October 20, 2024 • 47 mins
Do Woke Firms Go Broke? Part 1
In this episode of 'Questions in Finance,' university professors Kate Holland and Veljko Fotak explore the intersection of corporate profitability and social responsibility. They examine whether companies prioritizing ESG (Environmental, Social, and Governance) or CSR (Corporate Social Responsibility) practices can also deliver strong financial returns. Using historical financial perspectives and empirical evidence, they analyze corporate earnings, stock returns, and the effects of governance on firm performance. The episode delves into various aspects of ESG, including environmental impact and 'greenium'—the premium returns of environmentally conscious firms—highlighting the positive correlation between good ESG practices and financial success. Featuring studies and case examples, this comprehensive discussion addresses the financial and ethical dynamics of socially responsible investing in modern markets.
Timeline:
00:00 Introduction and Allbirds
03:42 Exploring the Concept of 'Woke' Firms
08:30 A Narrow View of Corporate Performance
14:05 Governance and Its Impact on Returns
21:13 Environmental Policies and Firm Returns
27:19 Correlation vs. Causation in ESG Performance
28:45 Historical Context of ESG Concerns
30:24 Back from Break: Discussing Corporate Responsibility
35:52 Green Firms in Brown Industries
44:31 Summarizing ESG Performance
45:49 Wrapping Up and Looking Ahead
Bibliography:
Bolton, Patrick, and Marcin Kacperczyk. "Do investors care about carbon risk?." Journal of Financial Economics 142, no. 2 (2021): 517-549.
Chan, Pak To, and Terry Walter. "Investment performance of “environmentally-fri
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Veljko (00:00):
Kate, what do you think about my new Allbirds?
Kate (00:03):
Oh yeah, your new Allbirds among all the other new shoes, in
this season's collection, so to say.
I like the Allbirds.
They look nice.
And I have a pair of myself,let's say maybe even a couple
because they're so comfy.
But did you buy them because , they'rea very clean company, they use
wool, they don't kill sheep.
(00:24):
And so they have these social valuesthat they put them front and center.
Did you buy your Allbirdsbecause of their social values?
Veljko (00:33):
I actually don't think I did.
I bought them because as you say, they'resome of the comfiest shoes around.
I think that the sociallyresponsible side helped.
You feel a little bit better about thepurchase because you bought something.
That's good for the environment,but ultimately I don't think
(00:54):
it drove my buying decision.
And maybe not everybodyknows what Allbirds are.
They're a shoe company.
They're from New Zealand.
And the big shtick is that theyuse wool, which supposedly is a
lot more sustainable than leather.
And I guess that's whatyou were referring to.
Funny thing is, my sister claims she willnever get caught in a pair of Allbirds.
Kate (01:14):
So those Italians, they only wear high heel shoes.
So, you know, gotta cut her some slack.
She just hasn't everowned a pair of Allbirds.
And if she does, you neverknow what she's gonna do.
Veljko (01:25):
You're right.
Actually, funny you should say, my motheralso swore never to wear them and after
she tried them, now she loves them.
Kate (01:32):
That's one thing that we seem to want to talk about buying this
product, buying the shoe, but let'slook at another question here.
Would you buy a stock in Allbirds?
You know, Allbirds became a publiclytraded company not that long ago.
Would you invest in them?
Veljko (01:49):
Well, so
I think I wouldn't, Kate.
Ouch!
Well, okay, so Allbirds hassome specific problems, to be
honest, as a company, right?
They have not, they went public recentlyand they actually, I think they've
(02:10):
been mismanaging their product line.
But I think that what you're hinting athere is more, would I invest in a company
because it is socially responsible, right?
Is this where we're going?
Kate (02:20):
That is correct.
That's correct.
Yes.
And Allbirds is just oneexample of such a company.
There's Patagonia and there's awhole set of firms that really bring
up their social values front andcenter for investors to consider.
So I guess the big question is, do thesecompanies that promote their social
values, are they profitable investments?
Veljko (02:41):
I think that's a question that we're going to explore today, right?
But we do have a lot of voicestelling us that woke firms go broke.
And so I guess we have two questionstoday, whether you want to word it in a
more politically correct way or manner.
It's either do woke firms go broke or dosocially responsible firms underperform?
(03:14):
Welcome to Questions in Finance,
Kate (03:16):
a podcast where we translate academic mumbo jumbo to answer
interesting questions in finance.
I'm Kate Holland.
Veljko (03:24):
And I'm Veljko Fotak.
Kate and I met when we were PhDstudents at the University of Oklahoma.
Kate (03:30):
Today we're university professors and we spend our days
teaching and researching companies,markets, and all things related.
So yeah, let's unpack this question.
Do woke firms go broke?
In other words, do sociallyresponsible firms underperform?
Veljko (03:49):
Well, let's, dissect this for a second.
Why do we talk aboutunderperformance specifically?
On one side, we are classicallytrained economists that grew up
in a post Milton Friedman world.
Friedman of course, being the Chicagobased economist that in the 1970s, or
well, in 1970, enshrined a new worldviewby stating that the social role of
(04:15):
corporations or the only concern of firmsshould be the maximization of shareholder
wealth, which became effectivelyour, our business school mantra.
Kate (04:24):
For sure.
Veljko (04:25):
We have been taught that firms maximize shareholder value
by focusing specifically anduniquely on shareholder value.
And mathematically, it is anargument that makes a lot of sense.
You achieved the most optimaloutcome, in terms of wealth,
with unconstrained optimization.
(04:46):
That is, if you start prioritizingor co-prioritizing other things,
society, the environment, and so forth,you will stay away from pure wealth
maximization and your wallet will suffer.
That's how we have been trained.
And yet, we, we do see novel, evidenceon the other side of this debate, , at
(05:07):
the micro level, at the firm level,that finds that there are a possible,
tangible rewards for sociallyresponsible behavior, that translate
into economic performance as well.
So for example, your customers mightbe more likely to buy your products
or pay slightly higher prices.
You might get into trouble a littlebit less often, with the environmental
(05:29):
protection agency or perhaps sued,a little bit less often, in workers'
compensation claims, if you're asocially responsible firm that doesn't
pollute or treats workers fairly.
And interestingly, some of the strongesteffects that we are actually going
to see in the academic literatureare coming from the financing side.
Kate (05:49):
Yep.
Correct.
Veljko (05:50):
Banks give socially responsible firms, cheaper loans.
It's like a halo effect.
There is this assumption thatbecause you're polluting a bit
less or treating your employees alittle bit more, fairly, you're less
likely to run away with my money.
And well, there is research thatactually seems to suggest that
there is some truth to that.
(06:11):
And finally, we do have right now apolitical backlash against socially
responsible investing, with voices,mostly from the right of the political
spectrum, telling us that "woke" firms"go broke" and justifying opposition
to socially responsible investing onthe basis of alleged under performance.
(06:33):
So this is a bit of context of today'squestion and where we are coming from.
Well, there's lots andlots to unpack here.
Probably a good way to start thisconversation is to figure out
a couple of definitions, right?
Kate (06:49):
For sure.
I have to say, I totallydislike this woke slang.
Just thought, it just makesmy skin bubble, so to say.
Veljko (06:58):
Okay.
I think that's a fair point.
"Woke".
It feels like it's beenhijacked a bit as a term, right?
I mean, it should havea positive connotation.
You're awake, you're aware, right?
You understand what's going on around you.
Kate (07:11):
Definitely doesn't have a positive connotation in today's world.
Veljko (07:14):
I think it has been hijacked by the critics of social activism, right?
In implying something negative about it.
The good news is that in finance, that'snot what we generally use, as a term.
We usually talk about sociallyresponsible firms and actually tend
to slice it a little bit more, whenwe talk about socially responsible
(07:37):
firms, people in finance will oftenfall into the use of an alphabet soup.
We like talking about E S G, right?
So firms concerned for the environment,for society and for governance.
Kate (07:53):
Yep.
That's right.
. E for environment, S for socialand G for governance, right?
This ESG matrix.
Another way to refer to it also, CSR, , soto say corporate social responsibility.
Veljko (08:06):
I mean the alphabet soups are endless.
There's CSR for corporatesocial responsibility.
There is SRI for sociallyresponsible investment.
Kate (08:13):
That's right.
Veljko (08:14):
ESG of course as we said, and I'm sure we could keep at it, but okay.
What we're talking about here ishow concerned are firms for the
external parties, for society,how concerned are they about their
impact on the environment, right?
Kate (08:29):
Correct.
Veljko (08:30):
On the other side, I think that we need to spend a
moment talking about performance.
Kate (08:35):
Right.
We want to see whether the sociallyresponsible firms have better performance
than socially irresponsible firms that aresimilar, like in the same industry, right?
Or, or what?
Veljko (08:46):
Yeah, but I think that in some ways today we're
going to be narrow, right?
When we're talking aboutperformance in this episode, we're
going to be talking do sociallyresponsible firms generate profits,?
Kate (08:58):
Right?
And because you could talk aboutperformance from so many different angles.
I mean, you can talk about are adoing good for their society, are
a doing good for the employees...
There's so many aspects,but today you're correct.
We're going to focuson one specific aspect.
If the firm is profitable, meaning dothey provide higher stock returns over
time if they're socially responsible
Veljko (09:20):
You said something interesting, I guess we would all somehow imply
or almost give for granted thata socially responsible firm leads
to better social outcomes, right?
Yet, it's far from granted thatthe firms that we rate as being
socially responsible actuallyachieve socially desirable outcomes.
we are Going to be looking at firmprofitability in a narrow sense.
(09:43):
Do they generate returns forinvestors and shareholders, right?
At the end of the day,
correct, correct,
and leave out the social question.
Kate (09:51):
So we will be talking about profitability from a point of view
of corporate profitability, corporateearnings, and also a measure of
stock returns, which is related.
So for earnings, when we're talkingabout earnings, it's literally how
many dollars a company makes from theirsales minus expenses, the earnings
(10:11):
on net income related measures thatlisteners could have heard things like
EPS earnings per share or ROA returnon assets or ROE return on equity.
