Doing Well by Doing Good? Risk, Return, and Environmental and Social Ratings

We analyse the risk and return relationship of firms sorted by environmental and social (ES) ratings. We document that ES ratings do not have a statistically significant relationship with either average stock returns or unconditional market risk measures. Firms with high ES ratings have significantly lower downside risk than firms with lower ES ratings. However, a two standard-deviation move across stocks on ES score results in a decrease in downside risk measuring only 4–8% of the underlying downside risk measure’s standard deviation. This decrease in downside risk for high ES firms can be partly attributed to the news sentiment about the firms and institutional trading. Our results suggest that ES investing may not be justified solely based on the risk-return relationship of ES firms.