Who invests in companies that score highly on the metrics of environmental, social responsibility and governance (ESG)?
Long-term institutional investors like pension funds do. And they’re less likely to sell stock in companies that score well on ESG metrics in the face of poor returns or earnings shortfalls.
That’s the core finding of the research awarded the 2021 Moskowitz Prize by the Kellogg School of Management. Awarded annually, the Prize is the premier global recognition for research in sustainable finance. Prize judges identify an exceptional paper focused on sustainable and responsible investing with the potential to impact practice.
This year’s recipients are Laura Starks of the University of Texas McCombs School of Business, Parth Venkat of the University of Alabama Culverhouse School of Business and Qifei Zhu of the Nanyang Business School for their paper “Corporate ESG Profiles and Investor Horizons.”
The inaugural Moskowitz Prize, named after pioneering sustainable-finance researcher Milton Moskowitz (1932-2019), was awarded in 1996.
The prize was the brainchild of Lloyd Kurtz, head of social impact investing at Wells Fargo Private Wealth Management and current visiting scholar at Kellogg. An analyst at the time when he conceived of the award, Kurtz believed there weren’t sufficient empirical studies to understand the scope, dynamics, and impact of sustainable investing. He created the Moskowitz Prize to address this problem in part by raising awareness of and incentivizing sustainable finance research.
“The point was to bring data and facts into a conversation that at that time was primarily ideological,” Kurtz said.
Kurtz is among this year’s Moskowitz Prize judges, which includes Kellogg Dean Francesca Cornelli and Kellogg faculty members Ravi Jagannathan, Mitchell Petersen and Dave Chen. Kellogg received sponsorship support for the Prize from eight major financial institutions, including premier sponsors Bailard, Breckinridge Capital, the Calvert Institute for Responsible Investing and Russell Investments.
Investing in high-ESG firms
To understand patterns related to investing in high-ESG businesses, the prize-winning researchers examined institutional investors’ portfolio holdings — those of pension funds, mutual funds, and others — and changes in those holdings, along with identifying who shareholders of higher- and lower-ESG firms were.
“We wanted to understand if there were certain types of investors recognizing the value of ESG,” Starks said. “We hypothesized that the institutional investors with longer-term investing horizons will be more interested in high-ESG firms and more patient with high-ESG firms that have poor returns or earnings shortfalls — they will give them more slack.”
The study’s empirical results support that prediction on multiple levels. For example, the researchers find that the portfolios of longer-term investors, or those with longer gaps between buying and selling, do have a higher proportion of high-ESG-firm stocks than shorter-term investors’ portfolios do. Similarly, at the firm level, they find that high-ESG firms have greater proportions of long-term investors as shareholders. As hypothesized, long-term investors are less likely to sell a high-ESG firm than a low-ESG firm after a company has poor stock returns or an earnings shortfall.
The study also examined reactions to a firm’s change in ESG standings. As expected, when a firm is recognized for its ESG efforts — in this case, being added to the FTSE4Good USA Index — long-term investors are more likely to increase their holdings of that business. “That helps us get at causality between high ESG and investing,” Starks said.
The research finds these investors are more patient toward firms added to that ESG index and less patient toward firms dropped from it. The findings represent good news for firms that prioritize ESG.
“The implication for firm management is that if you have better ESG, you’re going to be more attractive to long-term investors,” Starks said. “There’s a belief that firms prefer longer-term investors because their stock price doesn't get affected by small events; there’s not as much volatility. So to get these investors you should improve your ESG, which is good for society overall.”
The trend is here to stay
“The findings suggest that ESG considerations are influencing investment decisions of investors with longer investment horizons,” Jagannathan said. “If long-term investors are getting into ESG issues in a big way while making portfolio-choice decisions, that means the trend is here to stay. It is not a passing fad.”
Fellow Moskowitz Prize judge Kurtz said, “The idea is that if markets are myopic and fixated on one- and two-year performance, they might be getting the long-term picture wrong and there might be opportunity for long-term investors to profit. And most of the things ESG investors care about like climate change tend to have long time horizons. So, Starks and her team show that companies with stronger ESG performance are preferred by investors with longer time horizons, which ties together debates about whether long-termism is good and ESG is good.”
“Investors in higher-ESG companies are willing to look through the bad news because they have confidence in the sustainability of the story,” Kurtz said. “The research shows that institutional investors are placing a bet that ESG provides significant clues to a firm’s sustainability of operations and economic success.”
Importance on the sustainable finance landscape
The Moskowitz Prize, now well into its third decade, represents an important award on the broad sustainable finance landscape.
“I’ve been doing research in ESG and teaching ESG investing for 10 years,” Starks said. “So I've been very aware of this prize, and for all of us it’s such an honor to win such renowned recognition for quality research on ESG and corporate social responsibility.”
“Study of ESG investing has become mainstream. Lots of serious academics are working on that issue now, and the Prize has played a small role, so we’re happy about that,” Jagannathan said.
Kurtz, who originated the Moskowitz Prize, notes how it has sustained relevance over time.
“As mainstream interest in ESG surged, I thought the prize would go by the wayside,” he said. “But what happened instead was that suddenly you have a lot of people coming into the [ESG investing] field, who need to sort out signal from noise. This is an emerging, multi-layered field with lots of innovation, and there is a certain amount of hyperbole that comes with that. The prize can help identify high quality work that really deserves attention. The 26 papers the Prize represents is a pretty good body of literature.”
Megan Kashner, Kellogg’s director of social impact, is pleased to see long-time researcher and field leader Starks win this year’s prize.
“Because we lead not only the Moskowitz Prize, but also the Kellogg-Morgan Stanley Sustainable Investing Challenge and the global Impact & Sustainable Finance Faculty Consortium, we know the value that Laura Starks brings to the field of sustainable finance as a whole,” she said. “Laura has written pioneering research in this area for many years, has mentored researchers in the field, and collaborates across the sector to advance sustainable finance and ESG leadership globally. It’s a pleasure to celebrate her work in this way with this prize.”