Environmental, social, and governance factor and financial returns: what is the relationship? Investigating environmental, social, and governance factor models

Abstract

Sustainable finance and environmental, social, and governance (ESG) issues have garnered significant attention in both industry and academia. However, the lack of consensus on these concepts has led to confusion about their impact on investors and markets, hindering the interpretation of empirical data and the development of effective regulations. This highlights the need for transparent analyses from the finance research community. By reviewing recent asset pricing literature to determine if it has effectively identified an ESG factor, the paper examines theoretical models linking ESG factors to asset performance, with differing views on whether high-ESG firms yield lower returns due to reduced risk or outperform due to sustainable practices and market sentiment. The paper also reviews empirical studies, presenting findings on whether green assets outperform brown assets in financial markets. The paper contributes to the debate on integrating ESG into investment strategies without compromising returns, providing practical insights for investors and policymakers navigating responsible investing.