All of those performance measuresare related to profitability are
driven by corporate earnings.
So we will be talking aboutprofitability from a point of view
of corporate profitability, corporateearnings, and also a measure of
(10:36):
stock returns, which is related.
Veljko (10:39):
Then there was another point that we probably need to
make, which is the necessity totalk about risk adjusted returns.
Kate (10:47):
So the basic concept there is the higher risk something is, the higher
returns that something should provide.
So if your investment is riskier,it should provide you with a higher
return to compensate you for that risk.
The lower the risk, the lower the return.
So let's talk about, if we thinkabout ESG firms, firms that have
(11:07):
high environmental, social, andgovernance standards versus low.
Which ones are riskier?
Veljko (11:13):
How we generally interpret low levels of social responsibility in
finance is as a risk factor in many ways.
If you're looking at the environmentalliterature, that's when these things
become the most obvious, firms thatdon't behave well in an environmental
sense, tend to get sued, think about, oilspills in the gulf and things like that.
(11:35):
So in some sense, I guess if weare comparing the performance of
socially responsible and sociallyirresponsible firms, the danger
here is that the socially notresponsible firms are riskier.
They produce higher return, which iscompensation for risk and perhaps not
(11:56):
even sufficient compensation for risk.
That does not mean that they'recreating higher value in a
risk-adjusted sense.
Kate (12:02):
Right.
So we are comparing like apples andoranges when you're looking at something
that's safer and something that's riskier.
So you need to make allof them plumps, right?
So you need to look at the riskadjusted returns basically.
Veljko (12:13):
Correct.
So, you know, hopefully all thestudies that we are going to be
mentioning today are going to tryto adjust for risk, but right.
We know that research is notalways perfect and we'll try
to comment on some of that.
Kate (12:26):
Yeah.
So again, in terms of how we measuringperformance here, we will be looking at
corporate performance and specificallyearnings and some stock return,
especially risk adjusted measures.
Veljko (12:37):
Awesome.
Kate (12:38):
Right.
I think it's going to be too cloudyif we don't quickly explain before
we get to the end of the episodeto our listeners what we mean.
Like a quick example here, like youcan think of what we call brown firms.
It's like oil firms thatbasically drill for oil.
They're polluting theenvironment in a way, right?
But they actually produce thelargest amount of green patents.
(12:59):
You can see that many of the oil firmsare going to be ranked as, very green
and they will rank very high on ESG.
So here we have a firm thatranks very high on ESG, but It's
really that good for society.
That's the questions that like, weare highlighting here, but actually,
just wanted to clarify a bit.
Veljko (13:16):
Yeah, but I think this is why nobody trusts us
researchers anymore, right?
Because we have oil companiesrating high on the dimension.
Kate (13:24):
In their defense, I mean, we need to drill for oil.
And if some of them make some greenpatents that make these technologies
less polluting, that's a big plus.
Veljko (13:33):
Okay.
We'll get to the E in a second.
But I think that in some sense,
Kate (13:38):
You want to start backwards.
You want us to go ESG.
You want to start with G.
So you want to start with the last letter.
Veljko (13:45):
I, yes, I do.
Perhaps because I thinkit's the easiest one.
I mean, let's get itout of the way, right?
What we want to do now is takea little bit of a deep dive into
some of the empirical evidence.
And the good news is that researchin finance has actually documented
how the G impacts performance.
Kate (14:05):
G we're talking about governance here.
And, what is governance?
Governance is a set of mechanisms thatallows the firm owners who are, everyday
investors, you guys who are listeningto this podcast, to have an interest
alignment with firm management, like theCEO of the firms, the executives of the
firm, so that they're all looking forwardtowards making the firm profitable.
(14:28):
So these governance systemshelp align these interests.
Veljko (14:32):
And not to nitpick, but hopefully we are aligning the managers
with the interest of investors, right?
And all the other way around.
Kate (14:38):
Correct.
Of course, of course.
Veljko (14:39):
Yeah, I knew what you meant, but you just made for an easy target.
No, so jokes aside.
Governance, institutions and rulesand regulations that align the
interests of managers and investors.
You're absolutely right.
Now, I have often felt a little bitawkward here, in including governance
(14:59):
within the ESG domain or the debateon socially responsible firms.
I know you feel slightly differentlyabout this, Kate, but my view has always
been a well governed firm can chooseto do socially responsible things,
or a well governed firm can chooseto do socially irresponsible things.
(15:21):
I'm not sure that the G reallyaligns with my understanding of
corporate social responsibility.
Kate (15:28):
Yeah, so just to translate it, I think, let me see if I'm
understanding what you're saying.
What you're saying is that firmsthat have very efficient governance
mechanisms, these firms that areefficient in terms of how they run,
in terms of alignment of interestbetween shareholders and managers,
could actually still produce productsthat are bad for society in a way.
(15:48):
Or produce products that aregood for society, they can do
it very efficiently either way.
Veljko (15:53):
Yeah, I mean, you can be very efficient at being an evil bastard, right?
I mean.
Kate (15:57):
Well, you know, that's where my, my not objection, but
I have a different point of view.
I feel like if the firm is well governed,those will be good firms overall.
And that's where the connectionbetween the governance and S stands
from just like overall goodness.
But again, yeah, we will get tothat later, but I agree with you.
You know, I think that governance isthe cleanest out of the dimensions
(16:18):
of ESG, and I'm not sure how it wasactually tagged on to ESG because
there's not much there directly relatedto social responsibility in there.
I mean, we're talking about independentdirectors, CEO chairman roles, salary...
Veljko (16:33):
let's give our listeners a couple of examples of what we
mean with good governance, right?
You mentioned havingindependent directors,
having directors on the boardthat are truly monitoring CEOs
and keeping management honest.
Kate (16:49):
Yeah.
Yeah.
Not like your uncle, you know,who's sitting there and you as a
mafia boss or something like that.
Veljko (16:55):
Is this because I'm Italian?
Kate (16:57):
Oh, no, no.
Just an example that came to mind.
Veljko (17:00):
So this is an impersonal you.
So, we are talking about governanceand you said, why is it included?
I have a cynical view, right?
I think that when portfolio managershad to justify the use of these ESG
criteria and investment, they wanted tojustify it on the basis of performance.
(17:24):
ESG portfolios perform well and of course
Kate (17:29):
That's the stories they wanted to sell.
That's the stories, that's thestories they wanted to sell basically.
Veljko (17:33):
Absolutely, but...
Kate (17:33):
Because they wanted to get money from investors.
That sounds like a good story.
Veljko (17:37):
But to me it feels like the G was tackled in there not
because it philosophically belongs,but because it actually does seem
to generate positive returns.
Kate (17:46):
So, so you're suggesting that there is solid empirical evidence that good
governance is related to positive returns.
Let's name a couple ofpapers, like some key ones.
Veljko (17:54):
I'm going to stick to the big one, right?
And I'm going to talk about Gompers,Paul Gompers, Joy Ishii, and Andrew
Metrick and their paper published in theQuarterly Journal of Economics in 2003.
And for people that do work in thisindustry, they created something
known as the Governance Index...
Kate (18:15):
or the GIM index.
Veljko (18:18):
So this G index, they take 24 variables, measuring
different, things about thegovernance of the firm effectively.
What they're trying to measure is howstrong is the power of the manager, right?
So they identify firms thatthey call dictatorial, where
management is really strong.
(18:39):
And on the other extreme, theyhave more democratic firms where
presumably manager operates inthe best interest of shareholders.
Kate (18:47):
Right, right.
Veljko (18:48):
And here is the big clincher.
There are going to create portfoliosof democratic firms, they would
govern firms and what they callautarkic firms or detectorial firms,
the poorly governed, they're goingto look at the difference in returns
and they're going to show us that...
I guess this was the mideighties, there was a nine percent
Kate (19:09):
Punchline is coming.
So yeah,
Veljko (19:10):
The punchline is a big number.
The abnormal return on thewell governed portfolio is
nine percentage points a year.
Kate (19:18):
Wow.
So if, I, my portfolio consists mostlyof firms with better governance,
I'm going to make nine percentagepoints more year versus a punchline.
Portfolio of similar firms, butthat are not as well governed.
Veljko (19:31):
I just want to contextualize that 9%, right?
Equity returns at the time wereabout 9 percent a year, right?
So what this means is that you'redoubling the return on your equity
portfolio if you're restrictingit to well governed firms.
Now.
Kate (19:51):
Impressive.
You definitely want to have yourmoney in well governed firms.
Veljko (19:56):
Well, but I mean, it's not really surprising, I mean,
well run firms perform well.
I mean, now to recognize what Gompers,Ishi, and Metrick deserve, they
found a way to measure it, right?
And they found a way to rate, rank firms.
Kudos to them for their work.
Now, as we said, their workactually is built on a lot of prior
research that shows that theseindividual things matter, right?
(20:20):
And there was a lot of research comingafterwards and I'm not gonna, we should
not probably pretend that all of thisis totally uncontroversial, right?
I believe that it's fairly uncontroversialthat well governed firms perform better.
How exactly you measure them?
How exactly do you identify them?
Kate (20:35):
There's so many quarks in there.
That's right.
But I think we've said enough for now
Veljko (20:38):
That's correct.
Kate (20:39):
Yeah, that's definitely a very strong result.
G is positively related with returns.
We've covered G of ESG,one of the dimensions.
And there exists a clear relationship.
There are firms that have higher G's thatare better governed, have higher returns.
But we're not quite so sure that Gbelongs into this group of socially
(21:01):
responsible actions of firms, someone of the views is marketing.
So let's move on.
Let's move on to our next factors.
Let's talk about this Efactor and then the S factor.
So what do you have tosay about this E factor?
Is there a relationship betweenfirms that are E environmentally
stronger and their returns?
(21:23):
Firms that have betterenvironmental policies?
Do they over time provide betterreturns to their shareholders?
Veljko (21:29):
Kate, we were talking about definitions, and the E,
the E stands for environment.
Kate (21:38):
Environment, right.
