The Role of Governance and ESG on Financial Performance

Abstract

The global shift towards sustainability has intensified focus on robust ESG practices among companies and investors. Analyzing long-short portfolios of 225 Japanese and 498 US companies from 2004 to 2023 using the Fama-French five-factor and Carhart models, we found predominantly negative alphas. In the US, alphas show a large magnitude and statistically significant, indicating an ESG premium, whereas in Japan, they were insignificant. Our results shows that portfolios with lower ESG scores outperform those with higher scores. Additionally, comparing random forest and univariate sorts, we found that univariate sorts provide better insights into ESG scores in our setting.