How much – and why – do individual investors value ESG-related activities of firms? In a new working paper, we shed light on these questions by studying how retail investors transact in their personal portfolios around a primary source of information about such activities: the news. News events provide an ideal setting because they allow us to overcome measurement challenges, such as investors’ frictions in becoming aware of and subsequently understanding companies’ underlying ESG performance. For example, there is considerable disagreement across ESG ratings providers, as well as concerns about “greenwashing” or “social washing” by companies.
Leveraging novel data from Factset TruValue Labs’ Spotlight data solutions, we empirically demonstrate that retail-investor trading increases by approximately 8.5 percent on days when major ESG news becomes public. This finding suggests that retail investors in the United States collectively incorporate ESG-related news as an important determinant of their investment decisions. In the cross-section, we show that all categories of such news generate significant trading by retail investors, with news related to “Leadership and Governance”’ affecting trading the most. We also find substantial heterogeneity in the timing of investors’ reactions, with significant growth in their reactions over time.
We further explore the role of investor attention. We find significant increases in direct measures of investor attention (Google search and Bloomberg terminal activity) during periods of ESG news releases. Moreover, we find that retail investors’ trading activity around the release of ESG news is particularly pronounced for news that garners significant investor attention. These findings highlight the critical role of investors’ information awareness and processing constraints in incorporating ESG-related information into their portfolio decision-making process.
We also provide evidence of why retail investors care about ESG-related news. Specifically, retail investors could value ESG-related factors for pecuniary or non-pecuniary reasons. To shed light on whether retail investors have non-pecuniary preferences, we leverage the fact that investors’ perceptions of a news event’s ESG performance implications (i.e., positive or negative changes in a firm’s ESG performance) can be uncorrelated or even negatively correlated with investors’ beliefs about its implications for firm value. Our evidence strongly indicates that retail investors do not have non-pecuniary preferences. Instead, the pecuniary implications of ESG news (i.e., impacts on risk or returns) lead retail investors to engage in trading. Across multiple specifications, we find that retail investors’ portfolio allocation decisions are largely independent of the information revealed about ESG performance. Furthermore, our inferences hold in an examination of the trading behavior of investors potentially most likely to have non-pecuniary preferences, younger investors using the Robinhood trading platform.
We contribute to a growing literature that explores whether investors value ESG-related factors in their investment decisions. Our approach complements prior research by focusing on how investors transact around nearly all newsworthy ESG-related events. In doing so, we also contribute to a large literature on retail investor decision-making. Our findings highlight that retail investors appear to focus on news events’ implications for stock performance while also exhibiting information awareness and acquisition costs.
In exploring these issues, we help to reconcile mixed evidence found in concurrent studies and add new evidence relevant to the ongoing policy debate regarding those who invest on behalf of retail investors. Several states have already adopted regulations that ban ESG-related investment considerations in pension portfolios, and many others are proposing similar regulations. Much of the motivation for these restrictions relates to concerns that ESG investing may inhibit pension portfolio financial performance.
At a minimum, we highlight that outright bans on ESG considerations in retirement portfolios may be misguided. We show that retail investors (i.e., pension participants) already appear to consider ESG-related factors important in their portfolio objectives and that such considerations need not conflict with wealth creation. Our findings also strongly suggest that retail investors only value ESG-related factors for pecuniary reasons. Therefore, citing retail investors’ non-pecuniary objectives (e.g., supporting environmental or social issues) to allow investment strategies that sacrifice financial performance may be inadvisable.
Taken together, our findings support recent changes in federal regulation that overturned Trump-era rules largely banning ESG considerations in retirement funds. Despite recent pushback by Republicans who are attempting to block the recent regulation changes, the changes appear largely consistent with how individuals transact in their personal accounts.
This post comes to us from Qianqian Li at Stanford University, Professor Edward Watts at Yale University, and Professor Christina Zhu at the University of Pennsylvania. It is based on their recent article, “Retail Investors and ESG News,” available here.