Authors: ESG Research Center
1. Introduction
With growing environmental awareness in recent years, ESG has received more attention and has been built into strategic planning by more and more companies. ESG is composed of three factors: environment, society, and governance. It measures the impact of business and investment activities on the environment and society and the strength of corporate governance – factors that represent a company’s non-financial performance (Atan, Alam, Said, & Zamri, 2018).
According to 2018 data, global ESG assets under management reached $30.7 trillion, accounting for 30% of total global assets under supervision. The proportion keeps rising steadily.
At present, there are relevant guidelines proposed by international organizations, such as the UN Principles for Responsible Investment (UNPRI) and ESG disclosure practices for listed companies issued by the United Nations Sustainable Stock Exchange (UN SSE) in 2015 for voluntary adoption by exchanges. In addition, there are also measures for mandatory information disclosure issued by stock exchanges, such as the ESG Reporting Guide issued in December 2015 by the Hong Kong Stock Exchange.
With great international interest in ESG investment, many empirical and theoretical studies have been carried out on ESG. In particular, the relationship between corporate ESG performance and financial performance has been widely studied.
Some studies have found that there is a negative correlation between corporate ESG performance and financial performance. For example, Brammer et al. (2006) find that there is a negative correlation between a company’s social performance indicator score and share returns. D. D. Lee et al. (2009) find that ESG Dynamics and Analysis China And Global Market Research there is a negative correlation between corporate social responsibility performance and market performance. Duque-Grisales and Aguilera-Caracuel (2019) use a sample of 104 transnational companies in Latin America and use panel data to study the relationship between corporate ESG score and financial performance. The study finds that there is a significant negative correlation between the two variables.
However, more studies have found a positive correlation between corporate ESG performance and financial performance. Friede et al. (2015) compiled more than 2200 studies on the correlation between ESG performance and financial performance since the 1970s. They found that 90% of studies find a non-negative relationship between ESG performance and financial performance. Based on indicators such as return on assets and rate of capital return, Nollet et al. (2016) studied the relationship between corporate social performance (CSP) and corporate financial performance (CFP) by using a non-linear model. They found a U-shaped relationship among corporate social performance, return on assets, and capital return rate, implying that excellent corporate social responsibility performance can improve financial performance in the long term.
K.-H. Lee et al. (2016) use a sample of South Korean companies from 2011 to 2012 and use the least square method and two-stage least square method to study the relationship between corporate environmental responsibility performance and financial performance. It was found that there is a significant positive correlation between corporate environmental responsibility performance, return on stockholder’s equity and return on assets. Similarly, Barnett and Salomon (2012) also find that companies with excellent corporate social responsibility performance usually perform better financially.
When making investment decisions, socially responsible investors weigh social or moral objectives more than economic benefits (Renneboog, Ter Horst, & Zhang, 2008). However, ESG investment is not merely an “emotional” investment. Companies with excellent ESG performance usually have high financial performance (Barnett & Salomon, 2012), good credit quality (Chang, Yan, & Chou, 2013), and substantial risk resistance capacity (Lins, Servaes, & Tamayo, 2017).
A review of the literature finds that excellent ESG performance can enhance corporate value. Cheng, Ioannou, and Serafeim (2014) find that the better corporate social responsibility performance, the lower the capital constraint, thus promoting growth capability and enhancing value by increasing research inputs and other practical measures. Liu and Zhang (2017) took a sample of heavy-polluting listed Chinese companies and studied the relationship between corporate governance, social responsibility information disclosure, and corporate value. It was found that higher levels of corporate governance promote corporate social responsibility information disclosure. Social responsibility information disclosure was found to be beneficial to the long-term value enhancement of an enterprise. Crifo, Forget, and Teyssier (2015) used field experiments to quantify the impact of corporate ESG practice disclosure on the value of non-listed companies. They found that excellent ESG practice enhances corporate value, while negative ESG performance reduces corporate value and investors’ willingness to invest. Barko, Cremers, and Renneboog (2018) come to a similar conclusion, namely that investors such as hedge funds and pension funds prefer to invest in companies with better ESG performance. Nollet et al. (2016) found that enterprises that build social responsibility into a strategy can increase consumers’ willingness to buy and investors’ willingness to invest, thus creating extra value for its products.
ESG performance can also increase a company’s market value. Masulis, Wang, and Xie (2007) find that companies with poor environmental performance and poor corporate governance are more likely to make poor decisions in acquisitions, thus reducing their market value. Qiu et al. (2016) find that the higher the degree of CSR information disclosure, the higher the market value of the company, with the positive correlation driven by a higher expected cash flow growth rate. Miralles-Quirós, Miralles-Quirós, and Gonçalves (2018) study environmental, social, and corporate governance factors and find that solid ESG performance can increase enterprise market value.
Lo and Sheu (2007) studied large non-financial enterprises in the United States from 1999 to 2002, exploring whether corporate sustainability impacts market value. They found a significant positive correlation between these two variables, indicating that companies with clear sustainable development strategies are more likely to obtain higher valuations by investors in financial markets.
