Sustainability: Recent Research

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Valuation of carbon emission allowance options under an open trading phase
Tony Wirjanto headshot

The paper ‘Valuation of carbon emission allowance options under an open trading phase’ by Tony Wirjanto and co-authors Mingyu Fang and Ken Seng Tan presents valuation models of emission allowance options under an emission trading scheme, operating in an open trading phase, where unused allowances are banked to subsequent phases without any limit. Empirical studies are carried out to show that allowance option prices exhibit similar volatility smiles to those of the stock market.

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Are ESG Ratings a True Measure of Sustainable Practices?
Amar Mahmoud headshot

Recent research has cast doubt on the accuracy and consistency of ESG ratings. One significant concern is the divergence in ESG ratings by different providers. If ESG ratings from different providers measure sustainable practices by firms, they should be highly correlated. However, this is not the case, as research documents a low level of correlation between ESG ratings from different providers. Consequently, the next logical question is: what drives ESG ratings?

This research letter by Amar Mahmoud surveys three recent studies that address drivers of ESG ratings. These studies shed light on factors influencing ESG ratings that may not align with sustainable practices.

Majid Mirza's paper was recently published in the Journal of Management and Sustainability
majid mirza headshot

Majid Mirza's paper which was recently published in the Journal of Management and Sustainability entitled 'Private Capital Markets and Sustainability Research: A Systematic Literature Review':

Private equity and venture capital now control over $10 trillion in assets under management, however, research on sustainability linkages with the private markets have been sparse. The paper conducts the first ever systematic literature review on private equity and venture capital work with a sustainability lens, analyzing almost 5,000 papers and shows how less than 1% have any sustainability linkages. This shows that there is a 'science-practice gap' when it comes to the study of private markets and sustainability practices.

Read the full paper.

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Are ESG Ratings Informative About Companies' Social Responsible Behaviors Abroad? Evidence from the Russian Invasion of Ukraine

A discussion with the CSPM co-director Elizabeth Demers and Jurian Hendrikse.

Please see the corresponding study that is available.

Authors: Daniyal Ahmed, Elizabeth Demers, Jurian Hendrikse, Philip Joos, and Baruch Lev.

More Research

The impact of terrorist attacks and mass shootings on earnings management

seda oz headshot

The paper 'The impact of terrorist attacks and mass shootings on earnings management' (The British Accounting Review, In Press) by Seda Oz investigates the role of salient events on accrual-based and real earnings management activities. Seda uses terrorist attacks and mass shootings as salient events and conjecture that the negative effects of terrorist attacks and mass shootings spill over and lead to pessimistic risk assessments of financial reporting choices. - The findings show a decrease in accrual-based and real earnings management for firms located in the impacted regions. - The documented effects are driven by firms with high information asymmetry levels and pessimistic annual reports. Additional analysis reveals that affected firms decrease the readability of their annual reports, suggesting affected firms engage in a more complex narrative disclosure. The findings of this paper support the argument that managers exhibit a cognitive bias which affects their financial reporting choices.

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A report of pension fund fossil fuel financial returns and divestment

Olaf weber headshot

Summary: This report by Olaf Weber presents the results of analyses conducted on a group of pension funds that face popular demands to decarbonize their investment holdings (Climate Safe Pensions Network (CSPN)). The funds' cumulative values with and without public equity energy investments have been analyzed for the time between 2013 and 2022. The analyses demonstrate that the cumulative value of the public company equity portfolio of pension funds would have been 13 percentage points higher on average if the funds had been divested from the energy sector ten years ago. Even during the last three years, the cumulative value of the ex-energy portfolios has been only 2 percentage points smaller than the value of the conventional portfolios. However, share prices in the energy sector increased recently. For the six funds analyzed using data obtained from the Bloomberg database, the total value of the ex-energy portfolios would have been $424.6 billion, while the total value of the reference portfolios was $402.8 billion. Hence, the difference is more than $20 billion. Furthermore, the carbon footprint of the original and ex-energy portfolios have been calculated based on the ratio of holdings compared to the total market values of the holdings for 2022. The carbon footprint difference between the original and ex-energy portfolios is 16.6 percent or 279 million metric tonnes. This is the equivalent of the energy use of 35 million homes per year. Overall, we could demonstrate that energy divestment makes sense from a financial, climate exposure, and climate impact perspective.