I mean, look, so what we mean there byE, there's, there's multiple things,
but we're obviously going to betalking about e emissions and emissions
Veljko (21:49):
broad metrics of impact on the environment, right?
Kate (21:51):
That's correct.
Yes.
Veljko (21:52):
I read an article in the Economist recently that was arguing that we should
just look at emissions only for the E.
Their point was that it's the mostobjectively measurable dimension.
Kate (22:06):
These emissions, there's a lot of, super cool data sets.
One is known as true cost, so thistrue cost data set provides emissions
and splits them into scope one,scope two, and scope three emissions,
Depending on the severity of thepollutants that the company emits.
Veljko (22:24):
That that does sound pretty intriguing.
It's the most objectivelymeasurable dimension.
But clearly it's an incomplete one, right?
Water pollution.
there's all sorts of other, thingsthat, that there's, how much
trash you're producing, right?
There are all these other effects,but, but okay, to just wrap our head
(22:46):
around the E measures how the firmcontributes positively or negatively
to the natural environment around it.
Kate (22:54):
Correct, correct.
We're going to be talking aboutclimate change related issues
here, brown and green firms.
So all of this kind of sits underthe e umbrella And those were
just some examples of what getscounted under this e dimension.
Veljko (23:07):
Absolutely.
Awesome.
And here, Kate, I did a deep diveinto the literature on the E.
And the problem is it feels likedrinking from a fire hydrant, right?
There's just so much, it's the hot topicof the day everybody's writing about.
So, let me start with what I thinkis a great literature review paper.
(23:31):
This is work by Gunnar Friede,Timo Busch and Alexander Bassen.
This was published in 2015 in the Journalof Sustainable Finance and Investment.
And, I wish they could see you.
So Kate is a journal's knob.
Let me explain this.
We, we, we clearly have better orlet's say more selective journals
(23:55):
in our profession and some which areperhaps not, not quite as selective.
And, this journal, it certainlydoesn't rank towards the top,
and, Kate and I perhaps differ.
At times in how much weight to give to it.
Kate (24:12):
I am interested in listening to the findings.
Any literature is going to be interestingbecause they review the literature.
, it's not that I'm a journal snob.
It's probably shows my ignorance becauseI'm not too familiar with the journals
outside of the top six, I would say,in finance, accounting and economics.
So
Veljko (24:29):
That, that, that, that's the definition of a
journalist now, but, okay...
So, let me blow your mind hereon what these, researchers did.
So Friede, Bush, Bassan, theyactually came up with this.
Review 2, 200 individual studiespublished over the span of 40 years.
Kate (24:48):
2, 200 studies.
These are papers on ESG?
Veljko (24:53):
Correct.
All of them not only paperson ESG, but papers specifically
on ESG and firm performance.
Actually, some of them are aboutfirm performance, some about ESG and
the performance of investment funds.
So they look both at the corporateside and the investment side
of the debate, if you will.
But okay.
Let me give you one figure herethat I think really summarizes.
(25:17):
A lot of it out of the studies that lookspecifically at corporate performance, 59
percent document a positive associationbetween environmental performance
of firms, environmental ratings offirms and their either stock price
performance in some of the studiesor operating performance metrics.
(25:40):
So
Kate (25:41):
59 sounds pretty good.
So then the question is whatwas happening to the other,
like 40 percent there, right?
Veljko (25:47):
Okay.
So 59 percent are findinga positive association.
4 percent of studies actually findthe opposite, they're actually
finding a negative association.
Kate (25:57):
Interesting, interesting.
Veljko (25:59):
Yeah, so roughly speaking, you have this almost 60 percent of studies
finding positive, 4 percent findingnegative, and then the remainder, 35
percent or so, finding no association...
what does one draw from this?
If you go back to our originalquestion, do woke firms under-perform
do socially responsible firms?
Kate (26:19):
And if we consider E as a definition of woke here, being environmentally
safe, environmentally positive.
Well, I mean, as woke in that perspective
Veljko (26:29):
On the G dimension, we already ruled out under performance,
Kate (26:32):
right?
Veljko (26:33):
It's quite the opposite.
Well governed firms outperform.
Now we're on the E and the evidence forunderperformance comes from 4 percent
of studies, 60 percent finds positive.
I think that if you'reasking me, do environmentally
conscious firms underperform?
(26:53):
Then the answer is resounding
Kate (26:55):
No.
No, yeah.
Veljko (26:57):
If you were asking the opposite side of the question, do environmentally
conscious firms outperform?
I think I would be alittle bit more cautious.
60 percent of studies find thatyes, they do, but then 30 percent
of studies find they don't.
Right?
But there is another point we probablyshould raise in this conversation.
(27:19):
Correlation is not causation.
Kate (27:21):
Right.
Right.
Veljko (27:23):
And in general, that's been a problem in this stream of the literature.
Kate (27:27):
Yeah, so when a firm, you're saying it gets wealthy and profitable, that's
when it's going to start caring aboutthe environmental factors and all start
improving its performance and so on.
For example, I know that theUniversity of Missouri had one of the
cleanest, power plants here, and theyworked hard to achieve that status.
After which Berkeley tookthe first spot as having the
(27:49):
cleanest on campus power plant.
But neither of the universities couldhave been thinking about having the
cleanest power plant if they weren'tmaking enough money from tuition
and if they weren't profitable.
Veljko (28:02):
Oh, no, that's a really interesting point.
I'm actually discussing a paperat a conference next week and
one of the authors is Houston,
Kate (28:12):
Houston, Texas.
Veljko (28:15):
No, Houston being the last name of one of the authors.
And the funny thing is I,
Kate (28:20):
Joel Houston.
Veljko (28:21):
Oh, okay.
See, I totally unprepared.
Yes.
But that's absolutely correct.
The title of the paper,which I'm also unprepared.
130 years of corporate socialresponsibility, I believe
is the title of the paper.
Kate (28:34):
Wow, nice.
Yeah,
Veljko (28:35):
Actually.
I was just reading this afternoonand not preparing for this podcast,
but preparing for the conference andthey do something that's really cool.
They actually use language processing,and they scan news articles
back hundreds or so years, right?
And again, I'm fuzzyon the details, right?
(28:57):
I just read this first draft.
But so they go back 100 plus years andthey scan news articles and they actually
find when concern for the environmentis the highest in the population.
And then they link it to macroeconomicfactors, wars, events out there.
(29:18):
And the big finding is thatwhen the economy is doing really
well, there's a very high levelof concern for the environment.
When the economy does poorly, nobody cares
. Kate: Right, right.
So this is, this is interestingbecause this is going back really
historically back 130 years.
Because if I'd say, if I were todate this ESG interest rate, For the
public, I'd go back probably to likesometime around 2010, 2012, when,
(29:45):
people started talking about sociallyresponsible from, and even more I
would say, maybe 2017 and 18, wheneverwe've seen more votes in shareholder
meetings that are favoring corporatedisclosure on environmental factors.
So I would say that thisinterest in ESG is growing.
For investors, it's only been the lastdecade or so, but interesting that they
(30:06):
find that if you go back over the last130 years, this interest exists, but
it exists when we are in good times.
All right, so we are back from our break and we are now in our office.
(30:29):
For full disclosure, we werepreviously on Kate's boat.
And
Kate (30:33):
it might have been a bit windy.
So if you hear some wind noises, that'swhat's coming from the first part.
Veljko (30:38):
We'll see if we can clean it up in our post processing.
I have a creaky chair here.
So.
We'll see.
We'll see whether the chairis better than the wind.
Okay.
So we were talking
Kate (30:52):
No comment.
No comment.
Veljko (30:53):
Well, we, we do have our notes in front of us.
So let's recognize the authors here of130 years of corporate responsibility.
Kate (31:03):
Joel Houston,
Veljko (31:03):
Sihon Kim and Boyan Lee.
They certainly deserverecognition for this great paper.
So back to us, we were talkingabout E and performance, right?
Do firms that rate highon environmental performance
actually produce abnormal profits.
As I said earlier, it's almost likedrinking from a fire hydrant, but
(31:24):
I'll mention a couple of papers.
We have a paper from the Financial AnalystJournal published in 2004 portfolios
of firms with a high E they find 6percent per year of normal performance.
Another paper, Journal of Bankingand Finance, a couple of years
later, it was published in 2014.
It's a paper by Pak Chan andTerry Walter, and they actually
(31:49):
find something very similar.
They make portfolios of firmsthat rate high on environmental
performance, and they get an abnormalreturn of around 7 percent per year.
So, quite quite strong results.
They actually dig a little bitinto the corporate side as well.
They find that firms that rate highactually have an easier time getting
(32:12):
loans, an easier time raising capital and,and other positive spillovers as well.
Kate (32:17):
I'm going to add to that.
There's a paper by Bolton and Kacperczyk.
That's a 2021 Journalof Financial Economics.
That's Patrick Boltonand Marcin Kacperczyk.
And what they show is a link betweencarbon emissions and firm returns.
So firms that have higher total carbondioxide emissions, so, you know,
(32:37):
produce more polluting substances likecarbon dioxide, earn higher returns.
So they're compensating theirshareholders for this additional risk.
Veljko (32:47):
Oh, yes, Kate.
That's a great paper.
And of course, publishedin a great journal.
And yet I do think that thereis a certain risk here of
confusing our listeners a bit.
Because there is a distinction betweenexpected returns and realized returns.
And there are some inter temporaldynamics here, here at play as well.
(33:09):
In other words, if your firm becomesriskier, your cost of capital goes up.
That means higher returnsto your current investors.
And yet that tends to havenegative consequences on firm
profitability going forward.
Your marginal net present value projectbecomes negative and effectively you,
(33:35):
you, you, you grow more slowly, right?
It tends to have a negativeeffect on your growth rates and
your profitability going forward.
Nevertheless, it's an interesting,nuanced, finding here.
Kate (33:48):
Probably the popular paper in like emissions right now.
Right.
I would say in our literature.
Veljko (33:53):
Fair enough.
I have another paper herethat I did want to mention.
