Is ESG investment rewarded or just doing good? Evidence from China

The question of whether ESG investment is rewarding is a key determinant of its attractiveness to investors. Despite extensive research, a consensus remains elusive. This paper delves into the potential costs and benefits of ESG preferences in the Chinese stock market by constructing three-dimensional portfolios that integrate risk, return, and investor ESG preference. Instead of providing a binary answer of whether ESG investment is rewarding, we offer a glide path of costs to investors for achieving their ESG goals. Furthermore, given the potential market cap bias, we examine the differences in costs between portfolios composed of large-cap and small-cap stocks. Our empirical findings are twofold: first, if investors have a relatively low preference for companies' ESG performance, their investment is as rewarding as those with no ESG preference. However, if they have a high level of preference for ESG performance, their investment may be just doing good. This means that if the level of ESG preference is below a certain threshold, the costs of ESG preference are minimal or even zero. However, when the threshold is crossed, the costs rise sharply. Second, these costs vary significantly between portfolios with different market capitalizations. Specifically, incorporating ESG factors into small-cap portfolios often results in higher financial sacrifices compared to large-cap portfolios. These insights are crucial for investors seeking to balance financial and non-pecuniary objectives, providing guidance for optimizing ESG integration strategies in their investments.