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Why ESG Academic Research Matters

In This Post:

  • A new research article is published and doesn't make much of a splash...yet.

  • Rethinking the link between sustainability and stock price.

  • SASB's dominance in materiality assessments may be numbered.


Why ESG Academic Research Matters

Hey ESG and Sustainability teams, did you feel that last week? Did you feel the earth beneath your feet shake?

Probably not, because the BIG NEWS that I am referring to--the news that could reopen a debate that is sure to rock the ESG industry--did not make it into many mainstream news media headlines. That’s because it came about in a newly released academic journal article, which is a surefire way to ensure any big news is delayed for at least six more months.

But this new journal article is important and worth discussing now instead of six months from now.

For context, the underlying promise of much of ESG throughout the early 2000s was that companies with good ESG performance were more aligned with risks and opportunities and demonstrated superior stock returns over time than were companies with poor ESG performance. This shouldn’t be surprising as the entire field of ESG as a practice was developed by institutional investors as a form of risk management across their investment portfolios. The logic of the relationship is baked in: ESG--Risk--Stock Returns.

Although the logic was clear, the empirical evidence was not. The race was on to identify how ESG data (or Corporate Sustainability, in some fields of research even though the two terms are not fully interchangeable) were linked to investment performance. The stakes were high: if the logic held, then ESG should become an integral component of all investment decision-making, but if the logic did not hold then ESG was nothing more than a variation of SRI or Impact Investing, as we discussed in our last newsletter.


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Now...Back to it!

Some early research was successful in bringing evidence to bear, but nonetheless left too many unanswered questions or methodological caveats. It wasn’t until 2016, with the publication of Khan, Serafeim, and Yoon’s paper in The Accounting Review, that the weight of evidence would tip in favor of ESG and the financial world more broadly would take note. (A public access copy is available here.)

In this paper, the authors mapped corporate sustainability investments--or what companies were spending money on--onto a materiality filter informed by the industry-specific SASB materiality standards and correlated these to respective stock performance. They discovered that the stock returns of companies with good performance on material sustainability issues significantly outperformed companies with poor performance on these issues and that companies with good performance on material issues and poor performance on immaterial issues performed even better. In short, ESG was linked to stock returns, and the key was in understanding materiality (as we explored in yet another previous newsletter.)

Since then, the use of ESG data in investment decision-making has grown steadily, and ESG is now a field and industry of its own.

But now in 2022, in their newly published article in Journal of Financial Reporting, Berchicci and King have sought to replicate the all-important (should we say seminal!?!) Khan, Serafeim, and Yoon study, but to no avail. (A public access copy of the study is available here.)

Berchicci and King suggest that earlier evidence supporting SASB materiality-linked ESG data as a predictor of stock returns is in fact simply a statistical artifact attributable to the modeling process and a few of the subjective decisions and assumptions which had to be made given the nature of the data at hand.

The authors further conclude that investment portfolios reliant on materiality-weighted ESG measures should not outperform the market. This is a critically important finding as it cuts to the core of the preferred ESG portfolio development strategy since 2016.

So does this mean that sustainability is not linked to stock performance?

Absolutely not.

The 2016 study has been turned to as having built the case to link corporate sustainability to stock performance but this is an overly generous interpretation of the study’s findings. This is to be expected when academic research transitions into the popular sphere as the minutiae of academic focus is somehow transformed into broad generalization and recommendations.

The recent article may be framed by some as a rebuttal to the earlier article but this is not the case. Both research projects are exploring the same issue and collaboratively advancing our understanding of how corporate sustainability is linked to stock performance. The 2016 article even used the term “First Evidence” in its title knowing that more research would be needed to continue this line of investigation. The idea is that research compounds and over time knowledge is co-generated and shared. Although these two articles come to different conclusions, they actually support each other--this is how good academic research is supposed to proceed, but it is also a relationship that is often lost in translation in popular media coverage

( … I seem to have drifted onto a tangent, back to our focus for today…)

The particular line of investigation explored in these studies is if industry-scaled determinations of materiality can be relied upon to predict stock performance. The 2016 article suggested that materiality-weighted ESG measures--as defined by industry-scaled SASB materiality determinations--could inform the development of an investment portfolio capable of outperforming the market. The more recent 2022 study suggests that this is not the case. This research does not call into question if corporate sustainability is linked to stock outperformance, rather it calls into question the use of industry-scaled SASB materiality frameworks throughout portfolio development.