A Journal of Corporate Finance byDale Griffin and our dear friend,
Omrane Guedhami, Kai Lee, and, GuangliLu I love this paper because they
don't just look at the United Statesand they don't just look at Western
Europe, but they actually look at 43countries over the period 2003 to 2015.
(34:17):
They have almost 5,000 firmsin their overall sample.
And again, they find a pretty stronglink to performance a pretty strong link
between environmental performance offirms and all sorts of corporate outcomes.
This is not just stock priceperformance, but they find these
firms have higher levels of cashflows, but actually lower cash flow
(34:39):
volatility and a lower cost of capital.
Kate (34:41):
Nice.
Veljko (34:42):
And, yes, yes.
It, it gives,
Kate (34:44):
A lower cost of capital.
Veljko (34:47):
Yes.
I suspect this comes fromthe loan side, right?
I mean, they get cheaper loans, because,in the banking literature, I had a
paper on banking trust, there areall these spillover effects, right?
Kate (35:01):
This is consistent with the paper by Bolton and Kacperczyk.
Because as the firms with lower emissions,provide lower returns, which would be
consistent with the lower cost of capital.
And you're right, like that's impressivethat the paper you are mentioning
by, Omrane, Omrane and Kai Li andco authors, they are looking across
(35:21):
multiple countries because the paper byBolton and Kacperczyk looks at the U.
S.
specifically.
So they look, you know, over a longperiod of time, 2005 through 2017.
Veljko (35:33):
Yeah.
And this is something interesting.
I don't know how much time we want tospend dwelling on this but, when it comes
to some of these relationship betweencorporate social responsibility and,
and firm performance and firm value,the strongest findings are usually
not coming from the United States.
Maybe we should actually spend just onemoment mentioning brown firms versus
(35:57):
brown industries, because there is adanger here of identifying specific
industries or whole industries as beingon the wrong side of this debate, and I
think it's a fallacy that perhaps even wefall guilty of when chatting about this.
Kate (36:20):
What we mean by brown industries, so non environmentally friendly
industries are industries that that aremore likely to pollute like industries
that deal with, with oil, refiningand exploration and production firms.
Patrick Bolton and Marcin Kacperczykmentioned that, specific to a few
salient industries in which we seethe biggest emissions and the biggest
(36:46):
pollutants, certain firms in those brownindustries get some additional screening
by their institutional investors.
Meaning that institutional investors orthe owners of these firms in the brown
industries know which firms are thebrownest and which firms are the greenest?
(37:08):
Because, within an industry, evenif it's a oil polluting industry, if
it's an exploration and productionindustry, there could be green firms
that actually file a lot of greenpatents and try to make the exploration
activities as clean as possible.
And there's other firmsthat don't do the same.
And it seems like, the authors pointout that institutional investors
(37:29):
provide extra monitoring to thesebrown firms in brown industries.
Those that do not try to be good on E.
Veljko (37:38):
I guess what I'm taking away from this point is that ultimately
we should always be looking at theseratings within an industry and not
necessarily across industries, right?
Because of course, if you're amanufacturing firm, I mean, let's not go
to the extremes of, of oil firms, right?
But even if you're a manufacturingfirm of any kind, of course, you're
(37:59):
gonna produce more emissions thanif you're a tech firm, right?
Or, and well, maybe that'snot even true today, right?
Kate (38:06):
Well, no, no, no, it's still true.
It's still true.
Yeah.
Veljko (38:10):
But the point is some industries, are going to be more or
less socially responsible, right?
But by the nature, but we're
Kate (38:17):
talking about environmental, environmental responsibility right now.
But yeah, it's true.
Some industries will be moreenvironmentally conscious and others
would be less environmentally conscious.
And some firms within those industrieswill also differ in how they think
about environmental responsibility.
So this was in the Wall Street Journal.
It's an article about Ziploc.
(38:38):
So, uh, basically
Veljko (38:40):
Ziploc like the bags,
Kate (38:42):
Ziploc like, like the bags.
Veljko (38:44):
Okay.
You're surprising me here, Kate.
I don't know where you're going with this.
Kate (38:48):
So single use plastics, right?
So if you think about the environmentalimpact of single use plastics, it's
very damaging to the environment.
Single use plastic Ziplocare not commonly recycled.
40 percent of the world's millionsof tons of plastics produced in
packaging ends up being this singleuse plastic and over 85 percent of
(39:11):
that plastics ends up in the land.
But interestingly, Fisk Johnson, whois leading the company, he's a fifth
generation CEO in this family around.
S.
C.
Johnson company, which makesZiploc bags, Miss Mayers, Clean
Day soaps and Windex cleaners.
He's actually a huge supporterof the clean environment.
(39:32):
He's an interesting person overall.
He has five degrees and includinglike a PhD in physics, and he is
very concerned about the environment.
And kind of an oxymoron.
You have this very Brown industryproducing single use plastic,
and you have a CEO who caresdeeply about the environment.
(39:52):
And so this is an example of a greenCEO or CEO with green values and
trying to have his firm performinggreen matters in the Brown industry.
Veljko (40:03):
So, but do they perform well?
Kate (40:07):
I have not looked at the stock chart of SC Johnson to see how it
compares like with the S and P 500.
So I don't know if they perform well,but one thing that he says in his defense
of like, why is he producing such aterrible product for the environment?
He said, all right, you could say.
(40:27):
Well, single use plastics is terriblebusiness and we could just get out of
it, but somebody else who's less wellintended is going to just take that up.
It's a free market.
My argument is that it's betteroff in our hands because we are
trying hard to make changes.
So what I can say is that he is using5 percent of his pre tax profits in his
(40:47):
company to fund a team that directlyreports to him that's focusing on
addressing global health problems.
And reducing of the issues associatedwith plastics and plastics recycling.
Veljko (41:03):
Okay.
Yeah, that's super interesting.
I guess the big point here, we canhave green firms in brown industries.
Kate (41:08):
Aiming to, to be green, right?
They still produce a lot of plastic.
So I guess there's a spectrum.
You are right the industry is reallyimportant, but I just want to point
out that within each industry,there's some firms that are green,
even if an industry is brown.
Veljko (41:24):
Fair enough.
I was more interested in the moreexplicit link to performance.
I think you had a paper by Pastorand Stambaugh, if I'm not mistaken.
Kate (41:31):
Pastor.
So it's Lubos Pastor, RobertStambaugh and Lucian Taylor.
Veljko (41:36):
Alright.
Kate (41:36):
It's a paper published in 2022.
They dissect the green return.
They show what they call the greenium.
The greenium.
Veljko (41:44):
Oh, I love that.
Kate (41:45):
The greenium.
Veljko (41:46):
So, so, so what's the greenium?
Kate (41:48):
The greenium is the return of,
Veljko (41:51):
it's the green premium.
Is that what the greenium
is
Kate (41:53):
green premium, yes.
Veljko (41:54):
Oh, wow.
Okay.
Kate (41:55):
Yeah, basically it's the return of green stocks over brown stocks.
And they show that from 2012 tillnow, and they started in 2012 because
that's when the data becomes available.
So that's in the period when people havereally been caring about climate and this
climate concern has been at a much higherlevel than in prior historical periods.
(42:18):
They create these portfolios ofgreen firms and brown firms.
And basically they show that the portfolioof green firms outperforms that of
brown firms by 174 percentage points.
So over 2012 through, throughthe recent time period.
They also bring an interesting exampleof German green bonds that have
outperformed their higher yielding nongreen twins as this greenium widened.
(42:43):
So there's several examples they'reshowing that green assets deliver
higher returns in the recent years.
So they're very specific about thisrecent year phenomenon because we've
had a higher concern for climate.
Veljko (42:56):
All right.
Okay.
But.
I still think you were going totell me something about green
firms versus green industries.
Kate (43:02):
And in this paper, their main idea is looking at green firms, versus
brown firms and this 174 percentreturn difference sounds striking.
Veljko (43:13):
Yeah, that's huge, right?
Kate (43:14):
Yes, that's right.
That's right.
Cumulative return difference.
But industries really play a large role.
So whether you are a green or brownindustry does explain a large proportion
of this 174 percent difference.
Veljko (43:31):
So 174 is not industry adjusted.
So once they adjust for theindustry, is there still,
Kate (43:37):
There's still a difference.
Whatever the characteristics of thatindustry, let's say it's brown, you
still do better if you are a greenera firm in that industry, as they
have information on that as well.
But the main point is that, industriesexplain a larger, three times more
of that 174 percent difference.
Veljko (43:56):
Oh, that's interesting.
The greenest firms within an industrystill outperformed the brownest firms
within an industry, but across industryeffects are much stronger than within.
Kate (44:07):
Right.
So you might want to participatein like green industries.
Veljko (44:11):
Makes sense.
Makes sense.
And I guess that matches what my intuitionwould have been about this, but those
are some really interesting results.
Kate (44:18):
Again, I have to point out they are, very specific that this is from
2012 through now, when our climateconcerns have been the highest.
Veljko (44:27):
Gotcha.
Gotcha.
Kate (44:29):
Let's see if we can see if we can summarize.
Are we ready to summarize E?
Veljko (44:33):
Oh, yes.
Yes.
Kate (44:35):
So what are the main takeaways here?
Veljko (44:37):
The main takeaway is that to go back to our original question,
do socially responsible firms doenvironmentally conscious firms
in this sub chapter, underperform,again, the answer is a very, very
resounding no, they do not underperform.
(44:58):
Now, when it comes to evidence ofoutperformance, as always, it's
a little bit more controversial.
And the correlation is clearly positive.
I mean, there's study after studyafter study here showing that firms that
rate high on the E dimension actuallyhave high stock price performance.
(45:19):
But as always, correlationis not causation.
Let's be clear the channel that'susually identified here in the
literature it's a legal channel, right?
Kate (45:30):
Seems like not only legal It seems like the Bolton and Kacperczyk paper also
points to the cost of financing channel.
It's more expensive for these dirtyfirms to borrow money as well.
So there's several channels.