Cost of Damage of Pluvial Flooding Due to Climate Change: A Preliminary Assessment

Tony Wirjanto headshot

This paper, by Yogi Samoa and Tony Wirjanto, adopts a deep learning methodology in assessing economic cost of damage arising from pluvial flooding which occurrence is increasingly exacerbated by global climate change. This investigation exploits a recently released, sizable claim database from the US National Flood Insurance Program and meteorological data from National Oceanic and Atmospheric Administration in training several competing models which are later used for prediction on test datasets which have not been used in the training process. Separate analyses are provided in this paper for claims on building and claims on content.

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Navigating Uncertainty in ESG Investing: A Reinforcement Learning Approach to ESG- Related Portfolio using Mean-Variance Utility, ESG-Modified CAPM, and Fama-French Six-Factor model with Component Factors E, S and G.

Tony Wirjanto headshot

The abstract for the paper 'Navigating Uncertainty in ESG Investing: A Reinforcement Learning Approach to ESG- Related Portfolio using Mean-Variance Utility, ESG-Modified CAPM, and Fama-French Six-Factor model with Component Factors E, S and G.' by Jiayue Zhang, Ken Tan and Tony Wirjanto, is being edited for a conference presentation. The earlier version of it has drawn great excitement from experts in the field.

Abstract:

To create a portfolio that is optimized for both financial returns and returns generated from sustainability factors, this paper incorporates ESG scores explicitly in the reward function of conventional Reinforcement Learning model (as a branch of Machine Learning model) in order to analyze the effect of various ESG ratings published by major rating agencies on the coherence of investment strategies more robustly. Widespread confusion due to uncertainty induced by high heterogeneity in published ESG ratings is treated in the model as a source of ambiguity (or Knightian uncertainty) and four ESG ensemble strategies are proposed to cater to investors’ different risk and (smooth) ambiguity preference profiles. Additionally, the paper uses a Double-Mean-Variance model to combine the objectives of financial returns and ESG scores, defines three types of investors with respect to their ambiguity preferences and constructs novel ESG-modified Capital Asset Pricing Models to evaluate the performance of the resulting optimized portfolio. Lastly the paper also extends the Fama-French three-factor model to examine the contribution of each separate component of the three pillars of ESG to separate out factors from anomalies.

Your Emissions or Mine? Examining How Emissions Management Strategies, ESG Performance, and Targets Impact Investor Perceptions

adam vitalis headshot linking to his profile

Efforts to mitigate greenhouse gas emissions and curb climate change have recently become significant areas of concern to policymakers. We (Adam Vitalis and his co-authors Joseph Johnson, Jochen Theis and Donald Young) examine how management’s focus on mitigating its direct versus indirect emissions influences the ability to attract capital from investors, and how this ability is moderated by the firm’s environmental, social, and corporate governance (ESG) performance combined with adoption of an external emissions target. Using an experiment, we find that investors perceive a firm with a relatively poor ESG performance record as more socially responsible and are therefore more willing to invest when management focuses on mitigating direct versus indirect emissions. We also find that, regardless of ESG performance, adopting an external industry-based emissions target diminishes willingness to invest when management focuses on mitigating indirect emissions, but not when they focus on mitigating direct emissions. Our results provide insights for policymakers as to one impact of disaggregating direct (i.e., Scope 1) and indirect (i.e., Scope 2) emissions in ESG reporting.

View the full paper: Your Emissions or Mine? Examining How Emissions Management Strategies, ESG Performance, and Targets Impact Investor Perceptions

Motivating Employees with Goal-Based Prosocial Rewards

Doing good can be good for business. Adam Presslee and his co-authors Leslie Berger and Lan Guo find that employees rewarded for goal attainment with a donation to charity outperform those rewarded with cash. This study provides some preliminary evidence that rewarding employees with such prosocial rewards can be a win-win-win: employees win because they feel good about themselves, shareholders win because of the increased performance and reputation, and society wins because of the increased support for charity. 

