregious misrepresentations to investors are in the ESG space, and they could trigger liability first. Increasing scientific, political, and economic pressures may push prosecutors over the thin line from civil liability into potential criminal liability. A direct criminal ESG case for corporate fraud—and potentially individual liability for its agents or directors—may appear in U.S. courts soon. … U.S. businesses should shift their perspective to request standardization with international developments” (p. 55/56).

Responsible investment research: ESG regulation

Good sustainable funds: Incentives of Socially Responsible Fund Managers: Remuneration Incentives or Job Loss Concerns? by Lin Wang, John Vaz, and John Watson as of April 1st, 2022 (#34): “This study presents empirical research on U.S. equity funds management behaviour, focusing on differences between funds with and without an SRI focus. Funds investing with additional non-financial objectives have a reduced investable universe … We observe that SRFs hold more stocks relative to CFs (Sö: conventional funds) … we find that ESG funds provide equivalent returns to CFs but with more favourable Sharpe ratios and lower risk … SRFs undertake relatively less risk shifting than CFs or ESG funds … we also … investigate window dressing, namely the favourable framing of reported fund characteristics relative to actual performance. … we find that SRFs undertake less window dressing” (p. 27/28). My comment: Compare with my fund ESG plus SDG-Alignment mit guter Performance: FutureVest ESG SDG – Responsible Investment Research Blog (prof-soehnholz.com)

Ungreen funds: Green funds have a Paris alignment problem in S&P Global Sustainability Quarterly Third Quarter Edition 2022, as of June 7th, 2022: “From a universe of nearly 12,000 equity mutual funds and exchange-traded funds representing more than $20 trillion in market value, S&P Global Sustainable1 found that about 11% are currently aligned with the Paris Agreement goal of limiting global warming to “well below” 2°C. … Only about 12% of green funds are on budget to meet the goal of the Paris Agreement —… One in three green funds and climate funds are on a trajectory to overshoot even a less ambitious 3°C warming scenario, in which flooding, drought and sea level rise would pose severe risks to human life and society” (p. 48).

Country SDG benefits: Do the SDGs affect sovereign bond spreads? First evidence by Eline ten Bosch, Mathijs van Dijk, and Dirk Schoenmaker as of March 1st, 2022 (#166):“… we study the relation between the performance of a country on the SDGs and its sovereign CDS spread. … we find a significant negative relation between the SDG Index and the CDS spread. Our results suggest that a standard deviation increase in the SDG Index is associated with a negative impact on the 5-year CDS spread of 17.2 basis points. …. We see evidence consistent with our hypothesis that the SDGs may decrease perceived country risks” (p. 27/28).

Low greenium? Rethinking the Value and Emission Implications of Green Bonds by Jitendra Aswani and Shivaram Rajgopal as of October 10th, 2022 (#138): “Contrary to past work …, we demonstrated that the shareholders‘ reaction to the announcement of green bonds is both negative and significant. … few firms issue most of the green bonds. Tesla is one of the major ones that issued 75% of the U.S. green bonds from 2013- 2018. … investors in the secondary market of green bonds have access to additional information, such as green project performance reports and green auditors’ second-opinion reports on how the proceeds from the green bonds were used. Here, it was found that green bonds trade at a negative 23 basis premium in the secondary market, while this is mainly attributable to the green bonds of the financial sector. The green bonds issued by the four main polluting or “brown” sectors, namely, the energy, industrial, materials, and utilities industries, entail smaller greenium values compared with those pertaining to the financial sector. This finding is somewhat surprising because it is expected that investors will reward the polluting firms for cutting their emissions rather than rely on financial firms to provide loans to the polluters such that they can improve their environmental impact. Green bonds are more likely to be issued by firms with low environmental scores and low ESG scores. Despite an implicit motivation to improve their environmental record, there was no change in the environmental performance of the issuers of the green bonds compared with their matching counterparts, even after four years” (p. 22/23).