Veljko (45:44):
Okay, fair enough.
Kate (45:45):
Makes sense.
Okay.
That sounds good for E.
Veljko (45:48):
Awesome.
Well, Kate, they say thatprofessors are in love with
the sound of their own voices.
And perhaps you and I arenot exceptions to that rule.
This episode is getting a little bitlonger than we were originally planning.
So why don't we wrap it up here andthen split it into a two-part episode.
(46:13):
So let's conclude this and then wecan invite our listeners to listen
to part two for the discussionon the S of ESG, the social part.
Kate (46:26):
Well, I guess what we need to say now is thank you, our listeners.
If you've enjoyed this podcast,please like us, follow us on your
favorite podcast platform, and wewould love to hear some feedback.
Veljko (46:41):
Indeed, and stay tuned for future episodes of Questions in Finance.
Cheers
Kate, what do you think about my new Allbirds?
Kate (00:03):
Oh yeah, your new Allbirds among all the other new shoes, in
this season's collection, so to say.
I like the Allbirds.
They look nice.
And I have a pair of myself,let's say maybe even a couple
because they're so comfy.
But did you buy them because , they'rea very clean company, they use
wool, they don't kill sheep.
(00:24):
And so they have these social valuesthat they put them front and center.
Did you buy your Allbirdsbecause of their social values?
Veljko (00:33):
I actually don't think I did.
I bought them because as you say, they'resome of the comfiest shoes around.
I think that the sociallyresponsible side helped.
You feel a little bit better about thepurchase because you bought something.
That's good for the environment,but ultimately I don't think
(00:54):
it drove my buying decision.
And maybe not everybodyknows what Allbirds are.
They're a shoe company.
They're from New Zealand.
And the big shtick is that theyuse wool, which supposedly is a
lot more sustainable than leather.
And I guess that's whatyou were referring to.
Funny thing is, my sister claims she willnever get caught in a pair of Allbirds.
Kate (01:14):
So those Italians, they only wear high heel shoes.
So, you know, gotta cut her some slack.
She just hasn't everowned a pair of Allbirds.
And if she does, you neverknow what she's gonna do.
Veljko (01:25):
You're right.
Actually, funny you should say, my motheralso swore never to wear them and after
she tried them, now she loves them.
Kate (01:32):
That's one thing that we seem to want to talk about buying this
product, buying the shoe, but let'slook at another question here.
Would you buy a stock in Allbirds?
You know, Allbirds became a publiclytraded company not that long ago.
Would you invest in them?
Veljko (01:49):
Well, so
I think I wouldn't, Kate.
Ouch!
Well, okay, so Allbirds hassome specific problems, to be
honest, as a company, right?
They have not, they went public recentlyand they actually, I think they've
(02:10):
been mismanaging their product line.
But I think that what you're hinting athere is more, would I invest in a company
because it is socially responsible, right?
Is this where we're going?
Kate (02:20):
That is correct.
That's correct.
Yes.
And Allbirds is just oneexample of such a company.
There's Patagonia and there's awhole set of firms that really bring
up their social values front andcenter for investors to consider.
So I guess the big question is, do thesecompanies that promote their social
values, are they profitable investments?
Veljko (02:41):
I think that's a question that we're going to explore today, right?
But we do have a lot of voicestelling us that woke firms go broke.
And so I guess we have two questionstoday, whether you want to word it in a
more politically correct way or manner.
It's either do woke firms go broke or dosocially responsible firms underperform?
(03:14):
Welcome to Questions in Finance,
Kate (03:16):
a podcast where we translate academic mumbo jumbo to answer
interesting questions in finance.
I'm Kate Holland.
Veljko (03:24):
And I'm Veljko Fotak.
Kate and I met when we were PhDstudents at the University of Oklahoma.
Kate (03:30):
Today we're university professors and we spend our days
teaching and researching companies,markets, and all things related.
So yeah, let's unpack this question.
Do woke firms go broke?
In other words, do sociallyresponsible firms underperform?
Veljko (03:49):
Well, let's, dissect this for a second.
Why do we talk aboutunderperformance specifically?
On one side, we are classicallytrained economists that grew up
in a post Milton Friedman world.
Friedman of course, being the Chicagobased economist that in the 1970s, or
well, in 1970, enshrined a new worldviewby stating that the social role of
(04:15):
corporations or the only concern of firmsshould be the maximization of shareholder
wealth, which became effectivelyour, our business school mantra.
Kate (04:24):
For sure.
Veljko (04:25):
We have been taught that firms maximize shareholder value
by focusing specifically anduniquely on shareholder value.
And mathematically, it is anargument that makes a lot of sense.
You achieved the most optimaloutcome, in terms of wealth,
with unconstrained optimization.
(04:46):
That is, if you start prioritizingor co-prioritizing other things,
society, the environment, and so forth,you will stay away from pure wealth
maximization and your wallet will suffer.
That's how we have been trained.
And yet, we, we do see novel, evidenceon the other side of this debate, , at
(05:07):
the micro level, at the firm level,that finds that there are a possible,
tangible rewards for sociallyresponsible behavior, that translate
into economic performance as well.
So for example, your customers mightbe more likely to buy your products
or pay slightly higher prices.
You might get into trouble a littlebit less often, with the environmental
(05:29):
protection agency or perhaps sued,a little bit less often, in workers'
compensation claims, if you're asocially responsible firm that doesn't
pollute or treats workers fairly.
And interestingly, some of the strongesteffects that we are actually going
to see in the academic literatureare coming from the financing side.
Kate (05:49):
Yep.
Correct.
Veljko (05:50):
Banks give socially responsible firms, cheaper loans.
It's like a halo effect.
There is this assumption thatbecause you're polluting a bit
less or treating your employees alittle bit more, fairly, you're less
likely to run away with my money.
And well, there is research thatactually seems to suggest that
there is some truth to that.
(06:11):
And finally, we do have right now apolitical backlash against socially
responsible investing, with voices,mostly from the right of the political
spectrum, telling us that "woke" firms"go broke" and justifying opposition
to socially responsible investing onthe basis of alleged under performance.
(06:33):
So this is a bit of context of today'squestion and where we are coming from.
Well, there's lots andlots to unpack here.
Probably a good way to start thisconversation is to figure out
a couple of definitions, right?
Kate (06:49):
For sure.
I have to say, I totallydislike this woke slang.
Just thought, it just makesmy skin bubble, so to say.
Veljko (06:58):
Okay.
I think that's a fair point.
"Woke".
It feels like it's beenhijacked a bit as a term, right?
I mean, it should havea positive connotation.
You're awake, you're aware, right?
You understand what's going on around you.
Kate (07:11):
Definitely doesn't have a positive connotation in today's world.
Veljko (07:14):
I think it has been hijacked by the critics of social activism, right?
In implying something negative about it.
The good news is that in finance, that'snot what we generally use, as a term.
We usually talk about sociallyresponsible firms and actually tend
to slice it a little bit more, whenwe talk about socially responsible
(07:37):
firms, people in finance will oftenfall into the use of an alphabet soup.
We like talking about E S G, right?
So firms concerned for the environment,for society and for governance.
Kate (07:53):
Yep.
That's right.
. E for environment, S for socialand G for governance, right?
This ESG matrix.
Another way to refer to it also, CSR, , soto say corporate social responsibility.
Veljko (08:06):
I mean the alphabet soups are endless.
There's CSR for corporatesocial responsibility.
There is SRI for sociallyresponsible investment.
Kate (08:13):
That's right.
Veljko (08:14):
ESG of course as we said, and I'm sure we could keep at it, but okay.
What we're talking about here ishow concerned are firms for the
external parties, for society,how concerned are they about their
impact on the environment, right?
Kate (08:29):
Correct.
Veljko (08:30):
On the other side, I think that we need to spend a
moment talking about performance.
Kate (08:35):
Right.
We want to see whether the sociallyresponsible firms have better performance
than socially irresponsible firms that aresimilar, like in the same industry, right?
Or, or what?
Veljko (08:46):
Yeah, but I think that in some ways today we're
going to be narrow, right?
When we're talking aboutperformance in this episode, we're
going to be talking do sociallyresponsible firms generate profits,?
Kate (08:58):
Right?
And because you could talk aboutperformance from so many different angles.
I mean, you can talk about are adoing good for their society, are
a doing good for the employees...
There's so many aspects,but today you're correct.
We're going to focuson one specific aspect.
If the firm is profitable, meaning dothey provide higher stock returns over
time if they're socially responsible
Veljko (09:20):
You said something interesting, I guess we would all somehow imply
or almost give for granted thata socially responsible firm leads
to better social outcomes, right?
Yet, it's far from granted thatthe firms that we rate as being
socially responsible actuallyachieve socially desirable outcomes.
we are Going to be looking at firmprofitability in a narrow sense.
(09:43):
Do they generate returns forinvestors and shareholders, right?
At the end of the day,
correct, correct,
and leave out the social question.
Kate (09:51):
So we will be talking about profitability from a point of view
of corporate profitability, corporateearnings, and also a measure of
stock returns, which is related.
So for earnings, when we're talkingabout earnings, it's literally how
many dollars a company makes from theirsales minus expenses, the earnings
(10:11):
on net income related measures thatlisteners could have heard things like
EPS earnings per share or ROA returnon assets or ROE return on equity.
All of those performance measuresare related to profitability are
driven by corporate earnings.
So we will be talking aboutprofitability from a point of view
of corporate profitability, corporateearnings, and also a measure of
(10:36):
stock returns, which is related.
Veljko (10:39):
Then there was another point that we probably need to
make, which is the necessity totalk about risk adjusted returns.
Kate (10:47):
So the basic concept there is the higher risk something is, the higher
returns that something should provide.
So if your investment is riskier,it should provide you with a higher
return to compensate you for that risk.
The lower the risk, the lower the return.
So let's talk about, if we thinkabout ESG firms, firms that have
(11:07):
high environmental, social, andgovernance standards versus low.
Which ones are riskier?
Veljko (11:13):
How we generally interpret low levels of social responsibility in
finance is as a risk factor in many ways.
