Navigating the Green Wave: An Empirical Study of ESG's Effects on Financial Performance

Abstract

With an increasing focus on sustainable investing, the Environmental, Social, and Governance (ESG) criteria have become crucial. Many investors now seek financial returns through responsible investment practices, often evaluating companies based on ESG ratings. This approach, however, raises an important question: do companies with higher ESG scores actually outperform those with lower scores? Numerous studies have investigated the effects of ESG on financial performance, reaching different conclusions. Most research has focused on companies in Europe, the UK, or the US, while the sustainability-wise topperforming countries of Scandinavia, on their own, remain a relatively unexplored area. Motivated by this research gap, this thesis examines the effects of ESG on the financial performance, proxied by stock returns, of publicly listed companies in Scandinavia from 2011 to 2022.

Using stock and ESG data from the LSEG Eikon Data Stream, the analysis included 97 Scandinavian companies after filtering. Annually rebalanced portfolios sorted after the highest and lowest 20% of ESG scores, as well as individual E, S, and G pillar scores, were analysed utilising linear multiple regression. The Fama-French five-factor model was used to analyse the portfolios' excess return exposure towards the five factors. The analysis found that none of the analysed portfolios achieved abnormal returns, as alphas were zero and statistically insignificant. In other words, there is no statistical evidence of any ESG effects on stock returns for Scandinavian companies in the period 2011-2022. For all regressions, the Fama-French factors appear to explain the variation in stock returns with average R² values of 70%, with specifically the market factor, the value factor, and the investment factor having statistical significance. The findings of this thesis are therefore consistent with existing research, as most portfolio-based studies also link a natural relationship between ESG and financial performance.