Scope 3 premium? Environmental Standards and Stock Returns by William O. Brown, Xiaoli Gao, Yufeng Han, Dayong Huang, and Fang Wang as of October 5th, 2022 (#85): “One crucial empirical question is how to deal with the numerous environmental variables. Previous studies either use one single variable, such as CO2 emission, or an aggregate score. Taking advantage of the granularity of the numerous E variables, we use machine learning methods to estimate the relation between the E variables and future stock returns and find strong evidence that the E variables can positively predict future returns … scope 3 CO2 emission, plays a vital role. Overall we provide strong evidence that … green firms earn a lower expected return, but higher realized returns due to shocks to climate change concerns and that investors gain from ESG mandate” (p. 28).

ESG data, reporting and voting research: ESG Regulation

ESG reporting premium: Do Scope 3 Carbon Emissions Impact Firms’ Cost of Debt? by Ahyan Panjwani, Lionel Melin, and Benoit Mercereau as of Oct. 17th, 2022 (#25): “… we find that firms that disclose scope 3 emissions receive a discount in credit markets, the scope 3 disclosure premium, particularly in Europe and Asia Pacific while the trend is starting to emerge in North America as well. Moreover, firms that report higher scope 3 emissions do not face a higher cost of borrowing. …. firms in the energy, materials, and utilities sectors …, unlike scope 1 and 2, do not report scope 3 emissions more than other sectors despite being the dominant contributors to emissions overall” (p. 33)

Responsible data deficits: EU Green Taxonomy Data – A first Vendor Survey by Andreas G.F. Hoepner and Viola I. Schneider as of October 19th, 2022 (#27): “Preliminary data from a first data vendor survey suggests that Alignment of Revenue, including a full pass of Do No Significant Harm Criteria and Minimum Social Safeguards, assessed against the first Climate Delegated Act currently ranges in the low single digits. Mean Eligibility in the same context was at least above 20 per cent. The results raise important questions on whether mid cap firms may have advantages over large cap firms and if the business model of the assessor influences the assessment outcome. This paper classifies all Do No Significant Harm (DNSH) criteria of the first Delegate Act into five categories from a usability perspective and highlights related shortcomings” (abstract).

Voting hypocrisy: Sustainable voting behavior of asset managers: Do they walk the walk? by Wilma de Groot, Jan de Koning, and Sebastian van Winkel as of Feb. 24th, 2021 (#951): “We investigate … ESG voting patterns using a decade of voting data with more than 20 million observations. Asset managers predominantly vote against social and environmental proposals. Especially, large and passive asset managers vote the least in favor of these proposals and despite the increased attention to sustainability integration, they hardly vote more in favor of these proposals than a decade ago. Moreover, signatories of the PRI do not vote more often in favor of environmental and social issues” (abstract).

Traditional investment research

Better less-rich? Wealth as a moderating effect on gender differences in portfolio holdings by Raul Riefler, Ylva Baeckström, and Onur Kemal Tosun as of October 15th, 2022 (#1): “Using a unique data set of 6,556 investment advisory clients of a large European wealth management institution we reveal … While overall women’s portfolios contain less equity exposure and produce lower returns compared to men’s, women with less than EUR200,000 invested hold riskier portfolios, pay higher advisory fees and achieve greater returns compared to men. Across both genders these smaller investors absorb more risk and have higher returning portfolios than their wealthier peers” (abstract).

Pro buy-and-hold (1): Cut Your Losses and Let Your Profits Run by Dirk G. Baur and Thomas Dimpfl as of September 30th, 2022 (#33): “… for randomly chosen portfolios comprised of large US stocks. We find that “cut your losses” clearly underperforms the buy-and-hold strategy. … Cutting losses during the 2008 crisis performs better than the benchmark for half of all portfolios but not consistently and not during the 2020 crisis. We demonstrate that the poor performance of the old adage is due to weak loser stocks (that do not strictly fall) and strong winner stocks (that do strictly rise) which implies that the best strategy is to let both losses and profits run. The results also question the relevance of the disposition effect as we do not find any evidence that “holding losers too long” is bad for investors” (abstract). My comment: See Einfaches Risikomanagement kann erstaunlich gut funktionieren – Responsible Investment Research Blog (prof-soehnholz.com)

