Busting the Myth! Do Higher ESG Rated Firms Really Bring Higher Returns?

Hrafn DaviĆ° Hrafnsson & Yuliya Umin

Student thesis: Master thesis


This thesis aims to contribute to the debate of whether environmental, social and governance (ESG) ratings have a positive or negative effect on returns of firms. This study is conducted on ESGrated stocks in both the US and developed Europe markets over a sample period from December of 2005 to January of 2018, in order to investigate whether higher-rated ESG firms have higher abnormal returns than lower-rated. Equally-weighted decile portfolios were formed based on the level of each ESG rating and multi-factor models were applied in order to study the relationship. A general conclusion based on high and low-rated portfolios was not clearly evident. For the sustainable investor in US stocks, the highest abnormal return was found in not only the highest-rated but also the smallest firms of the entire ESG-rated sample and this was true for all individual ratings with the only exception being Governance. However, when dividing the entire sample by ratings only, in US lower abnormal returns were found when investing in highly-rated firms as opposed to lower-rated. For the European sample, a slight trend of highly-rated firms having more significantly positive abnormal returns was found. Thus, for European stocks, it was generally found that sustainable investors can earn positive abnormal returns while the same trend was not found in the US. Overall, a higher Governance rating appeared to be the most detrimental to returns in US. On the other hand, in Europe, higher abnormal returns were observed for higher ESG Combined ratings. Overall, this paper hopes to add value to both the sustainable and conventional investor in order to pinpoint the differences in returns between ESG-rated stocks in the hopes of helping them make better investing decisions and optimise their abnormal returns.

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
Publication date2018
Number of pages131