View the full paper: Motivating Employees with Goal-Based Prosocial Rewards

Corporate Human Capital Disclosures: Early Evidence from the SEC’s Disclosure Mandate

Elizabeth Demers

In November 2020, the SEC issued amendments to Regulation S-K requiring filers to provide expanded discussions related to the firm’s human capital (HC). This study, by Elizabeth DemersVictor Xiaoqi and Wang Wu, provides the first large-sample descriptive evidence related to the resulting HC disclosures during the first year of the regulation’s implementation. Our findings confirm that, in the absence of detailed guidance under the principles-based regulation, filers’ HC disclosures are extremely heterogeneous in terms of their length, numerical intensity, tone, readability, and similarity with peer firms. The disclosures tend to be very positively-toned and inherit many of the properties of the firm’s other Item 1 disclosures. Consistent with investor complaints, the disclosures are generally not numerically intensive. Firms for which HC is strategically important do not provide superior disclosures, and time trends suggest that firms have learned over the first year of the non-directive regulation to provide disclosures that are longer and more optimistic, but less informative (i.e., more similar or boilerplate and less numerically intensive). Overall, our comprehensive evidence validates concerns regarding the heterogeneity (i.e., lack of comparability), lack of specificity, and dearth of numerical disclosures being provided under the new principles-based rules.

View the full paper: Corporate Human Capital Disclosures: Early Evidence from the SEC’s Disclosure Mandate

The Influence of Firms’ Emissions Management Strategy Disclosures on Investors’ Valuation Judgments

adam vitalis headshot linking to his profile

Recent accounting research indicates that capital markets price firms’ greenhouse gas (GHG) emissions and that disclosed emissions levels are negatively associated with firms’ market values. The departure point for this study, by Joseph Johnson, Jochen Thesis, Adam Vitalis and Donald Young, is to investigate whether investors value firms differently based on the strategies firms use to mitigate GHG emissions. These strategies include making operational changes, which reduces emissions attributable to the firm, and purchasing offsets, which reduces emissions unattributable to the firm. Using an experiment, we hold constant a firm’s financial performance, investment in emissions mitigation, and net emissions, and find evidence that nonprofessional investors perceive the firm to be more valuable when it primarily uses an operational change strategy versus an offsets strategy. However, consistent with theory, this result only occurs when the firm’s prior sustainability performance is below the industry average and not when it is above the industry average. This difference in firm value is consistent with the notion that nonprofessional investors believe information about a firm’s emissions management strategy is material. Supplemental exploratory analyses reveal that our results are mediated by investors’ perception that an operational change strategy is more socially and environmentally responsible than an offsets strategy for below industry average firms. Implications for our findings on theory and practice are discussed.

View the full paper: The Influence of Firms’ Emissions Management Strategy Disclosures on Investors’ Valuation Judgment

Tax Aggressive Behavior and Voluntary Tax Disclosures in Corporate Sustainability Reporting

Voluntary tax disclosure is increasingly more common in corporate sustainability reporting, particularly following new standards from the Global Reporting Initiative and increasing public pressure and stakeholder demands. Jillian Adams, Elizabeth Demers and Ken Klassen examine tax aggressiveness and country institutional and societal characteristics as primary determinants of firms’ decisions around voluntary tax disclosure in their sustainability reporting, particularly whether firms disclose any tax information and the degree to which they provide the more proprietary data on country-by-country reporting (CbCR). We find a one-to-one match between tax metrics and disclosure decisions in that effective tax rates, which are easily observed, relate positively to the decision to disclose any tax information. In contrast, aggressive international income shifting, which is difficult to detect, is negatively related to the decision to provide the more informative CbCR. Countries’ regulatory environment and the strength of freedom of expression and the press are also strongly associated with increased disclosure in both decision settings. These results are inconsistent with greenwashing in this setting and are important to stakeholders interested in understanding the dynamics that underly sustainability reporting.

