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Sustainable Finance and Asset Prices

Paper Session

Sunday, Jan. 8, 2023 10:15 AM - 12:15 PM (CST)

Sheraton New Orleans, Rhythms III
Hosted By: American Finance Association
  • Chair: Lucian Taylor, University of Pennsylvania

Flow-Driven ESG Returns

Philippe van der Beck
,
Swiss Federal Institute of Technology Lausanne (EPFL) and Swiss Finance Institute

Abstract

I show that the returns from sustainable investing are strongly driven by price pressure from flows towards sustainable funds, causing high realized returns that do not reflect high expected returns. Using a structural model, I estimate investors’ ability to accommodate the demand from sustainable funds, which is given by their elasticity of substitution between stocks. I show that every dollar flowing from the market portfolio into sustainable mutual funds increases the aggregate value of green stocks by $0.4. The price pressure from flows supports the effectiveness of impact investing by lowering green firms’ cost of capital. In the absence of flow-driven price pressure, sustainable funds would have underperformed the market from 2016 to 2021. To this end, I develop a new measure of total capital flows into managed portfolios. The price pressure from total ESG flows is highly correlated with empirically observed returns, both in the time-series and in the cross-section. I support the structural estimates with reduced-form evidence, showing that index inclusions and mandate-driven portfolio additions by sustainable mutual funds significantly boost the prices of green stocks.

Is Carbon Risk Priced in the Cross-Section of Corporate Bond Returns?

Tinghua Duan
,
IESEG School of Management
Frank Weikai Li
,
Singapore Management University
Quan Wen
,
Georgetown University

Abstract

This paper examines the pricing of a firm's carbon risk in the corporate bond market. Contrary to the "carbon risk premium" hypothesis, bonds of more carbon-intensive firms earn significantly lower returns. This effect cannot be explained by a comprehensive list of bond characteristics and exposure to known risk factors. Investigating sources of the low carbon alpha, we find the underperformance of bonds issued by carbon-intensive firms cannot be fully explained by divestment from institutional investors. Instead, our evidence is most consistent with investor underreaction to the predictability of carbon intensity for firm cash-flow news, creditworthiness, and environmental incidents.

Who Pays for Sustainability? An Analysis of Sustainability-Linked Bonds

Julian Koelbel
,
University of St. Gallen, Massachusetts Institute of Technology, and Swiss Finance Institute
Adrien Lambillon
,
University of Zurich

Abstract

We examine the novel phenomenon of sustainability-linked bonds (SLBs). These bonds’ coupon is contingent on the issuer achieving a predetermined sustainability performance target. We estimate the yield differential between SLBs and non-sustainable counter- factuals by matching bonds from the same issuer. Our results suggest that issuing an SLB yields an average premium of -9 basis points on the yield at issue compared to a conventional bond, although this premium decreased over time. On average, the savings from this reduction in the cost of debt exceed the maximum potential penalty that issuers need to pay in case of failure of the sustainability performance target. This suggests that SLB issuers can benefit from a ’free lunch’, i.e. a financial benefit despite not reaching the target. Investigating the drivers of the premium, we show that there is no clear empirical relationship between the yield at issue and the coupon step-up agreement of SLBs. Instead, an issuer’s first SLB seems to command a significantly larger premium, suggesting that especially the first SLB is seen by investors as a credible signal of a company’s commitment to sustainability.

Is History Repeating Itself? The (Un)Predictable Past of ESG Ratings

Florian Berg
,
Massachusetts Institute of Technology
Kornelia Fabisik
,
University of Bern
Zacharias Sautner
,
Frankfurt School of Finance and Management

Abstract

The explosion in ESG research has led to a strong reliance on ESG rating providers. We document widespread changes to the historical ratings of a key rating provider, Refinitiv ESG (formerly ASSET4). Depending on whether the original or rewritten data are used, ESG-based classifications of firms into ESG quantiles and tests that relate ESG scores to returns change. While there is a positive link between ESG scores and firms’ stock market performance in the rewritten data, we fail to observe such a relationship in the initial data. The ESG data rewriting is an ongoing rather than a one-off phenomenon.

Discussant(s)
Ralph Koijen
,
University of Chicago
Yoshio Nozawa
,
University of Toronto
Daniel Garrett
,
University of Pennsylvania
Alexander Ljungqvist
,
Stockholm School of Economics
JEL Classifications
  • G1 - Asset Markets and Pricing