Investors are also concerned about climate change

The financial landscape has changed significantly in recent years, driven by investors looking to make sense of their investments on the one hand and increased regulation on the other. Many reforms in the form of European directives and rules concern the adequacy of information provided to investors in order to support the flow of capital into projects that ensure the sustainable transition of our society.

Faced with this paradigm shift, academic research plays an important role. At HEC Liège, the School of Management at the University of Liege, research in finance aims to inform private and professional investors, as well as financial professionals, about the challenges of sustainable finance.

What are ESG ratings?

ESG ratings are scores given to companies to measure their environmental (E), social (S), or the quality of their governance (G). There are different models. Some take a quantitative approach and combine a set of sub-indicators based on input data (eg greenhouse gas emissions by companies); others add a layer of analysis and interpretation. Some ESG scoring models collect information through surveys or discussions with companies; others do so solely on the basis of publicly available documents and information. The object of analysis may also differ: risks and / or opportunities for the development of the company, the impact on stakeholders, as well as an analysis that combines these points of view.

It also raises the question of the existence of non-financial sub-indicators on which the ratings are based. There are still significant barriers to obtaining information as very few companies actually report all of this information. Rating agencies make assumptions and extrapolate data (usually) based on industry practice. Because of these methodological differences, as well as the lack of access to the same sources of information, agencies give different ratings.

Impact of Information Uncertainty

The question naturally arises whether this uncertainty of non-financial information creates confusion for investors in assessing the value of financial assets. Preliminary research by HEC Liège shows that this uncertainty does make it difficult for investors to evaluate the company. In addition, there are significant frictions between supply and demand in the allocation of capital for sustainable investments: investors show limited understanding of ESG performance in the process of capital allocation. The results of studies conducted at HEC Liège even show that investors rely much more on the name of investment products when choosing investment products than on the ESG score.

What about Covid?

How has the Covid crisis affected investor preferences and awareness? On their investment behavior?

The pandemic has heightened investor focus on environmental and social issues, as evidenced by higher investment inflows to funds with higher ESG ratings. Scientific studies show that investors’ fears about climate change are putting pressure on the cost of financing “green” companies and that the investor is demanding a premium on earnings.

ESG rating compared to financial performance

Many studies focus on the predictive nature of ESG performance in relation to a company’s economic performance. For example, there is scientific evidence that employee well-being is a source of productivity, that environmental risk affects company profitability. The question is whether these ESG scores are capable of reflecting these elements. A study by HEC Liège shows that these rankings are influenced by characteristics external to sustainability, such as company size or a company’s ability to communicate. When these external elements are taken into account, our results show that predictive linkage is struggling to survive.