The 2016 study provided the first evidence of a link between industry-scaled SASB materiality frameworks and stock performance, but the broader popular narrative took this as evidence of how corporate sustainability is linked to stock performance. So much so that most ESG investment portfolios and ETFs are developed following this materiality-weighted approach. This new study does not call corporate sustainability into question, but it certainly does undermine the claims of applicability of SASB materiality frameworks--claims that have broadly been accepted as settled.

And this makes sense. For SASB to be able to provide a materiality framework applicable to the entire economy it has to operate at the scale of industry or higher, any more refined and it would become unmanageable--a framework with 40,000 distinct entries is not a framework, it’s a database. Yet, the idiosyncrasies of stock pricing operate predominantly at the corporate scale, which is why two companies in the same industry can have two wildly different stock prices. This discrepancy in scales means the SASB materiality framework is useful in guiding initial corporate sustainability decisions and understandings, but not likely useful in identifying information and insights which are not already factored into market dynamics.

SASB has been discussing materiality at an industry-level while sustainability and stock price are developed at a corporate level. SASB was quick to latch onto the 2016 study as it brought unprecedented attention to its work, but the reality is that the SASB materiality framework was not intended to be relied upon to inform market-beating portfolio selection.

I know it may be hard to tell from my writing, but I am very excited about this development. Since 2016, ESG--and corporate sustainability programs by extension-- have been increasingly shoe-horned into the SASB materiality framework. This isn’t necessarily bad as SASB does do good work, but it is quite limiting.

A company’s ESG is a reflection of its operations and relationships. Each company’s profile is unique unto itself, thereby creating an opportunity for each to set its own trajectory. Yet the financial markets' focus on industry-scaled SASB materiality has lost sight of such unique opportunities in favor of standardization.

I don’t care much for SASB to tell me what should be important for any given company. Rather, I care what that company tells me is important, what it tells me it is doing about what it thinks is important, and what it tells me it expects the outcomes of these actions to be. I can then decide for myself if I agree with its assessment and strategic trajectory.

As I said, SASB does do good work…but their work should not be prescriptive to entire industries and markets. If you are a company just starting out in ESG and/or Sustainability, or an investor just starting to incorporate ESG into your decision-making processes, then becoming familiar with SASB materiality is a good first step, but certainly do not limit yourself to this or you risk missing out on possibly some of the greatest opportunities.

This new study provides the support some investors may need to start looking beyond the SASB framework…and if investors start looking beyond the framework this provides the catalysts some companies may need to start contemplating more integrated and daring moves in their ESG and Sustainability programs and reporting.

Sustainability is the new competitive imperative, and this recent study is laying the groundwork for companies to start making bolder plays. ESG is going to get more exciting (...but I say this from an academic’s perspective of time, so please don’t start the countdown just yet).


What This Means for CSOs: The perpetual question for corporate ESG and Sustainability teams has long been: What should we focus on? With dominant asset and investment management firms internalizing the findings of the 2016 study and designing investment portfolios according to SASB-weighted ESG metrics the answer became simple: Focus on whatever SASB believes is material to your industry.

Simple, but not very helpful. ESG and Sustainability are integral components of competitive business strategy, yet to design programs based on industry-wide determinations of materiality is to forego such potential competitive advantage.

This new study provides support for you to start taking more ownership over what you believe to be material for your company. So, What is important to your company? What are you doing about it? What are the outcomes you expect from these actions? Answer these questions without limiting yourself to the SASB framework and you are well on your way to developing a more strategic materiality assessment for your programs.


In the end, there is no one approach to materiality and the most recent academic research is starting to make that clear. ESG and Sustainability succeed based on materiality, and the opportunity to define what this means for you is at hand. We are focused on this space and will have more to say in our next edition, in the meantime, please connect with us on Twitter and LinkedIn, or from our website to continue this discussion.

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