The importance of ESG ratings on risk-adjusted stock performance

Abstract

In this thesis, we conduct an empirical study of whether Environmental, Social, and Governance (ESG) ratings impact risk-adjusted stock performance and its ability to be used as a signal in investment strategies. We form top and bottom decile portfolios based on three different ESG ratings and regress the portfolio excess returns on Fama-French risk factors. The study returned positive significant monthly 5-factor alphas of up to 0.57% for top portfolios in the European market and indicates that aggregated ESG scores can provide valuable information to private investors; however, the US study failed to produce the same evidence. The inconsistent results prevent us from providing a decisive answer on the impact of ESG ratings on risk-adjusted stock performance.