Corporate social strategies develop socially responsible actions with the goal of improving business performance and creating value for all stakeholders. These days, environmental, social, and governance (ESG) objectives play a crucial role within companies, which are faced with the imperative to pursue social, environmental, and financial performance at the same time, leading to improved corporate sustainability. It is now evident that ESG issues have an influence not only on profitability but also on the financial strength of various companies. Beginning in 2004 with the publication of the Who Cares Wins report by the United Nations Global Compact Initiative (UN, 2004), the importance of grouping three of the main pillars of ethical finance together has emerged, namely ESG. The environmental pillar assesses a company's efforts in terms of energy efficiency, greenhouse gas emissions, waste, water, and resource management. The social pillar refers to aspects related to gender policies, human rights protection, labour standards, workplace and product safety, public health, and income distribution, which affect employee satisfaction. Finally, the governance pillar covers aspects related to board independence, shareholder rights, manager compensation, control procedures and anti- competitive practices, and compliance with the law. It is an approach that follows a multidimensional logic with a view to improving quality of life expectations, innovation, and business competitiveness without neglecting the well-being of all human generations. Entrepreneurs, investors, and people in general have begun to become aware of this and be more sensitive in making decisions. More and more sustainable companies are striving to improve their ESG investments, and there is now a growing trend for investors to invest in socially responsible and sustainable companies. The concept of ESG performance is intended to provide an assessment of the degree to which a company manages ESG risks and opportunities (MSCI 2018). ESG scores make companies comparable in terms of actual risk factors that impact the cost of capital. In recent years, many studies have analysed the relationship between the ESG profiles of companies and their financial risk and performance characteristics by distinguishing, with respect to risk, between systematic and idiosyncratic stock risk. Systematic risk is macroeconomic in nature and describes the general market risk to which all companies are exposed, such as the risk of shocks in commodity prices, interest rates, or inflation rates. Systematic risk also includes industry-wide issues, such as regulatory changes and technological developments. Firm-specific risk, on the other hand, is specific to a firm. The distinction between systematic and firm-specific risk is important in analysing the impact of ESG characteristics on firm valuation because investors can typically diversify away from firm-specific risk; therefore, it is only the systematic risk component that determines the rate of return required by shareholders to offset the risk they are exposed to. Companies with sound ESG practices exhibit lower cost of capital, lower volatility, and fewer cases of corruption and corporate fraud (Bank of Italy, 2019). In this regard, several empirical studies highlight that "good practices" from an ESG perspective allow companies to benefit from competitive advantages, lower cost of capital, and better operational and market performance. The academic literature is unanimous in supporting the positive effect that ESG factors have on decreasing the cost of capital, pointing out that the main reasons for this contraction can be attributed to the reduction of information asymmetry. Sharfman and Fernando (2008), analysing a sample of 267 U.S. companies, have tested whether better environmental risk management is rewarded by financial markets in terms of lowering the cost of capital. In relation to the cost of capital, the results suggest a negative association between the latter and environmental risk management, due to the lower beta, an expression of the volatility of the company's stock. These results are confirmed by subsequent studies showing the negative association between sustainable business practices and the cost of capital, such that an increase in socially responsible actions implies a decrease in the cost of capital. Studies that, on the other hand, analyse sustainable financial and non-financial performance (again in relation to the cost of capital) have shown that each sustainable approach has an impact on the cost of capital, confirming the results of previous studies (El Ghoul et al., 2011; Matthiesen and Salzmann 2017; Cuadrado-Ballesteros et al., 2016). Nonetheless, the integration of critical perspectives within ESG finance literature is essential for advancing scholarly rigour and fostering a more nuanced understanding of the field, one better capable of fully realizing the hoped for "investor revolution" (Eccles and Klimenko, 2019) in the transition to a more sustainable economy. Existing critiques—such as portraying ESG practices as "ethical window dressing" (Muñoz et al., 2022) or highlighting the limitations of over-reliance on rating metrics (Berg et al., 2022)—serve a vital role in scrutinizing the efficacy and authenticity of ESG commitments. Incorporating