Digital
Article
Environmental
Sustainability
Two Factors that Determine
When ESG Creates
Shareholder Value
New research suggests that high-ability managers and applying
ESG practices to supply chains set successful initiatives apart.
by Aaron Yoon
This document is authorized for use only in Joseph Shields's MA ODCL Sem 4/27/02/2024 at Tata Institute of Social Sciences from Feb 2024 to Aug 2024.
HBR / Digital Article / Two Factors that Determine When ESG Creates Shareholder Value
…
Two Factors that Determine
When ESG Creates
Shareholder Value
New research suggests that high-ability managers and applying ESG
practices to supply chains set successful initiatives apart. by Aaron Yoon
Published on HBR.org / February 07, 2024 / Reprint H080CZ
EschCollection/Getty Images
A main criticism of corporate sustainability has long been that it
results in firms not putting shareholders first, thus contradicting
managers’ fiduciary duty. In 2016, however, I published a paper,
“Corporate Sustainability: First Evidence on Materiality,” with George
Serafeim and Mo Khan, that began to overturn that narrative. We
documented that considering financially material ESG factors (i.e.,
those sustainability activities that are related to the core sector
Copyright © 2024 Harvard Business School Publishing. All rights reserved. 1
This document is authorized for use only in Joseph Shields's MA ODCL Sem 4/27/02/2024 at Tata Institute of Social Sciences from Feb 2024 to Aug 2024.
HBR / Digital Article / Two Factors that Determine When ESG Creates Shareholder Value
…
practices of the firm) improve portfolio returns, which is consistent with
financially material sustainability activities creating shareholder value.
Some attributed the paper to ESG investing taking off. The Financial
Times called the paper a turning point on how investors viewed and
integrated ESG information. Yet despite its popularity among investors
and managers, sustainability remains a contentious topic; academic
consensus about whether it creates shareholder value has remained
elusive, and ESG investing has become caught up in a political war
in the U.S., with some conservative critics claiming it’s a fig leaf for
promoting a liberal agenda, and some liberal critics criticizing it for
not going far enough in addressing planetary challenges. According to
The Conference Board, a survey of more than 100 large U.S. companies
revealed that nearly half have experienced ESG backlash, and 61%
expect this pushback to persist or intensify in the next two years.
Yet ESG investing is not going away; almost all companies still claim
to engage in some form of ESG. So understanding the link between
ESG efforts and shareholder value remains as important as ever. Since
my paper in 2016, I have been uncovering the link between ESG and
shareholder value creation. I describe two examples below.
The importance of high-ability managers in choosing ESG projects
The quality of management may impact whether ESG activities enhance
shareholder value. In my research with Kyle Welch, we studied the stock
returns of U.S. firms between 2012 to 2020 and found that high-ability
managers allocate resources to ESG efforts in a way that enhances
shareholder value.
We identified high-ability managers using Glassdoor employee ratings
of senior managers. We found that the portfolio of firms with high-
ability CEOs as well as ESG investments outperformed the portfolio of
Copyright © 2024 Harvard Business School Publishing. All rights reserved. 2
This document is authorized for use only in Joseph Shields's MA ODCL Sem 4/27/02/2024 at Tata Institute of Social Sciences from Feb 2024 to Aug 2024.
HBR / Digital Article / Two Factors that Determine When ESG Creates Shareholder Value
…
firms with low-ability CEOs as well as ESG investments by 6.64% per
year. In addition, the portfolio of firms with high-ability CEOs as well as
ESG investments outperformed the group of companies with just high
ESG investments but low managerial ability, as well as firms with low
investments in ESG and high managerial ability.
What this shows is that both high-ability leadership and high ESG
investment are needed to maximize shareholder value. This makes
sense: When pressured to engage in ESG, CEOs would likely pick ESG
projects that generate shareholder value because their compensation is
typically tied to stock price.
The importance of supply chain ESG activities
In 2023, I also examined the long-term value implications of supply
chain ESG and the usefulness of this information to investors. Although
a well-known concept, supply chain risk has been difficult to quantify
because of two important hurdles: 1) Suppliers’ identities are often
hidden, and 2) there’s a lack of a credible measure of supplier ESG
practices, especially when suppliers are private. I along with Xuanpu
Lin, Guoman She, and Haoran Zhu created a measure that overcame
these problems.
Our research looked at U.S. listed companies and their supply chains,
composed of both private and public suppliers in the U.S. and
abroad, from 2009 to 2020. We obtained information about companies’
suppliers and data on negative ESG news events and used negative ESG
news events that occur at a firm’s suppliers as a proxy for the firm’s
supply chain ESG risk.
We found a link between the ESG risk in a company’s supply chain
and its future stock returns. Specifically, the portfolio of firms with the
Copyright © 2024 Harvard Business School Publishing. All rights reserved. 3
This document is authorized for use only in Joseph Shields's MA ODCL Sem 4/27/02/2024 at Tata Institute of Social Sciences from Feb 2024 to Aug 2024.
HBR / Digital Article / Two Factors that Determine When ESG Creates Shareholder Value
…
fewest supplier ESG incidents exhibited excess return of 6.77% annually
relative to the portfolio of firms with the most incidents.
The returns we observed were generated largely in three ways. The
first is supply chain stability. With fewer shocks and disruptions,
companies can fulfill customer orders, optimize inventory, and operate
more efficiently. The second is that responsible sourcing policies attract
socially conscious customers and investors, and help companies avoid
supply chain problems that can damage their brand and reputation.
Third, ethical sourcing can hedge regulatory risk and reduce legal
liabilities.
...
Why should ESG efforts be related to shareholder value? Simply stated,
it is because ESG activities are investment activities that consume
the resources of the firm. As such, investors, who should be making
bets on how effective different firms are in generating returns on their
respective investments, must exercise due diligence to uncover the link
between firm ESG efforts and shareholder value. Several key issues
remain and will likely dominate the ESG discussion in the years ahead:
how ESG information is disclosed; how it is processed by data vendors;
how it is used by investors; and how regulators oversee and regulate
ESG.
Moving forward, there will likely be tremendous opportunity in
the investment and accounting industry for greater disclosure and
transparency. For companies and their management, the more they
prioritize ESG investment and quantify how these activities contribute
to shareholder value, the more they will likely attract savvy investors
who want to reap that potential return.
Copyright © 2024 Harvard Business School Publishing. All rights reserved. 4
This document is authorized for use only in Joseph Shields's MA ODCL Sem 4/27/02/2024 at Tata Institute of Social Sciences from Feb 2024 to Aug 2024.
HBR / Digital Article / Two Factors that Determine When ESG Creates Shareholder Value
…
Editor’s Note, February, 15, 2024: This piece has been updated from its
original version to clarify details about the author’s 2016 research paper.
This article was originally published online on February 07, 2024.
Aaron Yoon is an assistant professor of Accounting & Information
AY Management at Northwestern Kellogg.
Copyright © 2024 Harvard Business School Publishing. All rights reserved. 5
This document is authorized for use only in Joseph Shields's MA ODCL Sem 4/27/02/2024 at Tata Institute of Social Sciences from Feb 2024 to Aug 2024.