Pro buy-and-hold (2): To Sell or Not to Sell? Disposition Effect and Investment Styles by Can Yilanci as of August 12th, 2022 (#173): “The term „disposition effect“ refers to the behavior of investors to show a higher propensity to sell stocks trading at a gain („winner stocks“) than to sell stocks trading at a loss („loser stocks“)”  (p. 2) … “I show that value funds show a strong disposition effect and that growth funds do not show a disposition effect. … Put differently, following an investment strategy that requires selling winners leads fund managers to show a disposition effect. This finding implies that the disposition effect might be wrongly thought of as a behavioral bias in the context of mutual funds. … Performance and disposition effect are negatively related. Thereby, reducing the propensity to sell winner stocks might have the potential to increase performance” (p. 23).

Diversification loss: Determinants of stock market correlations. Accounting for model uncertainty and reverse causality in a large panel setting by António Afonso, Krzysztof Beck, and Karen Jackson as of October 11th, 2022 (#42): “… a high degree of persistence in stock market correlations and show that current correlation is the best single predictor of future correlation. ….  bigger markets are tied by a stronger degree of synchronization of returns … markets of similar size are characterized by a higher degree of stock market comovement. … increasing capital mobility, financial development, and portfolio equity flows contribute to higher stock market comovement. … we identify reinforcing factors that facilitate higher stock market correlations” (p. 24/25).

Alternative investment research

PE is not so bad: Dissecting the Listing Gap: Mergers, Private Equity, or Regulation? by Gabriele Lattanzio, William L. Megginson, and Ali Sanati as of August 18th, 2022 (#518): “The number of US public firms has declined by about 50% since its peak in the mid 1990s. … We document that the US listing gap has indeed emerged in two distinct waves that occurred, respectively, over 1997–2001 and 2004–2008. … We find that the high level of M&A activity characterizing the US economy and the regulatory changes of the early 2000s have played major roles in causing the decline in the number of public firms. Importantly, PE activity contributes to shrinking, rather than inflating the US listing gap. This result suggests that the positive effect of PE on listings via spurring entrepreneurship and providing financing to private firms that later go public, dominates its effect of substituting public equity. These results highlight a central role for M&As in the emergence of the US listing gap. Further assessment of this channel shows that the effect of M&A occurs by preventing private companies from reaching their going-public phase, more so than by causing abnormal level of delistings. … we document that listing dynamics in major non-US developed economies follow a similar path as in the US, but with a few years of delay. For instance, we show that in France, Germany, and the UK, the number of listed firms peaked in the mid-2000s and has been declining since. We conduct similar listing gap estimations and decomposition analyses for these countries and conclude that the economics of listing dynamics and its relation to M&A and PE markets is very similar to what is observed in the US” (p. 33/34).

Private real estate problems: Catering and Return Manipulation in Private Equity by Blake Jackson, David Ling, and Andy Naranjo as of October 18th, 2022 (#14): “The central message of our paper is that some PERE GPs (Soehnholz: Private Equity Real Estate General Partners) manipulate interim returns in a manner consistent with their investors’ desire for such boosted returns. PERE GPs do not appear to manipulate interim returns to fool their LPs, but rather because their LPs want them to do so. This allows these LPs to report higher returns alongside lower reported volatility in the short term. This catering view of return manipulation is consistent with the overwhelming LP preference to access real estate investments through PERE funds rather than more volatile marked-to-market REITs. … We show manipulations are widespread, economically significant (amounting to about 470 bps), and accomplished primarily through a diverse set of timing strategies” (p.34).

Problematic AI: Tackling problems, harvesting benefits – A systematic review of the regulatory debate around AI by Anja Folberth, Jutta Jahnel, Jascha Bareis, Carsten Orwat, and Christian Wadephul as of Seltember 29th, 2022 (#23): “This article analyzes the academic debate around the regulation of artificial intelligence (AI). The systematic review comprises a sample of 73 peer-reviewed journal articles … The analysis concentrates on societal risks and harms, questions of regulatory responsibility, and possible adequate policy frameworks, including risk-based and principle-based approaches. … The assessments of the included papers indicate the complexity of the field, which shows its prematurity and the remaining lack of clarity” (abstract).