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Abstract
Socially Responsible Investing (SRI) has experienced substantial growth over the last decade, although there is still a lack of consensus on whether this form of investing leads to competitive investment returns. This paper considers the case for SRI by examining the relationship between a range of Environmental Social Governance (ESG) rating factors and financial performance of US listed companies. Previous research in this area has largely been at the portfolio level and focussed on return as a performance measure. This study makes an important contribution to the literature by utilising stock level data to consider the relationship between ESG ratings and not only stock return but also wider measures of financial performance, namely valuation and operating performance.
Using a multifactor framework, this study provides evidence of a significant positive relationship between a range of ESG rating criteria and market to book value and return on assets measures, whilst a positive although inconsistent relationship between ratings and stock return is apparent. I argue that the relationship with valuation and operating performance is more clearly identified due to these measures being based on annual data, hence being consistent with rating data and also more stable than stock return (which is impacted by shorter term factors). In comparison to Brammer et al. (2006), the analysis shows that higher stakeholder ratings on the whole are more positively related to stock return. The results are broadly consistent with findings of Galema et al. (2008), although additionally highlight the significance of higher ratings for both valuation and operating performance and that employee conditions are more relevant than other stakeholder rating criteria.