Leveraging data from the rating agency’s ESG Solutions and RepRisk, an ESG data science firm, the research draws a direct line from controversial ESG events that can be objectively measured – such as a chemical spill (environmental), the use of child labor (social), or corruption and bribery cases (governance) – and their business and shareholder impacts.
“We found that there is a meaningful benefit to a responsible ‘ESG risk management culture’ within a firm that can have a potentially material effect on equity returns,” said Doug Dwyer, managing director at Moody’s Analytics, who led the research.
He added, “ESG controversies can inflict reputational damage with significant financial and legal repercussions. Firms that actively manage these risks do a better job of boosting shareholder value.”
There have been several high-profile instances of firms facing lasting damage as a result of ESG-related failures.
In 2015, Volkswagen shares dropped after it was revealed that the amount of carbon emissions from its vehicles were being deliberately underreported, while failures in corporate governance led to the collapse of US healthcare firm Theranos in 2018, and German firm Wirecard in 2020.
The study which covered 13,000 controversies and over 3,000 public companies from 2013 to 2019, found that, controlling for other market factors, controversial ESG events have large and persistent negative effects on firm value, and the more severe the event the larger its impact.
Moderate-to-severe ESG events resulted in an average -4% one-year excess equity return, which represents a loss of approximately $400 million for a typical-sized firm in the study.
However, it revealed that companies that learn from past ESG controversies and improve their internal ESG risk practices can lower their future rate of ESG events and potentially enhance their returns, the research also showed.
“Together, the results of these research studies show the relevance of ESG controversies to a firm’s financial performance and, importantly, that companies can influence their ESG risk management cultures, while benefiting shareholders and other stakeholders,” Dwyer added.
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