View the full paper: Tax Aggressive Behavior and Voluntary Tax Disclosures in Corporate Sustainability Reporting

A Dollar for a Tree or a Tree for a Dollar? The Behavioral Effects of Measurement Basis on Managers’ CSR Investment Decision

adam vitalis headshot linking to his profile

Wei Jiang, Xi (Jason) Kuang and Adam Vitalis experimentally investigate how managers’ decisions to invest discretionary resources in the company’s corporate social responsibility (CSR) initiatives are affected by whether the investment decision is denominated in financial or nonfinancial measures (i.e., the measurement basis used for decision making). We posit that nonfinancial measures bring attention to the society-serving nature of CSR investments, thus activating the pro-CSR social norms of the company and managers’ personal CSR norms. Norm activation, in turn, influences managers’ investment decisions to the extent that social norms are congruent with personal norms. As predicted, we find that the level of CSR investment is higher under a nonfinancial measurement basis than under a financial measurement basis, but only when the manager is personally supportive of CSR. Supplemental analysis indicates that CSR-supportive managers continue to invest more under a combined financial/nonfinancial measurement basis than under a financial measurement basis only. Theoretical and practical implications are discussed.

View the full paper: A Dollar for a Tree or a Tree for a Dollar? The Behavioral Effects of Measurement Basis on Managers’ CSR Investment Decision

ESG did not immunize stocks during the COVID-19 crisis, but investments in intangible assets did

liz demers headshot linking to her profile

Environmental, social and governance (“ESG”) scores have been widely touted as indicators of share price resilience during the COVID-19 crisis. Contrary to this conventional wisdom, we present robust evidence that once industry affiliation, market-based measures of risk and accounting-based measures of performance, financial position and intangibles investments have been controlled for, ESG offers no such positive explanatory power for returns during the COVID crisis. Specifically, ESG is insignificant in fully specified returns regressions for each of the Q1 2020 COVID market crisis period and for the full COVID year of 2020. By contrast, a measure of the firm’s stock of investments in internally generated intangible assets is an economically and statistically significant positive determinant of returns during each of the Q1 market implosion and full 2020 COVID year periods. Our (Elizabeth Demers​​​​​​​, Jurian Hendrikse, Philip Joos and Baruch Lev​​​​​​​) results are robust to alternative measures of returns, as well as for using Refinitiv, Refinitiv II and MSCI data to capture ESG performance. We conclude that ESG did not immunize stocks during the COVID-19 crisis, but those investments in intangible assets did.

View the full paper: ESG did not immunize stocks during the COVID-19 crisis, but investments in intangible assets did

Ten financial actors can accelerate a transition away from fossil fuels

Investors have a central role to play in sustainability transitions, due to their inordinate influence on the governance of the fossil fuel extraction industry. Using network analysis, this paper links fossil fuel firms to equity owners, by distinguishing ownership characteristics of top shareholders and establishing a ranked list of the most prevalent shareholders based on emissions potential and network centrality. Our study (Truzaar Dordi, Sebastian Gehricke, Alain Naef and Olaf Weberreveals that among the most prevalent owners, are government signatories of the Paris accord and prominent American investment managers. We conclude that a concentrated number of investors have the potential to influence the strategic direction and governance of these firms and should consequently be held accountable for financing the economic activities that contribute to climate instability. This paper directly contributes to the fragmented body of academic research on financial systems and sustainability transitions.

View the full paper: Ten financial actors can accelerate a transition away from fossil fuels

