Sustainability priorities, corporate strategy, and investor behavior

• Date: 01 January 2019
• DOI: http://doi.org/10.1002/rfe.1052
• Author: Norma Juma,Reza Espahbodi,Amy Westbrook,Linda Espahbodi
• Published date: 01 January 2019

Rev Financ Econ. 2019;37:149–167. wileyonlinelibrary.com/journal/rfe

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© 2019 University of New Orleans

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INTRODUCTION

A growing number of companies have been reporting on their performance in environmental, social, and governance

(ESG) areas.1 Environmental, social, and governance reports, often referred to as Sustainability reports or Corporate Social

Responsibility (CSR) reports, are normally issued separately from the annual and quarterly financial reports and describe

companies’ investments and outcomes in a variety of activities that extend beyond basic compliance with applicable laws and

regulations. Depending on the company, ESG reports address topics ranging from carbon emission to water management to

diversity to child labor.

The increase in the supply of ESG information has paralleled investors’ demand for the same. As the world becomes more

developed and more interested in environmental and social issues because of global challenges such as climate change and

scarcity of natural resources, investors are increasingly calling for more ESG disclosures. Over 1,700 investors, representing

about US $62 trillion in assets under management, have signed the UN- backed Principles for Responsible Investment since

their launch in 2006 (UN PRI 2017). BlackRock, the biggest investor in public companies in the world with $6 trillion under

management, recently sent a letter to CEOs of public companies stating that they must show how they contribute to society, or

risk losing the money- management fir m's support (BlackRock 2018).

Received: 11 April 2018

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Accepted: 18 April 2018

DOI: 10.1002/rfe.1052

SPECIAL ISSUE ARTICLE

Sustainability priorities, corporate strategy, and investor

behavior

Linda Espahbodi1

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Reza Espahbodi2

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Norma Juma2

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Amy Westbrook2

1Inspiring Accounting Talent for a

Sustainable Society, Williamsburg, Virginia

2Washburn University, Topeka, Kansas

Correspondence

Reza Espahbodi, Washburn University,

Topeka, Kansas

Email: reza.espahbodi@washburn.edu

Abstract

Using a sequential experiment, this study examines whether integration of material

environmental, social, and governance (ESG) priorities into corporate strategy im-

pacts investors’ short- and long- term stock price assessments and investment alloca-

tion. In our examination, we consider the potential moderating effect of financial

performance. We find that integration of ESG priorities into strategy does not have a

significant effect on investors’ price assessments or investment allocation. This is

true regardless of the trend in the company's financial performance. Our results hold

across various demographics and the levels of investment knowledge and investment

experience. Investors’ perception of relevance and reliability of material ESG infor-

mation, however, has a mediating effect on their long- term price assessment and

investment allocation. Overall, our findings suggest that any future requirements on

disclosure of ESG information by regulators and standard setters should aim to im-

prove investors’ perception of the relevance and reliability of that information.

JEL CLASSIFICATION

M14, Q55, G11

KEYWORDS

corporate strategy, environmental, social, and governance (ESG) reports, investment decisions,

sustainability reports

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ESPAHBODI EtAl.

Regulation of ESG disclosure, along with ESG- related investigations of and enforcement actions against companies, also

is increasing. In 2010, the U.S. Environmental Protection Agency began requiring large emitters of greenhouse gasses to col-

lect and report data with respect to their greenhouse gas emissions (EPA 2009). That same year, the Securities and Exchange

Commission (SEC) issued guidance to public companies about how to disclose climate change- related matters (SEC 2010),2

and Congress passed the Dodd- Frank Act, which added more ESG disclosure requirements (Dodd- Frank 2010).3 Currently, the

SEC is considering modernizing Regulation S- K requirements for company disclosure relating to sustainability (SEC 2016),4

which would likely increase ESG disclosure.

Non- U.S. regulatory requirements are also increasing. For example, an EU directive requiring large public interest com-

panies to address policies, risks, and results relating to ESG matters in their annual reports came into effect for financial year

2017 (EU Directive 2014). The new requirement is expected to increase the number of EU companies producing sustainabil-

ity reports to nearly 7,000. The London Stock Exchange Group issued new ESG reporting guidance for climate change and

sustainability- related matters in Febr uary 2017 (LSEG 2017).

