Stuart L. Gillan, Jay C. Hartzell, Andrew Koch, and ... - Pitt Business

their value (and to avoid myopic behavior), or because investors simply place higher valuations
on such firms, or because it is in the managers’ own self interests. These possibilities differ in
terms of their predictions for relations between ESG or CSR performance and firm’s operating
performance, operational efficiency or revenues, managerial compensation, trading by
institutional investors, and ultimately, firm value.
We examine these relations in a sequence of tests in hopes of better understanding the
typical motive behind firms’ ESG decisions and the market’s response to those decisions. Using
KLD’s important index of firms’ environmental, social and governance strengths, concerns, and
the net of those two, we find little evidence that “good” ESG behaviors are typically pursued by
self-interested managers at the expense of shareholders. Instead, it appears that ESG firms
operate more efficiently, generate greater returns on assets, and have higher valuations. Further,
it does not seem to be the case that managers implementing stronger ESG policies are more
highly compensated than their peers, after controlling for standard determinants of
compensation. This suggests that if CEOs are using ESG policies to extract rents, it is not linked
to average profitability and expenses, and they are not also extracting rents via higher
compensation.
Interestingly, while these results are consistent with the idea that firms benefit from
investing in stronger ESG policies, the mechanism by which these practices are reflected in stock
prices is unclear. One natural candidate, increased institutional investment, does not appear to be
borne out in the data. If anything, it appears that on aggregate institutions own less, and sell
more, of firms that have greater scores along the environmental, social, and governance
dimensions, at least as measured by KLD through 2007. We do find some exceptions to these
overall finding in the case of KLDs governance rankings. Specifically, there is evidence
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