If you're looking at the environmentalliterature, that's when these things
become the most obvious, firms thatdon't behave well in an environmental
sense, tend to get sued, think about, oilspills in the gulf and things like that.
(11:35):
So in some sense, I guess if weare comparing the performance of
socially responsible and sociallyirresponsible firms, the danger
here is that the socially notresponsible firms are riskier.
They produce higher return, which iscompensation for risk and perhaps not
(11:56):
even sufficient compensation for risk.
That does not mean that they'recreating higher value in a
risk-adjusted sense.
Kate (12:02):
Right.
So we are comparing like apples andoranges when you're looking at something
that's safer and something that's riskier.
So you need to make allof them plumps, right?
So you need to look at the riskadjusted returns basically.
Veljko (12:13):
Correct.
So, you know, hopefully all thestudies that we are going to be
mentioning today are going to tryto adjust for risk, but right.
We know that research is notalways perfect and we'll try
to comment on some of that.
Kate (12:26):
Yeah.
So again, in terms of how we measuringperformance here, we will be looking at
corporate performance and specificallyearnings and some stock return,
especially risk adjusted measures.
Veljko (12:37):
Awesome.
Kate (12:38):
Right.
I think it's going to be too cloudyif we don't quickly explain before
we get to the end of the episodeto our listeners what we mean.
Like a quick example here, like youcan think of what we call brown firms.
It's like oil firms thatbasically drill for oil.
They're polluting theenvironment in a way, right?
But they actually produce thelargest amount of green patents.
(12:59):
You can see that many of the oil firmsare going to be ranked as, very green
and they will rank very high on ESG.
So here we have a firm thatranks very high on ESG, but It's
really that good for society.
That's the questions that like, weare highlighting here, but actually,
just wanted to clarify a bit.
Veljko (13:16):
Yeah, but I think this is why nobody trusts us
researchers anymore, right?
Because we have oil companiesrating high on the dimension.
Kate (13:24):
In their defense, I mean, we need to drill for oil.
And if some of them make some greenpatents that make these technologies
less polluting, that's a big plus.
Veljko (13:33):
Okay.
We'll get to the E in a second.
But I think that in some sense,
Kate (13:38):
You want to start backwards.
You want us to go ESG.
You want to start with G.
So you want to start with the last letter.
Veljko (13:45):
I, yes, I do.
Perhaps because I thinkit's the easiest one.
I mean, let's get itout of the way, right?
What we want to do now is takea little bit of a deep dive into
some of the empirical evidence.
And the good news is that researchin finance has actually documented
how the G impacts performance.
Kate (14:05):
G we're talking about governance here.
And, what is governance?
Governance is a set of mechanisms thatallows the firm owners who are, everyday
investors, you guys who are listeningto this podcast, to have an interest
alignment with firm management, like theCEO of the firms, the executives of the
firm, so that they're all looking forwardtowards making the firm profitable.
(14:28):
So these governance systemshelp align these interests.
Veljko (14:32):
And not to nitpick, but hopefully we are aligning the managers
with the interest of investors, right?
And all the other way around.
Kate (14:38):
Correct.
Of course, of course.
Veljko (14:39):
Yeah, I knew what you meant, but you just made for an easy target.
No, so jokes aside.
Governance, institutions and rulesand regulations that align the
interests of managers and investors.
You're absolutely right.
Now, I have often felt a little bitawkward here, in including governance
(14:59):
within the ESG domain or the debateon socially responsible firms.
I know you feel slightly differentlyabout this, Kate, but my view has always
been a well governed firm can chooseto do socially responsible things,
or a well governed firm can chooseto do socially irresponsible things.
(15:21):
I'm not sure that the G reallyaligns with my understanding of
corporate social responsibility.
Kate (15:28):
Yeah, so just to translate it, I think, let me see if I'm
understanding what you're saying.
What you're saying is that firmsthat have very efficient governance
mechanisms, these firms that areefficient in terms of how they run,
in terms of alignment of interestbetween shareholders and managers,
could actually still produce productsthat are bad for society in a way.
(15:48):
Or produce products that aregood for society, they can do
it very efficiently either way.
Veljko (15:53):
Yeah, I mean, you can be very efficient at being an evil bastard, right?
I mean.
Kate (15:57):
Well, you know, that's where my, my not objection, but
I have a different point of view.
I feel like if the firm is well governed,those will be good firms overall.
And that's where the connectionbetween the governance and S stands
from just like overall goodness.
But again, yeah, we will get tothat later, but I agree with you.
You know, I think that governance isthe cleanest out of the dimensions
(16:18):
of ESG, and I'm not sure how it wasactually tagged on to ESG because
there's not much there directly relatedto social responsibility in there.
I mean, we're talking about independentdirectors, CEO chairman roles, salary...
Veljko (16:33):
let's give our listeners a couple of examples of what we
mean with good governance, right?
You mentioned havingindependent directors,
having directors on the boardthat are truly monitoring CEOs
and keeping management honest.
Kate (16:49):
Yeah.
Yeah.
Not like your uncle, you know,who's sitting there and you as a
mafia boss or something like that.
Veljko (16:55):
Is this because I'm Italian?
Kate (16:57):
Oh, no, no.
Just an example that came to mind.
Veljko (17:00):
So this is an impersonal you.
So, we are talking about governanceand you said, why is it included?
I have a cynical view, right?
I think that when portfolio managershad to justify the use of these ESG
criteria and investment, they wanted tojustify it on the basis of performance.
(17:24):
ESG portfolios perform well and of course
Kate (17:29):
That's the stories they wanted to sell.
That's the stories, that's thestories they wanted to sell basically.
Veljko (17:33):
Absolutely, but...
Kate (17:33):
Because they wanted to get money from investors.
That sounds like a good story.
Veljko (17:37):
But to me it feels like the G was tackled in there not
because it philosophically belongs,but because it actually does seem
to generate positive returns.
Kate (17:46):
So, so you're suggesting that there is solid empirical evidence that good
governance is related to positive returns.
Let's name a couple ofpapers, like some key ones.
Veljko (17:54):
I'm going to stick to the big one, right?
And I'm going to talk about Gompers,Paul Gompers, Joy Ishii, and Andrew
Metrick and their paper published in theQuarterly Journal of Economics in 2003.
And for people that do work in thisindustry, they created something
known as the Governance Index...
Kate (18:15):
or the GIM index.
Veljko (18:18):
So this G index, they take 24 variables, measuring
different, things about thegovernance of the firm effectively.
What they're trying to measure is howstrong is the power of the manager, right?
So they identify firms thatthey call dictatorial, where
management is really strong.
(18:39):
And on the other extreme, theyhave more democratic firms where
presumably manager operates inthe best interest of shareholders.
Kate (18:47):
Right, right.
Veljko (18:48):
And here is the big clincher.
There are going to create portfoliosof democratic firms, they would
govern firms and what they callautarkic firms or detectorial firms,
the poorly governed, they're goingto look at the difference in returns
and they're going to show us that...
I guess this was the mideighties, there was a nine percent
Kate (19:09):
Punchline is coming.
So yeah,
Veljko (19:10):
The punchline is a big number.
The abnormal return on thewell governed portfolio is
nine percentage points a year.
Kate (19:18):
Wow.
So if, I, my portfolio consists mostlyof firms with better governance,
I'm going to make nine percentagepoints more year versus a punchline.
Portfolio of similar firms, butthat are not as well governed.
Veljko (19:31):
I just want to contextualize that 9%, right?
Equity returns at the time wereabout 9 percent a year, right?
So what this means is that you'redoubling the return on your equity
portfolio if you're restrictingit to well governed firms.
Now.
Kate (19:51):
Impressive.
You definitely want to have yourmoney in well governed firms.
Veljko (19:56):
Well, but I mean, it's not really surprising, I mean,
well run firms perform well.
I mean, now to recognize what Gompers,Ishi, and Metrick deserve, they
found a way to measure it, right?
And they found a way to rate, rank firms.
Kudos to them for their work.
Now, as we said, their workactually is built on a lot of prior
research that shows that theseindividual things matter, right?
(20:20):
And there was a lot of research comingafterwards and I'm not gonna, we should
not probably pretend that all of thisis totally uncontroversial, right?
I believe that it's fairly uncontroversialthat well governed firms perform better.
How exactly you measure them?
How exactly do you identify them?
Kate (20:35):
There's so many quarks in there.
That's right.
But I think we've said enough for now
Veljko (20:38):
That's correct.
Kate (20:39):
Yeah, that's definitely a very strong result.
G is positively related with returns.
We've covered G of ESG,one of the dimensions.
And there exists a clear relationship.
There are firms that have higher G's thatare better governed, have higher returns.
But we're not quite so sure that Gbelongs into this group of socially
(21:01):
responsible actions of firms, someone of the views is marketing.
So let's move on.
Let's move on to our next factors.
Let's talk about this Efactor and then the S factor.
So what do you have tosay about this E factor?
Is there a relationship betweenfirms that are E environmentally
stronger and their returns?
(21:23):
Firms that have betterenvironmental policies?
Do they over time provide betterreturns to their shareholders?
Veljko (21:29):
Kate, we were talking about definitions, and the E,
the E stands for environment.
Kate (21:38):
Environment, right.
I mean, look, so what we mean there byE, there's, there's multiple things,
but we're obviously going to betalking about e emissions and emissions
Veljko (21:49):
broad metrics of impact on the environment, right?
Kate (21:51):
That's correct.
Yes.
Veljko (21:52):
I read an article in the Economist recently that was arguing that we should
just look at emissions only for the E.
Their point was that it's the mostobjectively measurable dimension.
Kate (22:06):
These emissions, there's a lot of, super cool data sets.
One is known as true cost, so thistrue cost data set provides emissions
and splits them into scope one,scope two, and scope three emissions,
Depending on the severity of thepollutants that the company emits.
Veljko (22:24):
That that does sound pretty intriguing.
It's the most objectivelymeasurable dimension.
But clearly it's an incomplete one, right?