these critical viewpoints can mitigate potential biases and promote a more balanced discourse, thereby enhancing the credibility and robustness of academic research. Studies that systematically address these critiques could provide deeper insights into the normative and practical implications of ESG integration, ultimately contributing to more rigorous and comprehensive scholarship in the field of sustainable finance (UNEP-FI, 2018). This study, considering these theoretical premises, investigates whether the relationship between ESG merit and systematic risk has changed because of specific events that have steered the economy and financial markets towards an increased focus on ESG aspects, including the establishment of the 2030 Agenda for Sustainable Development on September 25, 2015, and the subsequent stipulation of the Paris Agreement on December 12 of the same year. The analysis is carried out using a methodological framework based, in line with previous literature, on econometric techniques traceable to the Capital Asset Pricing Model model declined by Sharpe in 1964 and the five-factor model developed by Fama and French in 2015. The analysis sample consists of 596 of the 600 companies included in the STOXX Europe 600 stock index in 2023, whose ESG scores are provided by Refinitiv. The market indices considered in the analysis are represented by both the MSCI world and the STOXX Europe 600 itself. For the purposes of the above verification, the sample is divided into quartiles based on the distribution of the relevant scores to verify any different impact on systematic risk after the specific event identified as being relevant to the path towards a more sustainability-based economy. The analysis focuses attention on both the overall ESG score and the three pillars (E, S, and G) considered individually. The empirical evidence obtained shows a reduction in systematic risk, following the stipulation of Agenda 2030 in September 2015, of greater significance in terms of both the size of the impacts and the statistical significance associated with them for equity indices constructed considering companies with higher ESG merit. The evidence provides interesting new functional elements for the study of the relationship between ESG merit and systematic risk, providing useful implications for decisions not only by policymakers but also by regulators regarding the integration of ESG factors into the risk measurement, monitoring, and management procedures of financial and non- financial firms. The study is structured as follows. The first chapter aims to provide a sufficiently comprehensive overview of the concept of sustainability and the strategic contribution made by businesses to the community, even with respect to the different legislative interventions aimed at focusing the attention of individuals and legal entities on sustainability and achievement of the 17 Sustainable Development Goals (SDGs) signed by 193 states and outlined in the 2030 Agenda. The second chapter delves into the concept of corporate risk through a review of prevailing national and international literature on the subject, from which it emerges that any organization, regardless of its size or sector, is called upon to manage its risks, whether they are related to economic aspects, ESG aspects, or both, ensuring that they are kept within acceptable levels over time. Risk management, and in particular the emerging ESG risks, has become a must-have practice to be applied by following a systematic and organized approach, with constant recourse to discipline-specific methodologies and techniques, including the provision of an effective Enterprise Risk Management Framework, which is a fundamental cornerstone of a good governance system. The third chapter initially looks at the recent development of ESG rating agencies and, consequently, ESG ratings. These are scores that encompass not only the quality of corporate governance systems but also environmental, social and, more generally, sustainability issues. After highlighting the main peculiarities of but also critical issues in such sustainability indicators, the chapter focuses on the relationship between ESG factors, systematic risk, and performance. About the first relationship, i.e. between ESG ratings and systematic risk, the literature agrees that firms with higher ESG ratings have lower systematic risk (a lower beta) and, consequently, a lower cost of equity than firms with lower ESG ratings. Regarding the relationship between ESG factors and performance, the literature shows mixed results. According to some studies, companies with high ESG ratings have higher returns especially during recessionary periods, thus showing themselves to be more resilient. However, in some circumstances, it has been found that non-proprietary managers often use the funds allocated for carrying out socially responsible activities for purely personal purposes. Such an attitude, in the long run, could undermine profitability and, therefore, business continuity. The fourth and final chapter, following the outlining of the research objectives, provides a description of the sample under investigation and the methodology used. In the last part of the chapter, the econometric model is presented, and then the results obtained from the analysis are discussed.
