Does Materiality Matter? Links Between ESG Issues and Firm Performance

Abstract

Using material classifications of sustainability categories, we map industry-specific sustainability indicators into materiality-adjusted firm-level ESG scores in a unique geographical sample of the Nordics and the United Kingdom for the 2009-2018 period. Common to the return predictability literature, top and bottom portfolios are sorted based on the residuals from an orthogonalization of changes in material ESG scores with respect to changes in common firm characteristics. Mixed evidence is found on the link between material ESG performance and future stock returns, with only one portfolio exhibiting a significant alpha. Furthermore, panel data fixed effects models are used to test the implications of material ESG performance on year-ahead accounting performance. We distinguish between top performers and improvers on material ESG by using changes and levels in the scores. Results show that the top improvers on material ESG scores exhibit positive future ROA, whereas there is no significant link between being a top performer and future profitability.