Water pollution.
there's all sorts of other, thingsthat, that there's, how much
trash you're producing, right?
There are all these other effects,but, but okay, to just wrap our head
(22:46):
around the E measures how the firmcontributes positively or negatively
to the natural environment around it.
Kate (22:54):
Correct, correct.
We're going to be talking aboutclimate change related issues
here, brown and green firms.
So all of this kind of sits underthe e umbrella And those were
just some examples of what getscounted under this e dimension.
Veljko (23:07):
Absolutely.
Awesome.
And here, Kate, I did a deep diveinto the literature on the E.
And the problem is it feels likedrinking from a fire hydrant, right?
There's just so much, it's the hot topicof the day everybody's writing about.
So, let me start with what I thinkis a great literature review paper.
(23:31):
This is work by Gunnar Friede,Timo Busch and Alexander Bassen.
This was published in 2015 in the Journalof Sustainable Finance and Investment.
And, I wish they could see you.
So Kate is a journal's knob.
Let me explain this.
We, we, we clearly have better orlet's say more selective journals
(23:55):
in our profession and some which areperhaps not, not quite as selective.
And, this journal, it certainlydoesn't rank towards the top,
and, Kate and I perhaps differ.
At times in how much weight to give to it.
Kate (24:12):
I am interested in listening to the findings.
Any literature is going to be interestingbecause they review the literature.
, it's not that I'm a journal snob.
It's probably shows my ignorance becauseI'm not too familiar with the journals
outside of the top six, I would say,in finance, accounting and economics.
So
Veljko (24:29):
That, that, that, that's the definition of a
journalist now, but, okay...
So, let me blow your mind hereon what these, researchers did.
So Friede, Bush, Bassan, theyactually came up with this.
Review 2, 200 individual studiespublished over the span of 40 years.
Kate (24:48):
2, 200 studies.
These are papers on ESG?
Veljko (24:53):
Correct.
All of them not only paperson ESG, but papers specifically
on ESG and firm performance.
Actually, some of them are aboutfirm performance, some about ESG and
the performance of investment funds.
So they look both at the corporateside and the investment side
of the debate, if you will.
But okay.
Let me give you one figure herethat I think really summarizes.
(25:17):
A lot of it out of the studies that lookspecifically at corporate performance, 59
percent document a positive associationbetween environmental performance
of firms, environmental ratings offirms and their either stock price
performance in some of the studiesor operating performance metrics.
(25:40):
So
Kate (25:41):
59 sounds pretty good.
So then the question is whatwas happening to the other,
like 40 percent there, right?
Veljko (25:47):
Okay.
So 59 percent are findinga positive association.
4 percent of studies actually findthe opposite, they're actually
finding a negative association.
Kate (25:57):
Interesting, interesting.
Veljko (25:59):
Yeah, so roughly speaking, you have this almost 60 percent of studies
finding positive, 4 percent findingnegative, and then the remainder, 35
percent or so, finding no association...
what does one draw from this?
If you go back to our originalquestion, do woke firms under-perform
do socially responsible firms?
Kate (26:19):
And if we consider E as a definition of woke here, being environmentally
safe, environmentally positive.
Well, I mean, as woke in that perspective
Veljko (26:29):
On the G dimension, we already ruled out under performance,
Kate (26:32):
right?
Veljko (26:33):
It's quite the opposite.
Well governed firms outperform.
Now we're on the E and the evidence forunderperformance comes from 4 percent
of studies, 60 percent finds positive.
I think that if you'reasking me, do environmentally
conscious firms underperform?
(26:53):
Then the answer is resounding
Kate (26:55):
No.
No, yeah.
Veljko (26:57):
If you were asking the opposite side of the question, do environmentally
conscious firms outperform?
I think I would be alittle bit more cautious.
60 percent of studies find thatyes, they do, but then 30 percent
of studies find they don't.
Right?
But there is another point we probablyshould raise in this conversation.
(27:19):
Correlation is not causation.
Kate (27:21):
Right.
Right.
Veljko (27:23):
And in general, that's been a problem in this stream of the literature.
Kate (27:27):
Yeah, so when a firm, you're saying it gets wealthy and profitable, that's
when it's going to start caring aboutthe environmental factors and all start
improving its performance and so on.
For example, I know that theUniversity of Missouri had one of the
cleanest, power plants here, and theyworked hard to achieve that status.
After which Berkeley tookthe first spot as having the
(27:49):
cleanest on campus power plant.
But neither of the universities couldhave been thinking about having the
cleanest power plant if they weren'tmaking enough money from tuition
and if they weren't profitable.
Veljko (28:02):
Oh, no, that's a really interesting point.
I'm actually discussing a paperat a conference next week and
one of the authors is Houston,
Kate (28:12):
Houston, Texas.
Veljko (28:15):
No, Houston being the last name of one of the authors.
And the funny thing is I,
Kate (28:20):
Joel Houston.
Veljko (28:21):
Oh, okay.
See, I totally unprepared.
Yes.
But that's absolutely correct.
The title of the paper,which I'm also unprepared.
130 years of corporate socialresponsibility, I believe
is the title of the paper.
Kate (28:34):
Wow, nice.
Yeah,
Veljko (28:35):
Actually.
I was just reading this afternoonand not preparing for this podcast,
but preparing for the conference andthey do something that's really cool.
They actually use language processing,and they scan news articles
back hundreds or so years, right?
And again, I'm fuzzyon the details, right?
(28:57):
I just read this first draft.
But so they go back 100 plus years andthey scan news articles and they actually
find when concern for the environmentis the highest in the population.
And then they link it to macroeconomicfactors, wars, events out there.
(29:18):
And the big finding is thatwhen the economy is doing really
well, there's a very high levelof concern for the environment.
When the economy does poorly, nobody cares
. Kate: Right, right.
So this is, this is interestingbecause this is going back really
historically back 130 years.
Because if I'd say, if I were todate this ESG interest rate, For the
public, I'd go back probably to likesometime around 2010, 2012, when,
(29:45):
people started talking about sociallyresponsible from, and even more I
would say, maybe 2017 and 18, wheneverwe've seen more votes in shareholder
meetings that are favoring corporatedisclosure on environmental factors.
So I would say that thisinterest in ESG is growing.
For investors, it's only been the lastdecade or so, but interesting that they
(30:06):
find that if you go back over the last130 years, this interest exists, but
it exists when we are in good times.
All right, so we are back from our break and we are now in our office.
(30:29):
For full disclosure, we werepreviously on Kate's boat.
And
Kate (30:33):
it might have been a bit windy.
So if you hear some wind noises, that'swhat's coming from the first part.
Veljko (30:38):
We'll see if we can clean it up in our post processing.
I have a creaky chair here.
So.
We'll see.
We'll see whether the chairis better than the wind.
Okay.
So we were talking
Kate (30:52):
No comment.
No comment.
Veljko (30:53):
Well, we, we do have our notes in front of us.
So let's recognize the authors here of130 years of corporate responsibility.
Kate (31:03):
Joel Houston,
Veljko (31:03):
Sihon Kim and Boyan Lee.
They certainly deserverecognition for this great paper.
So back to us, we were talkingabout E and performance, right?
Do firms that rate highon environmental performance
actually produce abnormal profits.
As I said earlier, it's almost likedrinking from a fire hydrant, but
(31:24):
I'll mention a couple of papers.
We have a paper from the Financial AnalystJournal published in 2004 portfolios
of firms with a high E they find 6percent per year of normal performance.
Another paper, Journal of Bankingand Finance, a couple of years
later, it was published in 2014.
It's a paper by Pak Chan andTerry Walter, and they actually
(31:49):
find something very similar.
They make portfolios of firmsthat rate high on environmental
performance, and they get an abnormalreturn of around 7 percent per year.
So, quite quite strong results.
They actually dig a little bitinto the corporate side as well.
They find that firms that rate highactually have an easier time getting
(32:12):
loans, an easier time raising capital and,and other positive spillovers as well.
Kate (32:17):
I'm going to add to that.
There's a paper by Bolton and Kacperczyk.
That's a 2021 Journalof Financial Economics.
That's Patrick Boltonand Marcin Kacperczyk.
And what they show is a link betweencarbon emissions and firm returns.
So firms that have higher total carbondioxide emissions, so, you know,
(32:37):
produce more polluting substances likecarbon dioxide, earn higher returns.
So they're compensating theirshareholders for this additional risk.
Veljko (32:47):
Oh, yes, Kate.
That's a great paper.
And of course, publishedin a great journal.
And yet I do think that thereis a certain risk here of
confusing our listeners a bit.
Because there is a distinction betweenexpected returns and realized returns.
And there are some inter temporaldynamics here, here at play as well.
(33:09):
In other words, if your firm becomesriskier, your cost of capital goes up.
That means higher returnsto your current investors.
And yet that tends to havenegative consequences on firm
profitability going forward.
Your marginal net present value projectbecomes negative and effectively you,
(33:35):
you, you, you grow more slowly, right?
It tends to have a negativeeffect on your growth rates and
your profitability going forward.
Nevertheless, it's an interesting,nuanced, finding here.
Kate (33:48):
Probably the popular paper in like emissions right now.
Right.
I would say in our literature.
Veljko (33:53):
Fair enough.
I have another paper herethat I did want to mention.
A Journal of Corporate Finance byDale Griffin and our dear friend,
Omrane Guedhami, Kai Lee, and, GuangliLu I love this paper because they
don't just look at the United Statesand they don't just look at Western
Europe, but they actually look at 43countries over the period 2003 to 2015.
(34:17):
They have almost 5,000 firmsin their overall sample.
And again, they find a pretty stronglink to performance a pretty strong link
between environmental performance offirms and all sorts of corporate outcomes.
This is not just stock priceperformance, but they find these
firms have higher levels of cashflows, but actually lower cash flow
(34:39):
volatility and a lower cost of capital.
Kate (34:41):
Nice.
Veljko (34:42):
And, yes, yes.
It, it gives,
Kate (34:44):
A lower cost of capital.
Veljko (34:47):
Yes.