Sustainability, Business Risk and ESG Rating - Empirical Evidence from the European Stock Markets
Matilda Shini
2025-01-01
Abstract
Corporate social strategies develop socially responsible actions with the goal of improving business performance and creating value for all stakeholders. These days, environmental, social, and governance (ESG) objectives play a crucial role within companies, which are faced with the imperative to pursue social, environmental, and financial performance at the same time, leading to improved corporate sustainability. It is now evident that ESG issues have an influence not only on profitability but also on the financial strength of various companies. Beginning in 2004 with the publication of the Who Cares Wins report by the United Nations Global Compact Initiative (UN, 2004), the importance of grouping three of the main pillars of ethical finance together has emerged, namely ESG. The environmental pillar assesses a company's efforts in terms of energy efficiency, greenhouse gas emissions, waste, water, and resource management. The social pillar refers to aspects related to gender policies, human rights protection, labour standards, workplace and product safety, public health, and income distribution, which affect employee satisfaction. Finally, the governance pillar covers aspects related to board independence, shareholder rights, manager compensation, control procedures and anti- competitive practices, and compliance with the law. It is an approach that follows a multidimensional logic with a view to improving quality of life expectations, innovation, and business competitiveness without neglecting the well-being of all human generations. Entrepreneurs, investors, and people in general have begun to become aware of this and be more sensitive in making decisions. More and more sustainable companies are striving to improve their ESG investments, and there is now a growing trend for investors to invest in socially responsible and sustainable companies. The concept of ESG performance is intended to provide an assessment of the degree to which a company manages ESG risks and opportunities (MSCI 2018). ESG scores make companies comparable in terms of actual risk factors that impact the cost of capital. In recent years, many studies have analysed the relationship between the ESG profiles of companies and their financial risk and performance characteristics by distinguishing, with respect to risk, between systematic and idiosyncratic stock risk. Systematic risk is macroeconomic in nature and describes the general market risk to which all companies are exposed, such as the risk of shocks in commodity prices, interest rates, or inflation rates. Systematic risk also includes industry-wide issues, such as regulatory changes and technological developments. Firm-specific risk, on the other hand, is specific to a firm. The distinction between systematic and firm-specific risk is important in analysing the impact of ESG characteristics on firm valuation because investors can typically diversify away from firm-specific risk; therefore, it is only the systematic risk component that determines the rate of return required by shareholders to offset the risk they are exposed to. Companies with sound ESG practices exhibit lower cost of capital, lower volatility, and fewer cases of corruption and corporate fraud (Bank of Italy, 2019). In this regard, several empirical studies highlight that "good practices" from an ESG perspective allow companies to benefit from competitive advantages, lower cost of capital, and better operational and market performance. The academic literature is unanimous in supporting the positive effect that ESG factors have on decreasing the cost of capital, pointing out that the main reasons for this contraction can be attributed to the reduction of information asymmetry. Sharfman and Fernando (2008), analysing a sample of 267 U.S. companies, have tested whether better environmental risk management is rewarded by financial markets in terms of lowering the cost of capital. In relation to the cost of capital, the results suggest a negative association between the latter and environmental risk management, due to the lower beta, an expression of the volatility of the company's stock. These results are confirmed by subsequent studies showing the negative association between sustainable business practices and the cost of capital, such that an increase in socially responsible actions implies a decrease in the cost of capital. Studies that, on the other hand, analyse sustainable financial and non-financial performance (again in relation to the cost of capital) have shown that each sustainable approach has an impact on the cost of capital, confirming the results of previous studies (El Ghoul et al., 2011; Matthiesen and Salzmann 2017; Cuadrado-Ballesteros et al., 2016). Nonetheless, the integration of critical perspectives within ESG finance literature is essential for advancing scholarly rigour and fostering a more nuanced understanding of the field, one better capable of fully realizing the hoped for "investor revolution" (Eccles and Klimenko, 2019) in the transition to a more sustainable economy. Existing critiques—such as portraying ESG practices as "ethical window dressing" (Muñoz et al., 2022) or highlighting the limitations of over-reliance on rating metrics (Berg et al., 2022)—serve a vital role in scrutinizing the efficacy and authenticity of ESG