Does ESG performance affect stock returns? Evidence from the automotive industry

Abstract

ESG scores are among the most controversial and debated topic in finance, both in the industry and in the academia. Financial professionals need ESG data both to meet the increasing demand from their clients for sustainable investments and to comply with new – or upcoming- stringent regulation coming from legislators. Nonetheless, institutional investors’ first goal remains to generate enough returns for their clients in the long term. Transition to a carbon-neutral economy is forcing executives across many industries to revolutionize their businesses and this process is naturally creating leaders and laggards, with the latter potentially witnessing a steep decline in profits for not adapting to this new business landscape. This is known in finance as transition risk and can be more relevant for some sectors more than for others. This research paper focuses on Automotive, for which transition risk is a key theme for industry players, as legislators and business leaders bet on electrification of road vehicles in order to curb CO2 emissions. So, are ESG scores able to correctly identify companies better positioned to face the transition? What does it imply in terms of financial performance? I employ Refinitiv data for a quantitative examination of the issue, constructing an ESG factor using the long-short portfolio approach, as pioneered by Fama and French. Subsequently, I incorporate this factor as an dependent variable in a regression analysis to assess the presence of a 'green'-'ESG' premium in automotive industry stock returns.