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KARISHMA SRIVASTAVA
FE-01092

5TH DEC. 2023

The impact of environmental, social, Governance (ESG) factors on stock prices and corporate

performance

INTRODUCTION

Environmental, Social and Governance (ESG) Investing has grown rapidly over the past decade, and
the amount of professionally managed portfolios that have integrated key elements of ESG
assessments exceeds USD 17.5 trillion globally, by some measures.1 Also, the growth of
ESG-related traded investment products available to institutional and retail investors exceeds USD 1
trillion and continues to grow quickly across major financial markets.
The growing investor interest in ESG factors reflects the view that environmental, social and
corporate governance issues – including risks and opportunities -- can affect the long-term
performance of issuers and should therefore be given appropriate consideration in investment
decisions. While definitions differ regarding the form of consideration of ESG risks, broadly
speaking ESG investing is an approach that seeks to incorporate environmental, social and
governance factors into asset allocation and risk decisions, so as to generate sustainable, long-term
financial returns.2 Thus, the extent to which the ESG approach incorporates forward-looking
financially-material information into expectations of returns and risks, and the
extent to which it can help generate superior long-term returns, is the focus of this report.
Over the past several years, considerable attention has been given to ESG criteria and investing, due
in part to at least three factors. First, recent industry and academic studies suggest that ESG investing
can, under certain conditions, help improve risk management and lead to returns that are not inferior
to returns from traditional financial investments. Despite the recent studies there is a growing
awareness of the complexity of measuring ESG performances. Second, growing societal attention to
the risks from climate change, the benefits of globally-accepted standards of responsible business
conduct, the need for diversity in the workplace and on boards, suggests that societal values will
increasingly influence investor and consumer choices may increasingly impact corporate
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performance. Third, there is growing momentum for corporations and financial institutions to move
way from short-term perspectives of risks and returns, so as to better reflect longer-term
sustainability in investment performance. In this manner, some investors
seek to enhance the sustainability of long-term returns, and others may wish to incorporate more
formalised alignment with societal values. In either case, there is growing evidence that the
sustainability of finance must incorporate broader external factors to maximise returns and profits
over the long-term, while reducing the propensity for controversies that erode stakeholder trust.

Impact of ESG factors on stock prices

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Former UN Secretary-General Kofi Annan initially put forth the idea of environmental, social, and

governance (ESG) in the UN Global Compact in 2004. ESG is a benchmark for assessing an

organization's non-financial performance in terms of governance, society, and the environment. The

China Securities Regulatory Commission (CSRC) updated the Code of Governance for Listed firms

in 2018 with the goal of enhancing the governance standards of China's listed firms. This revision

also created the foundational framework for ESG disclosure in China for the first time. The

"dual-carbon" goal1 mandates that businesses improve their production and consumption, and the

application of the ESG development concept has evolved into an objective need for both internal and

external corporate governance.

According to stakeholder theory, businesses should also consider the demands of all stakeholders

together, rather than just their own. China's economic growth has resulted in environmental issues

that are a reflection of uniform governance and a lack of knowledge of corporate responsibility. ESG

performance is one type of non-financial information that shows the state of a company's operations,

encourages the release of more confidential information into the public domain, and could enhance

information transmission efficiency.

Simultaneously, stock price synchronicity describes the extent of correlation between a stock's price

swings and the market's average price variations. This is a crucial metric for assessing the capital

market's effectiveness in terms of pricing and information transmission. The "idiosyncrasy

information view" (Morck et al., 2000; Qiu et al., 2020) and the "irrational noise view" (Li et al.,

2014; Chen and Doukas 2022) are the two primary points of view that are now included in research

on stock price synchrony. According to the "idiosyncrasy information view," a company's stock price

is typically influenced by market or industry conditions when its disclosure of idiosyncratic

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information is inadequate. Corporate's involvement in ESG initiatives releases more

enterprise-specific data, which may lessen information asymmetry and lower stock prices.

The most obvious explanation is that corporate ESG performance exists primarily to draw in

investors. ESG is more pertinent to capital markets, to start. Since the capital market and investors

are naturally intimately related, the original focus of ESG was on ESG responsible investment.

Secondly, ESG provides a well-defined benchmark for advancing business sustainability. ESG serves

as a more normative set of guidelines for investors, businesses, and rating agencies. Businesses must

include environmental, social, and governance considerations into their basic business strategies and

business models (Gillan et al., 2021). Lastly, the market can receive more accurate information about

corporations' ESG performance.

Impact of ESG factors and corporate performance

Many listed firms now participate in ESG practices not just as a. result of external pressure or the

management's own self-interest, but also as an unplanned action with the intention of adding value

as society awareness and the ESG system continue to advance. The ESG value-added theory,

which contends that ESG performance has a favorable influence on corporate value, is

supported by most study findings. Companies with great ESG performance typically also have

strong risk management, outstanding credit quality, and high levels of financial success.

Companies that improve their ESG management.

Their market value. Additionally, the market value will rise (Fatemi et al., 2017; Qiu M and Yin,

2019). Strong ESG performance helps listed firms acquire the respect of key stakeholders.

First, it is easier for listed companies to forge positive relationships with the government when

they perform well in ESG and achieve a relaxed environment for their own development. For the

government, listed companies with stronger economic strength and greater social influence are

the "key minority" to be grasped in order to promote ESG development (Liu, 2016). Leading
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listed firms have greater opportunity to gain financial support and preferred policy treatment since

the government plays a significant role in resource allocation, which improves financial

performance.