Professionals use ESG information differently

Some time ago, I wrote about how increased ESG disclosure leads to higher trust in the companies and a more positive attitude of investors towards the long-term prospects of these companies. But Sandra Chrzan and Christiane Pott from TU Dortmund put another twist on this research that I find interesting.

Ostensibly, they set out to test if the new EU Taxonomy for disclosure of environmentally sustainable activities leads to more trust in the company, but by choosing an anonymised real life consumer company and adding a little twist, I think they tested something far more interesting.

What they did is recruit both private (retail) investors and professional investors and presented them with the financial and non-financial ESG information of a consumer company. They used the real data of an existing consumer company and anonymised it and they presented the data to investors in three versions, financial information only, financial information plus qualitative ESG information, and financial information plus ESG information along the new EU Taxonomy regulation. But, and this is where the experiment gets interesting, they showed the ESG data in the EU Taxonomy in comparison to a peer group average, something that companies generally don’t do, but that is likely to become more common as the EU adopts the proposed new IFRS Sustainable Disclosure Rules.

And as chance had it, the ESG data of the anonymised consumer company was worse than the peer group average, which provides an interesting test. The EU and other regulators around the world introduce disclosure rules as a means to increase transparency and foster trust in the company. If that is what these disclosure rules do then investors should become more positively inclined to a stock no matter whether the ESG data disclosed is positive or negative. More disclosure is always better.

But if investors use ESG data as an additional means to assess the return prospects of a company above and beyond financial information, then positive ESG information should increase the attractiveness of a stock while negative ESG data should reduce it.

The chart below shows how likely private and professional investors were to recommend the stocks when presented with financial information only (FIN), financial and qualitative ESG information (ECO), and financial and EU Taxonomy information (EUT).

Likelihood of recommendation of a stock with and without ESG information

Source: Chrzan and Pott (2022).

For private investors, the likelihood of recommending the stock as a long-term investment increased when additional ESG information was provided. It didn’t matter if it was qualitative or quantitative ESG information along the EU Taxonomy. The positive effect of increased transparency trumped the actual content for retail investors. For professional investors, the effect was different. Disclosure of moderate or poor ESG information made them less likely to recommend the stock, particularly in the EU Taxonomy setup where data was compared to a peer group average. For the professionals, it is not about transparency and trust, it is about what a company does.

Across Europe, the future of ESG disclosures is clear. There will be more and more requirements to disclose data, targets, and the actions taken by the company to achieve these targets. And as ESG disclosures become standard, the benefits from increased transparency will diminish more and more. Meanwhile, the benefits of actually improving ESG credentials increases as more professional investors systematically use this kind of nonfinancial data in their analyses.