A new paper titled “Retail Investors and ESG News” by experts at Wharton and elsewhere has sharpened the debate on the role of environmental, social, and governance (ESG) information in framing sustainable investment strategies. The research finds that retail investors do care a lot about the ESG-related activities of the firms, but mainly if they affect the value of their investments — not necessarily with altruistic motives.
“Retail investors treat ESG information like they do financial information, and they trade [on such news] in the same way as financial news,” said Wharton accounting professor Christina Zhu. She co-authored the paper with Yale University accounting professor Edward M. Watts and Stanford University accounting doctoral student Qianqian Li. It was named an Outstanding Paper in the 2023 research paper prizes by Wharton’s Jacobs Levy Equity Management Center for Quantitative Financial Research and was recognized at the Frontiers in Quantitative Finance Conference on September 22.
Zhu said their research disputed findings by many surveys and experiments that retail investors “are willing to sacrifice a little bit of wealth for the environment [or other ESG causes].” According to the paper, retail investors care about ESG factors “primarily to the extent they are financially material for company performance.”
Their trading behavior also “predicts future abnormal returns” for financially material events, the paper added, noting that this finding is “consistent with retail traders benefiting from incorporating ESG-related information in their decision-making.” In other words, retail investors profit from trading on ESG-related information when it is relevant to firm value.
“Retail investors treat ESG information like it’s financial information, and trade [on such news] in the same way that they would trade if it were financial news.”— Christina Zhu
Zhu and her co-authors arrived at those findings after analyzing trading activity by retail investors around nearly 54,200 “distinct ESG-related news events” from December 2015 through August 2022. Retail investor trading activity was 5.7% higher on “ESG news days” than on “non-event days” across that time period. It was more pronounced — 8.1% higher on ESG news days — after 2020, which suggested an increasing sensitivity among retail investors to ESG-related news.
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Significantly, the study also found that “retail investor reactions to ESG news events are greater in magnitude than those to analyst forecasts and dividend announcements, but are smaller than those to earnings announcements and management guidance.”
Another important finding was that although all categories of ESG news events generated “significant trade” by retail investors, news related to “Leadership and Governance” aspects impacted their trading the most. “The G-type reactions (on governance aspects) are the biggest because they have a lot of impact on firm value,” Zhu said. “It’s still related to the other categories because it’s the governance of the E and S (environmental and social) portions.”
The paper also found that events with “more extensive media coverage and more pronounced increases in investor attention generate significantly more retail trade,” which it noted was consistent with the findings of other studies. “The significant increase in trading activity by retail investors around high-attention ESG events allows us to reject the hypothesis that they are indifferent to ESG-related information,” the paper stated.
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The study then goes on to investigate “why retail investors care about these issues.” The paper pointed out that, given these findings, an important question is “whether retail investors value ESG-related factors for pecuniary versus non-pecuniary reasons.”
It is of course possible that retail investors value ESG-related factors for non-pecuniary reasons, and that they are not looking to only maximize returns, the paper stated. They have the ability to pursue non-pecuniary goals since they are acting on their own and not constrained by the fiduciary duties that institutional investors have to perform on behalf of the investors they represent, the authors explained.
“When an event is good for the ESG performance of a company but bad for its stock price, retail investors are selling. They don’t seem to be willing to sacrifice financial returns for ESG performance.”— Christina Zhu
Incidentally, the paper cited research on ESG-related investing by institutional investors by Wharton finance professor Luke Taylor, Wharton finance and economics professor Robert F. Stambaugh, and Chicago University finance professor Lubos Pastor, which also disproved widely held perceptions. That paper, titled “Green Tilts” — also named Outstanding Paper in the 2023 Jacobs Levy awards — found that contrary to popular reports that ESG investing has crossed $35 trillion, large financial institutions have invested only $2 trillion of their total assets under management of $31.3 trillion in firms that adhere to ESG values.
Zhu’s study found that “the average retail investor does not have non-pecuniary preferences.” Specifically, it found that investors buy securities when the implications of ESG news for a firm’s performance are positive; conversely, they sell those securities when the implications are negative for portfolio performance. Those trading activities are “largely independent of the changes in expectations about a company’s ESG performance,” the paper stated.
“It means that when an event is good for the ESG performance of a company but bad for its stock price, retail investors are selling,” Zhu explained. “They don’t seem to be willing to sacrifice financial returns for ESG performance. If the ESG news is good for firm value, then they’re buying.”
According to Zhu, the findings of her paper could inform several proposed actions for regulators and policymakers. For instance, the Securities and Exchange Commission has been considering a requirement for publicly held companies to disclose their climate-related risks, she noted. Also, many states have banned the consideration of ESG factors in the investment decisions of their pension plans, she added.
“The evidence [from the study] is important because it’s at least one data point that can be used in shaping policy in the future,” Zhu said. “The basic takeaway is that ESG-related news matters to retail investors just like any type of financial information would matter to them.”