End of Week Notes

Did ESG improve resiliency during Q1

The academics weigh in.

Jon Hale
The ESG Advisor
Published in
8 min readAug 28, 2020


This week I summarize four academic papers that examine the impact of ESG during the first quarter when markets fell precipitiously because of the coronavirus pandemic.

Companies valuing stakeholders during pandemic had higher institutional flows and less negative returns

I wrote early on during the pandemic that corporations had no choice but to prioritize their stakeholders given the gravity of this crisis. But the standard view of shareholder-focused management suggests that cutting costs is the necessary response required so the company can protect shareholders and live to fight another day. Investors, in this view, might be expected to punish companies that prioritize stakeholders rather than cut costs.

On the other hand, while companies may be disposed toward cost-cutting, the magnitude of the crisis has focused so much media attention on corporate actions that companies cutting costs and laying off workers face significant reputational risks in doing so. Never before has so much information about corporate actions been so widely available and disseminated in traditional media, on the Internet and social media. It seems obvious given today’s media environment that having a reputation as a “corporation behaving badly” could do harm to the firm’s stock price during the crisis, not to mention hinder the firm’s longer-term prospects. Yet firms lacking built-in resilience may have no choice but to go the cost-cutting route.

Research from Harvard professor George Serefeim and associates addresses this issue. They looked at whether companies seen as prioritizing workers during the first stages of the pandemic experienced higher institutional money flows and less negative returns.

We study the association between corporate responses we see as plausibly important during this crisis, specifically related to labor practices, supply chain and operations, to determine whether companies with more positive sentiment around their response to the crisis experienced higher institutional money flows and less negative returns during the coronavirus pandemic.

Our hypothesis is that firms with more positive public sentiment for the way they respond to the COVID-19 crisis and their effects on employees, suppliers and broader society will experience higher institutional money flows and outperform their counterparts during the market collapse.

Using data from Truevalue Labs assessing sentiment across thousands of news sources, such as traditional media, blogs and industry publications, Serefeim and his co-authors found that companies with more positive sentiment and higher levels of media coverage around their labor, supply chain and operating responses to the crisis indeed experienced higher institutional money flows and less negative returns. The study covered the period from Feb. 20 to March 23.

Stocks with high Environmental and Social ratings demonstrated more resilience in Q1

A study by Rui Albuquerque et al. of U.S. stocks in the first quarter found that first quarter abnormal returns were significantly correlated with a firm’s Environmental and Social ratings, controlling for size, cash-to-assets, Tobin’s Q, leverage, and industry effects. A one standard-deviation increase in E&S ratings was associated with a 2.1% increase in quarterly returns. The study used Refinitiv and MSCI ESG ratings.

Why the resiliency?

Firms with credible ES policies have a more loyal customer base and face less price-elastic demands for their products. This in turn leads to reduced exposure for firms to systematic risk and increased valuations. In other words, customer resiliency drives firms’ stock resiliency.

To further explore the connection between customer loyalty and resiliency, the authors included advertising expenditures and found that firms with high E&S ratings coupled with high advertising expenditures outperformed by even more during Q1.

Intriguinely, they also found daily trading volume increases for high E&S rated firms after Feb. 24, the start of the downturn, “suggesting that some investors stepped in to stop the downward slide in prices, thus also reducing stock return volatility.”

Corporate Social Responsibility helped firms hold up better during the first quarter

This paper studied the links between corporate characteristics and stock-price reactions to the coronavirus pandemic during the first quarter, covering 6,000 firms globally. In contrast to the others discussed here, this one was less focused on ESG and moreso on an array of variables that might demonstrate resiliency during the downturn. They found that firms with the following characteristics experienced milder first-quarter declines in their stock:

a. stronger pre-2020 finances (more cash, less debt, and larger profits),

b. less exposure to COVID-19 through global supply chains and customer locations,

c. more CSR activities, and

d. less entrenched executives.

Furthermore, the stock prices of firms with greater hedge fund ownership performed worse, and those of firms with larger non-financial corporate ownership performed better.

Why do they posit that CSR activities may be connected to better performance during the downturn? Because they build trust with stakeholders:

Firms can strengthen their connections with these stakeholders through CSR activities, such as creating safe, healthy workplaces, engaging in ethical business practices, providing enduring, reliable services to customers, and investing in the local environment and community more generally. Such CSR activities signal a firm’s commitment to satisfying implicit contracts, which in turn boosts stakeholders’ willingness to support a firm’s operations, especially in difficult times.

