This paper may quickly become an historical artifact. It’s input, Environmental Social and Governance (ESG) ratings, and it’s output, algorithmic derivations of results using machine learning are analytical tools changing at such a pace as to condemn almost all research using them to obsolescence upon publication.
Moreover I, and many other investors, have spotted a fundamental flaw with the whole ESG-schtick, it can be and is being gamed. I’m sure many casino companies produce respectable ESG scores; but this is to overlook the fact these are businesses that ruin lives, provide no useful social utility and are, for me at least, univestable at any price. [I could go on!]
To the work then. Qinyan Xue (et al.) of the Capital University of Economics and Business in Beijing has looked at domestically listed stocks in China to see if there’s a relationship between high ESG ratings and Total Factor Productivity (TFP, quality profits in other words). No surprise, there is.
The mechanism by which this occurs is perhaps peculiar to China in that not only do high ESG scoring companies obtain financing on better terms than lower scoring peers but government grants are more forthcoming. I suspect, but not outlined in the paper, they also enjoy more of a general fair wind from authorities which further smooths their passage.
Where the paper earns its stripes is taking the work and seeing if high ESG scores are a reliable predictor of future performance. The fact they are suggests investors may not yet (but will soon enough!) have twigged there’s a correlation. Conversely they may have noticed but, like me, are suspicious of back-tested results?
This is solid academic work but I felt at the end of the read I’d learned only that good companies produce superior results over time, which I think we all know.
My definition of a ‘good’ company though would incorporate a lot more than just a look at an ESG score provided (in nearly all cases) by a for-profit and therefore likely conflicted third party.
You can review the paper yourself via this link ESG Rating Results and Corporate Total Factor Productivity.
Happy Sunday.