How Does ESG Emphasis Impact a Company’s Value?

Research co-authored by Wharton’s Serguei Netessine examines how discussing nonmaterial and material ESG factors in companies’ earnings calls influences their overall worth.

In a clear stance last spring, Bank of America’s CEO Brian Moynihan underscored the lender’s commitment to profits, declaring: “We are capitalists.” While this might seem like an obvious affirmation for a bank, it comes at a time when some Wall Street institutions are under fire from Republican politicians who argue that they are putting environmental, social, and governance (ESG) factors above shareholder returns. Moynihan had previously said that “capitalism is the system that will drive the best outcome, and so we believe in profits and purpose.”

This type of conflict has sparked a need for a deeper understanding of how ESG factors impact a company’s value. A recent research paper co-authored by Wharton senior vice dean for innovation and global initiatives Serguei Netessine explores this question by examining how companies discuss nonmaterial ESG factors (i.e., ones that are less important or less integral to the firm’s core business) versus material ones in their earnings calls — and how it influences their overall worth. Netessine’s co-authors include Sonam Singh and Ashwin V. Malshe from the University of Texas at San Antonio, and Yakov Bart from Northeastern University.

The researchers’ findings indicate that when companies focus on nonmaterial ESG factors in their quarterly financial updates, investors interpret it as a negative sign, signaling potential issues like higher costs, inefficient resource use, and distracted management. And the negative effects of nonmaterial considerations outweigh the positive effects of material ones on a company’s value.

For every 10% increase in emphasis on material ESG concerns, the company’s value goes up by 1.4%, but a similar increase in nonmaterial ESG emphasis leads to a 3% decline in value. Netessine said: “When companies discuss matters crucial to their business model — for example, a logistics firm discussing how to reduce their supply chain emissions — investors find it sensible. But very often companies talk about unrelated topics like saving penguins and planting forests. The markets hate that. It leads to a pretty dramatic decrease in the value of the company.”

The study suggests that investors and researchers should avoid combining material and nonmaterial ESG factors into one aggregate measure. “Investors should pay closer attention to what companies say in earnings calls. If the executives speak a lot about ESG but it’s not material, it will be negatively reflected in the value of the company. On the other hand, highlighting material ESG activities is reflected positively,” Netessine asserted.

Trade-offs Between ESG Goals and Financial Performance

While many studies stress the importance of addressing ESG concerns in business communication (some investors believe it’s crucial for long-term success), there is growing skepticism about the trade-offs between ESG goals and financial performance, as the Bank of America case illustrates. Some recent studies even suggest that focusing on ESG may not necessarily result in higher returns, adding fuel to the ongoing debate.

Netessine notes a dichotomy between retail and institutional investors in this context. “Individual stock-pickers are often willing to sacrifice financial returns for a more responsible and sustainable portfolio. This differs from large fund managers who must focus on financial returns due to their fiduciary duty,” he said.

Employing a deep learning model called ESG-BERT, Netessine and his fellow researchers studied earnings call transcripts from 6,730 firms in the period between 2005 and 2021. Their analysis reveals that the negative impact of nonmaterial ESG emphasis on a company’s value gets worse over time, with a yearly increase of 0.03%. This is attributed to the rising prominence of standards focused on materiality, such as those from the Sustainability Accounting Standards Board (SASB). “Investors expect companies to better distinguish between material and nonmaterial ESG factors,” Netessine added.

The research further highlights that the negative impact of nonmaterial ESG emphasis is more pronounced for companies in regulated industries, such as finance and banking. Netessine said this can be explained by investors’ desire for reassurance of steady returns, coupled with the potential harm to already thin profit margins resulting from the immediate costs of focusing on nonmaterial ESG considerations.

He suggests that these findings can ultimately help executives understand how ESG factors influence a company’s value. The paper may also help them balance the needs of investors who prioritize important ESG factors for financial reasons, and other stakeholders who want more attention on less financially crucial ESG issues.