This report investigates whether highly rated senior managers are more successful when allocating firms’ resources towards Environmental, Social, and Governance (ESG) projects that enhance shareholder value. The findings indicate that high-ability senior managers direct their resources towards value-enhancing ESG initiatives resulting in significant future stock returns compared to firms with low ratings on both measures.

Introduction

This report delves into the pressure that senior managers face when deciding to allocate funds to ESG projects. The competing views on corporate ESG efforts highlight the complexities associated with selecting ESG activities and deciding how much to spend on each initiative.

Method

The paper uses MSCI ESG ratings and Glassdoor employee ratings of senior managers as signals for firm ESG efforts and high managerial ability, respectively, to understand the role of senior manager ability in allocating capital to ESG. The paper undertakes a calendar-time portfolio regression design and uses different controls and fixed-effect structures to probe the relationships between the variables.

Management’s ESG resource allocation dilemma

The report highlights that senior managers face significant pressure to allocate resources to ESG efforts and that ESG efforts seem contrary to traditional shareholder value creation goals. The report notes that ESG efforts are motivated by conflicting theories with different shareholder value implications, leading to uncertainty on the type of ESG efforts senior managers should pursue.

ESG Ratings and Firm Characteristics

The study reveals that firms with highly rated managers and high ESG scores exhibit significantly higher future stock returns than firms with low ratings on both. The results are robust to various fixed effect structures and controlling for more covariates in a panel regression.

Manager ability and firm value

The report suggests that high-ability senior managers can select ESG projects that enhance shareholder value because their compensation is often tied to stock prices. It also notes that senior managers who have a fiduciary duty to shareholders face a complicated optimization problem that requires them to decide which projects to choose and what amount of resources to allocate.

Discussion and limitations

The report acknowledges that there is a discrepancy between ESG disclosure and performance, making it difficult for senior managers to assess which ESG activities to prioritize. The report suggests that high-ability senior managers who receive higher employee ratings may use ESG investments to generate superior performance. However, given the lack of mandatory regulatory disclosure requirements governing ESG information disclosure, this study’s findings may not apply in certain industries.

Conclusion

Overall, high-ability senior managers can improve their firms’ ESG investments, simultaneously creating shareholder value. The study suggests that investors and senior managers may need to consider multiple factors, including ESG ratings and managerial ability, when choosing where to allocate resources towards ESG efforts.