I suspect this comes fromthe loan side, right?
I mean, they get cheaper loans, because,in the banking literature, I had a
paper on banking trust, there areall these spillover effects, right?
Kate (35:01):
This is consistent with the paper by Bolton and Kacperczyk.
Because as the firms with lower emissions,provide lower returns, which would be
consistent with the lower cost of capital.
And you're right, like that's impressivethat the paper you are mentioning
by, Omrane, Omrane and Kai Li andco authors, they are looking across
(35:21):
multiple countries because the paper byBolton and Kacperczyk looks at the U.
S.
specifically.
So they look, you know, over a longperiod of time, 2005 through 2017.
Veljko (35:33):
Yeah.
And this is something interesting.
I don't know how much time we want tospend dwelling on this but, when it comes
to some of these relationship betweencorporate social responsibility and,
and firm performance and firm value,the strongest findings are usually
not coming from the United States.
Maybe we should actually spend just onemoment mentioning brown firms versus
(35:57):
brown industries, because there is adanger here of identifying specific
industries or whole industries as beingon the wrong side of this debate, and I
think it's a fallacy that perhaps even wefall guilty of when chatting about this.
Kate (36:20):
What we mean by brown industries, so non environmentally friendly
industries are industries that that aremore likely to pollute like industries
that deal with, with oil, refiningand exploration and production firms.
Patrick Bolton and Marcin Kacperczykmentioned that, specific to a few
salient industries in which we seethe biggest emissions and the biggest
(36:46):
pollutants, certain firms in those brownindustries get some additional screening
by their institutional investors.
Meaning that institutional investors orthe owners of these firms in the brown
industries know which firms are thebrownest and which firms are the greenest?
(37:08):
Because, within an industry, evenif it's a oil polluting industry, if
it's an exploration and productionindustry, there could be green firms
that actually file a lot of greenpatents and try to make the exploration
activities as clean as possible.
And there's other firmsthat don't do the same.
And it seems like, the authors pointout that institutional investors
(37:29):
provide extra monitoring to thesebrown firms in brown industries.
Those that do not try to be good on E.
Veljko (37:38):
I guess what I'm taking away from this point is that ultimately
we should always be looking at theseratings within an industry and not
necessarily across industries, right?
Because of course, if you're amanufacturing firm, I mean, let's not go
to the extremes of, of oil firms, right?
But even if you're a manufacturingfirm of any kind, of course, you're
(37:59):
gonna produce more emissions thanif you're a tech firm, right?
Or, and well, maybe that'snot even true today, right?
Kate (38:06):
Well, no, no, no, it's still true.
It's still true.
Yeah.
Veljko (38:10):
But the point is some industries, are going to be more or
less socially responsible, right?
But by the nature, but we're
Kate (38:17):
talking about environmental, environmental responsibility right now.
But yeah, it's true.
Some industries will be moreenvironmentally conscious and others
would be less environmentally conscious.
And some firms within those industrieswill also differ in how they think
about environmental responsibility.
So this was in the Wall Street Journal.
It's an article about Ziploc.
(38:38):
So, uh, basically
Veljko (38:40):
Ziploc like the bags,
Kate (38:42):
Ziploc like, like the bags.
Veljko (38:44):
Okay.
You're surprising me here, Kate.
I don't know where you're going with this.
Kate (38:48):
So single use plastics, right?
So if you think about the environmentalimpact of single use plastics, it's
very damaging to the environment.
Single use plastic Ziplocare not commonly recycled.
40 percent of the world's millionsof tons of plastics produced in
packaging ends up being this singleuse plastic and over 85 percent of
(39:11):
that plastics ends up in the land.
But interestingly, Fisk Johnson, whois leading the company, he's a fifth
generation CEO in this family around.
S.
C.
Johnson company, which makesZiploc bags, Miss Mayers, Clean
Day soaps and Windex cleaners.
He's actually a huge supporterof the clean environment.
(39:32):
He's an interesting person overall.
He has five degrees and includinglike a PhD in physics, and he is
very concerned about the environment.
And kind of an oxymoron.
You have this very Brown industryproducing single use plastic,
and you have a CEO who caresdeeply about the environment.
(39:52):
And so this is an example of a greenCEO or CEO with green values and
trying to have his firm performinggreen matters in the Brown industry.
Veljko (40:03):
So, but do they perform well?
Kate (40:07):
I have not looked at the stock chart of SC Johnson to see how it
compares like with the S and P 500.
So I don't know if they perform well,but one thing that he says in his defense
of like, why is he producing such aterrible product for the environment?
He said, all right, you could say.
(40:27):
Well, single use plastics is terriblebusiness and we could just get out of
it, but somebody else who's less wellintended is going to just take that up.
It's a free market.
My argument is that it's betteroff in our hands because we are
trying hard to make changes.
So what I can say is that he is using5 percent of his pre tax profits in his
(40:47):
company to fund a team that directlyreports to him that's focusing on
addressing global health problems.
And reducing of the issues associatedwith plastics and plastics recycling.
Veljko (41:03):
Okay.
Yeah, that's super interesting.
I guess the big point here, we canhave green firms in brown industries.
Kate (41:08):
Aiming to, to be green, right?
They still produce a lot of plastic.
So I guess there's a spectrum.
You are right the industry is reallyimportant, but I just want to point
out that within each industry,there's some firms that are green,
even if an industry is brown.
Veljko (41:24):
Fair enough.
I was more interested in the moreexplicit link to performance.
I think you had a paper by Pastorand Stambaugh, if I'm not mistaken.
Kate (41:31):
Pastor.
So it's Lubos Pastor, RobertStambaugh and Lucian Taylor.
Veljko (41:36):
Alright.
Kate (41:36):
It's a paper published in 2022.
They dissect the green return.
They show what they call the greenium.
The greenium.
Veljko (41:44):
Oh, I love that.
Kate (41:45):
The greenium.
Veljko (41:46):
So, so, so what's the greenium?
Kate (41:48):
The greenium is the return of,
Veljko (41:51):
it's the green premium.
Is that what the greenium
is
Kate (41:53):
green premium, yes.
Veljko (41:54):
Oh, wow.
Okay.
Kate (41:55):
Yeah, basically it's the return of green stocks over brown stocks.
And they show that from 2012 tillnow, and they started in 2012 because
that's when the data becomes available.
So that's in the period when people havereally been caring about climate and this
climate concern has been at a much higherlevel than in prior historical periods.
(42:18):
They create these portfolios ofgreen firms and brown firms.
And basically they show that the portfolioof green firms outperforms that of
brown firms by 174 percentage points.
So over 2012 through, throughthe recent time period.
They also bring an interesting exampleof German green bonds that have
outperformed their higher yielding nongreen twins as this greenium widened.
(42:43):
So there's several examples they'reshowing that green assets deliver
higher returns in the recent years.
So they're very specific about thisrecent year phenomenon because we've
had a higher concern for climate.
Veljko (42:56):
All right.
Okay.
But.
I still think you were going totell me something about green
firms versus green industries.
Kate (43:02):
And in this paper, their main idea is looking at green firms, versus
brown firms and this 174 percentreturn difference sounds striking.
Veljko (43:13):
Yeah, that's huge, right?
Kate (43:14):
Yes, that's right.
That's right.
Cumulative return difference.
But industries really play a large role.
So whether you are a green or brownindustry does explain a large proportion
of this 174 percent difference.
Veljko (43:31):
So 174 is not industry adjusted.
So once they adjust for theindustry, is there still,
Kate (43:37):
There's still a difference.
Whatever the characteristics of thatindustry, let's say it's brown, you
still do better if you are a greenera firm in that industry, as they
have information on that as well.
But the main point is that, industriesexplain a larger, three times more
of that 174 percent difference.
Veljko (43:56):
Oh, that's interesting.
The greenest firms within an industrystill outperformed the brownest firms
within an industry, but across industryeffects are much stronger than within.
Kate (44:07):
Right.
So you might want to participatein like green industries.
Veljko (44:11):
Makes sense.
Makes sense.
And I guess that matches what my intuitionwould have been about this, but those
are some really interesting results.
Kate (44:18):
Again, I have to point out they are, very specific that this is from
2012 through now, when our climateconcerns have been the highest.
Veljko (44:27):
Gotcha.
Gotcha.
Kate (44:29):
Let's see if we can see if we can summarize.
Are we ready to summarize E?
Veljko (44:33):
Oh, yes.
Yes.
Kate (44:35):
So what are the main takeaways here?
Veljko (44:37):
The main takeaway is that to go back to our original question,
do socially responsible firms doenvironmentally conscious firms
in this sub chapter, underperform,again, the answer is a very, very
resounding no, they do not underperform.
(44:58):
Now, when it comes to evidence ofoutperformance, as always, it's
a little bit more controversial.
And the correlation is clearly positive.
I mean, there's study after studyafter study here showing that firms that
rate high on the E dimension actuallyhave high stock price performance.
(45:19):
But as always, correlationis not causation.
Let's be clear the channel that'susually identified here in the
literature it's a legal channel, right?
Kate (45:30):
Seems like not only legal It seems like the Bolton and Kacperczyk paper also
points to the cost of financing channel.
It's more expensive for these dirtyfirms to borrow money as well.
So there's several channels.
Veljko (45:44):
Okay, fair enough.
Kate (45:45):
Makes sense.
Okay.
That sounds good for E.
Veljko (45:48):
Awesome.
Well, Kate, they say thatprofessors are in love with
the sound of their own voices.
And perhaps you and I arenot exceptions to that rule.
This episode is getting a little bitlonger than we were originally planning.
So why don't we wrap it up here andthen split it into a two-part episode.
(46:13):
So let's conclude this and then wecan invite our listeners to listen
to part two for the discussionon the S of ESG, the social part.
Kate (46:26):
Well, I guess what we need to say now is thank you, our listeners.
If you've enjoyed this podcast,please like us, follow us on your
favorite podcast platform, and wewould love to hear some feedback.
Veljko (46:41):
Indeed, and stay tuned for future episodes of Questions in Finance.
Cheers
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