Alternative approaches in ESG investing : four essays on investment performance & risk
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ESG (Environmental, social, and governance) investing is an investment philosophy to inform holistic and sound decision-making of investors for the purposes of both, nourishing a stable economy with acceptable rates of return while at the same time addressing stakeholders' non-financial concerns to preserve an inhabitable planet. Some scholars in finance argue that institutions subject to norms, i.e. responsible investors pay a financial cost from engaging in ESG activities. Moreover, they see ESG investing as distracting, inappropriate, risky and legally challenging. In response, several studies have emerged to show that ESG investing is a growing interest with investors, helps to mitigate financial risks, and does not need to represent a financial cost. Despite convincing evidence in a growing body of academic literature, many questions are still open to debate. Therefore, the principal objective of this thesis is to explore three dimensions of ESG investing, namely corporate environmental responsibility, renewable energy, and ESG disclosure quality. The research questions address issues relating to pension funds' investment decisions and legal obstacles resulting from utilising ESG information, financial return and risk implications of investing in renewable energy, substitutability of renewable energy for fossil fuel investments, and the effects of ESG disclosure quality on the expected cost of capital. To answer these questions, the thesis employs several standard and alternative empirical methods from the asset pricing and risk literatures. The thesis concludes the following. First, the integration of environmental responsibility into pension fund investment decision-making processes does not impede the financial and risk performance of pension funds. This means that pension funds should be allowed to consider such information in their investment decision making processes as the information does not reduce the overall financial return of the tested portfolios and does not violate trust law, i.e. the Employee Retirement Income Security Act (ERISA). Pension fund trustees have been prohibited to consider any non-financial criteria such as environmental, social, or governance criteria in their investment processes under trust law such as ERISA, when they could harm the finanical performance of the portfolio. To be more specific, a pension fund trustee breaches his fiduciary duties (the duty of loyalty and the duty of prudence), if he sacrifices the financial well-being of the pension fund for pursuing any other social goal (Langbein and Posner, 1980). In particular, the duty of loyalty is "...forbidding the trustee to invest for any object other than the highest return consistent with the preferred level of portfolio risk" (Langbein and Posner, 1980:98). Second, the thesis finds no evidence for sustained renewable energy equity premia. Furthermore, investments in renewable energy equity are considerably riskier than in fossil fuel energy equity, meaning that renewable energy firms are undergoing a period of high uncertainties related to their business model, low carbon prices, and lacking public and private infrastructure investment (Bohl et al., 2013; Kumar et al., 2012; Sadorsky, 2012b ). Finally, my thesis shows that companies with high ESG disclosure quality experience lower expected cost of equity and cost of debt financing, everything else equal.
Thesis, PhD Doctor of Philosophy