commitments. Incorporating these critical viewpoints can mitigate potential biases and promote a more balanced discourse, thereby enhancing the credibility and robustness of academic research. Studies that systematically address these critiques could provide deeper insights into the normative and practical implications of ESG integration, ultimately contributing to more rigorous and comprehensive scholarship in the field of sustainable finance (UNEP-FI, 2018). This study, considering these theoretical premises, investigates whether the relationship between ESG merit and systematic risk has changed because of specific events that have steered the economy and financial markets towards an increased focus on ESG aspects, including the establishment of the 2030 Agenda for Sustainable Development on September 25, 2015, and the subsequent stipulation of the Paris Agreement on December 12 of the same year. The analysis is carried out using a methodological framework based, in line with previous literature, on econometric techniques traceable to the Capital Asset Pricing Model model declined by Sharpe in 1964 and the five-factor model developed by Fama and French in 2015. The analysis sample consists of 596 of the 600 companies included in the STOXX Europe 600 stock index in 2023, whose ESG scores are provided by Refinitiv. The market indices considered in the analysis are represented by both the MSCI world and the STOXX Europe 600 itself. For the purposes of the above verification, the sample is divided into quartiles based on the distribution of the relevant scores to verify any different impact on systematic risk after the specific event identified as being relevant to the path towards a more sustainability-based economy. The analysis focuses attention on both the overall ESG score and the three pillars (E, S, and G) considered individually. The empirical evidence obtained shows a reduction in systematic risk, following the stipulation of Agenda 2030 in September 2015, of greater significance in terms of both the size of the impacts and the statistical significance associated with them for equity indices constructed considering companies with higher ESG merit. The evidence provides interesting new functional elements for the study of the relationship between ESG merit and systematic risk, providing useful implications for decisions not only by policymakers but also by regulators regarding the integration of ESG factors into the risk measurement, monitoring, and management procedures of financial and non- financial firms. The study is structured as follows. The first chapter aims to provide a sufficiently comprehensive overview of the concept of sustainability and the strategic contribution made by businesses to the community, even with respect to the different legislative interventions aimed at focusing the attention of individuals and legal entities on sustainability and achievement of the 17 Sustainable Development Goals (SDGs) signed by 193 states and outlined in the 2030 Agenda. The second chapter delves into the concept of corporate risk through a review of prevailing national and international literature on the subject, from which it emerges that any organization, regardless of its size or sector, is called upon to manage its risks, whether they are related to economic aspects, ESG aspects, or both, ensuring that they are kept within acceptable levels over time. Risk management, and in particular the emerging ESG risks, has become a must-have practice to be applied by following a systematic and organized approach, with constant recourse to discipline-specific methodologies and techniques, including the provision of an effective Enterprise Risk Management Framework, which is a fundamental cornerstone of a good governance system. The third chapter initially looks at the recent development of ESG rating agencies and, consequently, ESG ratings. These are scores that encompass not only the quality of corporate governance systems but also environmental, social and, more generally, sustainability issues. After highlighting the main peculiarities of but also critical issues in such sustainability indicators, the chapter focuses on the relationship between ESG factors, systematic risk, and performance. About the first relationship, i.e. between ESG ratings and systematic risk, the literature agrees that firms with higher ESG ratings have lower systematic risk (a lower beta) and, consequently, a lower cost of equity than firms with lower ESG ratings. Regarding the relationship between ESG factors and performance, the literature shows mixed results. According to some studies, companies with high ESG ratings have higher returns especially during recessionary periods, thus showing themselves to be more resilient. However, in some circumstances, it has been found that non-proprietary managers often use the funds allocated for carrying out socially responsible activities for purely personal purposes. Such an attitude, in the long run, could undermine profitability and, therefore, business continuity. The fourth and final chapter, following the outlining of the research objectives, provides a description of the sample under investigation and the methodology used. In the last part of the chapter, the econometric model is presented, and then the results obtained from the analysis are discussed.I documenti in IRIS sono protetti da copyright e tutti i diritti sono riservati, salvo diversa indicazione.