Other Research by Olaf Weber

Olaf weber headshot
  • Bolay, A.-F., Bjørn, A., Weber, O., & Margni, M. (2022). Prospective sectoral GHG benchmarks based on corporate climate mitigation targets. Journal of Cleaner Production, 134220. doi:https://doi.org/10.1016/j.jclepro.2022.134220
  • Chen, X., Weber, O., & Saravade, V. (2022). Does It Pay to Issue Green? An Institutional Comparison of Mainland China and Hong Kong’s Stock Markets Toward Green Bonds. Frontiers in Psychology, 13. doi:https://doi.org/10.3389/fpsyg.2022.833847
  • Dordi, T., Gehricke, S. A., Naef, A., & Weber, O. (2022). Ten financial actors can accelerate a transition away from fossil fuels. Environmental Innovation and Societal Transitions, 44, 60-78. doi:https://doi.org/10.1016/j.eist.2022.05.006
  • Fu, P., Narayan, S. W., Weber, O., Tian, Y., & Ren, Y.-S. (2022). Does Local Confucian Culture Affect Corporate Environmental, Social, and Governance Ratings? Evidence from China. Sustainability, 14(24), 16374. Retrieved from https://www.mdpi.com/2071-1050/14/24/16374
  • Ordonez-Ponce, E., Dordi, T., Talbot, D., & Weber, O. (2022). Canadian Banks and their Responses to COVID-19 – Stakeholder-oriented Crisis Management. Journal of Sustainable Finance &  Investmentdoi:https://doi.org/10.1080/20430795.2022.2069663
  • Ordonez-Ponce, E., & Weber, O. (2022). Multinational financial corporations and the sustainable development goals in developing countries. Journal of Environmental Planning and Management, 1-26. doi:10.1080/09640568.2022.2030684
  • Rauf, M. A., & Weber, O. (2022). Housing Sustainability: The Effects of Speculation and Property Taxes on House Prices within and beyond the Jurisdiction. Sustainability, 14(12), 7496. Retrieved from https://www.mdpi.com/2071-1050/14/12/7496
  • Saravade, V., Chen, X., Weber, O., & Song, X. (2022). Impact of regulatory policies on green bond issuances in China: policy lessons from a top-down approach. Climate Policy, 1-12. doi:10.1080/14693062.2022.2064803
  • Weber, S., & Weber, O. (2022). How Fashionable Are We? Validating the Fashion Interest Scale through Multivariate Statistics. Sustainability, 14(4), 1946. https://www.mdpi.com/2071-1050/14/4/1946
  • Weber, S., Weber, O., Habib, K., & Dias, G. M. (2023). Textile waste in Ontario, Canada: Opportunities for reuse and recycling. Resources, Conservation and Recycling, 190, 106835. doi:https://doi.org/10.1016/j.resconrec.2022.106835
  • Zhang, Y., & Weber, O. (2022). Investors' Moral and Financial Concerns - Ethical and Financial Divestment in the Fossil Fuel Industry. Sustainability, 14(4), 1952. Retrieved from https://www.mdpi.com/2071-1050/14/4/1952
  • Carè, R., & Weber, O. (2023). How much finance is in climate finance? A bibliometric review, critiques, and future research directions. Research in International Business and Finance, 101886. doi:https://doi.org/10.1016/j.ribaf.2023.101886

Are ESG Ratings Informative About Companies' Socially Responsible Behaviors Abroad? Evidence from the Russian Invasion of Ukraine

liz demers headshot

This study, by Daniyal Ahmed, Elizabeth Demers, Jurian Hendrikse, Philip Joos and Baruch Lev, exploits the Russian invasion of Ukraine as a revelation of the usefulness of Environmental, Social, and Governance (“ESG”) ratings to assess actual responsible corporate behavior. Extending Demers, Hendrikse, Joos, & Lev (2022), we collect data on European Stoxx 600 firms’ Russian exposure, pre-invasion Russia-related disclosures, post-invasion corporate response, ESG scores, and several market and financial variables. We focus our analysis on Stoxx 600 firms for three reasons. First, given the geographic proximity to Ukraine and the strong public outcry in Europe, European firms are likely to suffer more reputational damage from their economic relations with Russia. Second, the Stoxx 600 index represents an economically meaningful set of firms, covering large, mid, and small cap firms across 17 European countries, which together represent over 90% of the total European continent’s market capitalization. Third, Russia was the EU’s fifth largest trading partner in 2021, representing 5.8% of the EU’s total trade, while the European Union was Russia’s primary export market (European Commission, 2022).

View the full paper: Are ESG Ratings Informative About Companies' Socially Responsible Behaviors Abroad? Evidence from the Russian Invasion of Ukraine