To measure CSR, the authors use Refinitiv data — an overall CSR measure, an environmental measure, a social measure, and a CSR Strategy measure. For each one, they found that stock prices of firms with higher CSR scores fell less in response to COVID-19.

The results are consistent with the view that CSR investments strengthen the informal ties between a firm and its workers, suppliers, customers, and other stakeholders, enabling the firm to more effectively and efficiently work with those stakeholders, and enhance the firm’s likelihood of survival and future success.

The contrarian in the crowd: No ESG impact on stock prices in the first quarter

This paper came out in mid-August concluding that ESG was not a significant factor in stock performance during the first-quarter COVID-19 downturn. It quickly caught my attention because of its claim that Morningstar, along with BlackRock and MSCI, were “hyping” ESG’s ability to provide downside risk protection, based on several claims we have made:

Blackrock, the largest active investor in the world, reported better risk-adjusted performance across sustainable investment products globally (Blackrock 2020), Morningstar claimed that 24 of 26 ESG-tilted index funds outperformed their closest conventional counterparts (Hale 2020), and MSCI boasted that all four of their ESG-oriented indices outperformed a broad market counterpart index (Nagy and Giese 2020).

ESG funds and indexes absolutely outperformed during the first-quarter downturn, as I reported here. Why did they outperform? Two reasons:

1) ESG funds and indexes tend to be underweight Energy, which was the worst performing sector in the first quarter; 2) ESG funds and indexes tend to select stocks of companies with stronger/more positive ESG characteristics (measured in a variety of ways by different analysts and ratings systems) and such companies tended to lose less in Q1. Despite the stock-market recovery since then, ESG funds and indexes continue to outperform for the year to date.

It turns out that this paper, authored by a team led by Elizabeth Demers of the University of Waterloo, doesn’t directly address fund and index performance. But Demers et al. do take on a relevant question, which is whether the ESG characteristics of a company were directly, causally related to its stock performance in the first quarter. It could be that companies with more-positive ESG characteristics share other characteristics, particularly financial ones, that more directly “caused” their resilience in Q1.

Indeed, focusing on U.S. companies only, the authors find that:

ESG is significantly positively related to returns in the absence of other controls being included in the regression. When market-based measures of risk are added to the model as in the second specification, ESG remains significantly positively associated with returns.

But once they specify a full model with 27 independent variables, the ESG effect disappears. What was significant? Industry affiliation, market-based measures of risk, and accounting based variables that capture the firm’s financial flexibility (liquidity and leverage) and intangible assets.

Far from disproving all the “hype” around ESG as a resilience factor, I’d say they’re onto something quite different. Their findings suggest pathways through which ESG may affect stock performance. Clearly, some industries were more resilient than others to COVID-19, and high-beta firms lost more than low-beta firms in the first quarter. But positive ESG characteristics can lower a firm’s cost of capital and ESG can affect a firm’s reputation, suggesting a link between ESG and both financial flexibility and intangible assets.

Another quibble I have with this paper is that it uses one source of ESG data and only overall ESG ratings. Researchers should keep in mind that ESG ratings are not commodity products. Unlike every other variable the authors used in this paper, the choice of ESG rating makes a difference. That’s because ESG ratings are really a proxy for something far more complex —how a firm manages, performs and makes strategic decisions on an array of issues that affect the environment and stakeholders. The choice of data provider and of the ESG data being used (an overall rating, for example, vs. a subset of ESG-related measures that may be more directly relevant to the research design) can cause results to differ.

Companies with better ESG traits held up better than those with worse ESG traits during Q1. The question is, why?

Three of the authors suggest it’s because of something substantive: that firms with stronger connections to stakeholders because they’ve created safe and healthy workplaces, provided reliable services to customers, engaged in ethical business practices, and invested in their communities are more resilient in times of crisis — and that’s something investors increasingly recognize.

One paper suggests that the stocks of firms with better ESG traits were resilient in the first quarter not because of their ESG traits but because of other traits that are correlated with ESG, traits often associated with large, quality companies like lower leverage and a lot of intangible assets. Far from concluding that ESG is therefore a bunch of “hype,” their results suggest to me that more attention be paid to the pathways through which ESG can affect financial performance.



Jon Hale
The ESG Advisor

Global Head, Sustainable Investing Research, Morningstar. Views expressed here may not reflect those of Morningstar Research Services LLC. or its affilliates.