The third benefit of good ESG performance is to increase enterprise economic benefits. Ferrero-Ferrero, Fernández-Izquierdo, and Muñoz-Torres (2016) take 15 listed companies in Europe from 2002 to 2011 as their sample, finding that excellent ESG performance is an intangible asset that can boost economic benefits to a company. Similarly, Sila and Cek (2017) also find that excellent CSR performance can help improve a firm’s economic efficiency.
While many studies examine the relationship between corporate ESG performance and financial performance, few studies focus on the relationship between a company’s ESG performance and its stock liquidity. Stock liquidity, which indicates the ability to turn assets into cash quickly, is crucial in the market (Schwartz, 1988) (Amihud & Mendelson, 1988). Therefore, this paper aims to fill this gap and provide an empirical study on the relationship between ESG performance of listed companies in China and their stock liquidity.
2. Theory and Research Hypothesis
Theory
According to the literature review, we find that good ESG performance helps to enhance enterprise value (Barko et al., 2018; Cheng et al., 2014; Crifo et al., 2015; Liu & Zhang, 2017; Nollet et al., 2016), market value (Lo & Sheu, 2007; Masulis et al., 2007; Miralles-Quirós et al., 2018; Qiu et al., 2016), and economic benefits (Ferrero-Ferrero et al., 2016; Sila & Cek, 2017). Further, the paper explores and analyzes the two potential transmission mechanisms – “corporate value” and “investor attention.”
Through the “corporate value” channel, good ESG performance can enhance the intrinsic value of a company and build trust between the enterprise and investors. In particular, when risks emerge, companies with good ESG performance can better withstand risks and survive in the long run. Therefore, investors, especially socially responsible investors, are more willing to hold their shares for a long time to reduce investment risks and increase investment value.
Another linkage is the “investor attention” channel. When a company discloses information covering aspects such as green bonds issuance, poverty alleviation, and employee training, it will increase media exposure, leading to increased company visibility and investor attention, thereby attracting (socially responsible) investors to buy the company’s shares.
Research Hypothesis
According to the “corporate value” channel, investors should hold the stock of companies with better ESG performance for longer, reducing stock liquidity. Therefore, we raise hypothesis I (a): There is a negative correlation between a company’s ESG performance and stock liquidity.
In contrast, according to the “investor attention” channel, good corporate ESG performance (e.g., issuing green bonds) will improve corporate transparency, attract investors’ attention and broaden the investor base (Tang & Zhang, 2018), thereby increasing stock liquidity. Therefore, we raise hypothesis I (b): There is a positive correlation between a company’s ESG performance and stock liquidity.
3. Sample and Data
This paper studies companies that were listed on the CSI 300 index between January 2016 and June 2019. Non-equilibrium panel data was created every six months for the research period, giving 2,100 observations in total. Among these, the ESG score of listed companies comes from the IIGF ESG Database. Market data (including share returns, closing price, market value, industry, ownership) came from the CSMAR database.
Correlation between ESG and Stock Liquidity The “corporate value” channel means that investors should hold corporate stocks with better ESG performance for longer, thus reducing their liquidity. Therefore, a negative correlation would be expected between a company’s ESG performance and stock liquidity. The “investor attention” channel predicts that companies with excellent ESG performance will attract investors’ attention, thus increasing their stock liquidity. Therefore, a positive correlation would be expected between ESG performance and stock liquidity.
Next, using the sample of CSI index companies from January 2016 to June 2019, we explored the empirical relationship between a company’s ESG score and its stock liquidity to identify which channel has a more prominent market effect in China.
Corporate ESG Performance
In this paper, the ESG score represents corporate ESG performance. The higher the score, the better the ESG performance
From the table above, we can see that the ESG score of listed companies varies little over time, but the ESG performance level of different companies varies considerably: The highest ESG score recorded is 111.62 points, which is 69.44 points higher than the average. Due to various negative behaviors and risks, the lowest ESG score recorded is -19.48 points, which is 61.67 points lower than the average score.
It can be seen from the above figure, CSI300 listed companies scoring from 38 to 42 points account for the largest proportion (nearly 10%), followed by listed companies scoring between 34 and 38 points and between 42 and 44 points, both of which account for more than 8%. Nearly 70% of listed companies scored between 20 and 60 points.
Stock Liquidity
This paper adopts the Amihud (2002) method, which is widely used, to calculate stock liquidity. Amihud is the illiquidity indicator, that is, the higher the calculated value, the lower the stock liquidity. The specific formula is as follows:
4.Correlation between ESG and Stock Liquidity
Empirical Result Analysis of ESG and Stock Liquidity
First of all, the scatter diagram (Figure 2) indicates a quantitative correlation between ESG and stock liquidity. As the ESG score of a company increases, its stock liquidity also tends to increase, showing a positive correlation. It shows that the “investor attention” channel plays a dominant role in the market reaction to a company fulfilling its social responsibilities.
5. Conclusions
Through the empirical research and analysis above, we find a significant positive correlation between corporate ESG performance and stock liquidity, indicating that the “investor attention” channel plays a dominant role in the market reaction to a company fulfilling its social responsibilities. A company’s excellent ESG performance will attract the attention of investors, expand the investor base and increase stock liquidity. Moreover, the “investor attention” channel is mainly reflected by state-owned enterprises. In addition, it was found that the ESG performance stronger impacts stock liquidity of nonindustrial enterprises than the industrial ones.