Although regulators and investors appear to desire or require information about companies’ ESG performance, whether and

when (i.e., under what conditions) investors use that information in their decisions has been the subject of many survey, archival

and experimental studies. For example, an International Federation of Accountants survey finds that investors increasingly use

ESG disclosures to understand a company's ESG priorities and how they impact overall performance over a longer time horizon

(IFAC 2012). A 2015 survey by the CFA Institute indicates that 73% of respondents (portfolio managers and research analysts)

take ESG information into account in their investment analyses and decisions (CFA 2015). The results of these survey studies

indicate that investors increasingly demand ESG information and use it in their decisions. Investors also pay attention to the

long- ter m impact of ESG activities on overall performance.

Archival studies on whether and when investors use ESG disclosures have reached varied and sometimes contradictory

conclusions. Some archival studies have questioned the relevance of ESG information (e.g., Campbell & Slack, 2011; Deegan

& Rankin, 1997) and investors’ commitment to ESG priorities or their ability to convert their commitment into practice (e.g.,

Bailey, Klempner, & Zoffer, 2016). However, the majority have shown that ESG reports have an impact on corporate valu-

ation and are of decision- making relevance for investors (e.g., Ansari, Cajias, & Bienert, 2015; Cohen, Holder- Webb, Nath,

& Wood, 2011; Harkins & Arndt, 2012; Khan, Serafeim, & Yoon, 2016; Solomon & Solomon, 2006; Thompson & Cowton,

2004). Experimental studies also report mixed results. For example, Milne and Chan (1999) find that social disclosures only

have a marginal impact on investment decisions. Nevertheless, most experimental studies have shown that ESG information

impacts corporate valuation and investors’ decisions (Chan & Milne, 1999; Holm & Rikhardsson, 2008; Martin & Moser, 2016;

Reimsbach & Hahn, 2015), especially in the presence of ESG assurance and strategic relevance of ESG factors (e.g., Brown-

Liburd & Zamora, 2015; Cheng, Green, & Chi Wa Ko, 2015).

Overall, regulatory requirements, and the results of survey, archival, and experimental studies, conclude that ESG reports

influence investors’ decisions, that is, they represent value- relevant information. The conclusion that ESG reports influence

investors’ decisions is consistent with that of a meta- analysis by Margolis, Elfenbein, and Walsh (2007) who review 251 studies

and find that the bulk of the evidence indicates that ESG initiatives have a positive, but small, impact on firms and are relevant

to investors and influential in their decisions.

In this study, we take investors’ use (whether investors use ESG disclosures) as given and aim to advance our understanding

of when investors use ESG disclosures. In particular, we examine investors’ short- and long- term stock price assessments and

investment allocation in response to a company's inclusion in its strategy of ESG factors that are material for a company's in-

dustry (hereafter, ESG priorities), that is, priorities that have the greatest impact on the company's ability to create sustainable

shareholder value. In our examination, we consider the potential moderating effect of financial performance.

We posit that the investors’ stock price revisions will be greater when ESG priorities are integrated into corporate strategy

than when they are not, and expect that integration to influence the amount of money investors are willing to invest in a com-

pany. We also conjecture that the company's financial performance will moderate the relationship between the integration of

ESG priorities into company strategy and investors’ decisions. Furthermore, we conjecture that non- results in our experiment

may be due to investors not perceiving the integration of ESG priorities into corporate strategy as being important or meaning-

ful to risk/return analysis.

To test our hypotheses, we conduct a between- subject 2 × 2 sequential experiment using graduate students in a Master's of

Accountancy program as participants. Participants were provided industry, company, and selected financial data, manipulated

to show improving or declining sales and earnings by about 10%, for a medical device company (disguised).5 Participants were

asked to assess the stock price in the short and long run and to decide what portion of their additional funds to invest in the

company. They were then provided with the ESG information for the same company, manipulated for the ESG priorities to be

included in the company's strategy or not, and asked to repeat their stock price assessments and investment allocation.