Corporate ESG Profiles and Investor Horizons

Research Retrieved: April 2018
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Issue

A growing number of institutional investors have been voicing their support for ESG issues and incorporating them into their investment decision-making as these issues affect risks and returns of firms. Many ESG practices, e.g. curbing environmental pollution, contribute to the improvement of firm performance as well as reduction of litigation risks in the long-run but can be costly in the short-term. Therefore, investors with different time horizons may disagree on the value of ESG projects.

To address these issues, the authors examine changes in their portfolios and find that preferences for corporate ESG depend critically on investor horizons: Investors with longer horizons tend to prefer higher-ESG firms, while short-term investors prefer the opposite. Consistent with the importance of horizon, we find that investors behave more patiently toward high ESG firms, selling less after negative earnings surprises or poor stock returns.

Key Findings

The authors’ empirical results suggest that investor preferences for corporate ESG depend critically on their investment horizons:

  • ESG-support with long investment horizons: investors with longer horizons tend to prefer higher-ESG firms while investors with short-term horizons prefer the opposite. Mutual funds and 13F institutions with longer investment horizons have stronger preferences for high ESG firms.
  • Institutional investors can drive corporate short- and long-termism: The relationship explains seemingly conflicting evidence in the financial press. On the one hand, many allege that institutional investors exert pressure on corporate managers to beat their quarterly earnings expectations, hindering the managers’ ability to implement long-term strategies. On the other hand, some institutional investors are vocal in encouraging the managers of their portfolio firms to take a longer-term view.
  • Investors behave more patiently toward high ESG firms: Comparing positions of the same investor across different firms in their own portfolio, the authors show that institutional investors tend to sell portfolio holdings following negative earnings surprises, however, significantly less so when a firm has a high ESG score.

 

Practical Relevance

The paper contributes to the growing debate on whether corporate managers in the US have become too short-term oriented and take myopic actions that hurt long-term shareholder value. The authors thereby offer empirical support for the perspective that shareholders’ heterogeneous horizons are important in influencing corporate short-termism. In addition, the results suggest that corporate ESG profiles impact investors’ trading behaviors in a way that is consistent with the hypothesis that long-term investors foster long-term corporate strategies.