The Financial Value of Responsibility: ESG Scores and Stock Market Performance

Abstract

This thesis contributes to the existing literature on the relationship between ESG scores and stock returns by examining large-cap listed companies in Europe and Japan from the 1st of January 2010 to the 31st of December 2024. To address the gap in previous research, this thesis further investigates the relationships between individual ESG pillar scores and stock returns, incorporating the overall ESG category and ESG pillars within a single comparative framework. This study employs a portfolio-based approach, constructing decile portfolios based on ESG and ESG pillar scores retrieved from LSEG Workspace. Portfolio performance is evaluated using two measures: alpha, which captures abnormal returns, and the Sharpe ratio, which assesses risk-adjusted excess returns. Abnormal returns are estimated using the Fama-French three- and five-factor models, as well as the Carhart four-factor model, through Ordinary Least Square regressions. The results highlight contrasting findings between the two performance measures. Regression analyses indicate a neutral relationship between ESG scores and stock returns in both Europe and Japan, with this neutrality persisting across individual ESG pillars. In contrast, the Sharpe ratio reveals a positive relationship between ESG scores and stock returns in Europe, which is only equally reflected in the Social pillar, while the Environmental and Governance pillars remain neutral. In Japan, the Sharpe ratio indicates a neutral relationship between ESG scores and stock returns, which persists across the Environmental and Social pillars, while the Governance pillar exhibits a positive relationship.