Earlier this year, the U.S. Securities and Exchange Commission (SEC) implemented rules requiring public companies to disclose climate-related risks, enabling investors to make informed decisions. In contrast, over a dozen states have enacted legislation urging public pension funds to focus solely on financial returns, preventing them from boycotting fossil fuel investments or making decisions based on environmental, social, and governance (ESG) factors.
A study co-authored by Yale School of Management Professor Edward Watts offers insights into both sides of this debate. The research reveals that individual retail investors are already considering ESG factors in their investment decisions, but primarily for financial reasons.
“Retail investors are already trading around this stuff in their personal portfolios, so why should pension funds be any different?” Watts questions.
The study was conducted by Watts along with Stanford PhD student Qianqian Li and Christina Zhu from the Wharton School. They analyzed the behavior of retail investors during more than 54,000 ESG-related news events affecting nearly 3,300 publicly traded firms between 2015 and 2022. The findings show a 6% increase in retail trading on ESG news days compared to non-event days—rising to 8% after 2020. The researchers sought to determine whether these actions were driven by non-financial motives like social responsibility or by potential impacts on returns.
Their data suggests the latter: investors tend to buy stocks when news is expected to positively affect performance and sell when it’s negative. For instance, following Boeing's settlement of the 737 Max scandal—a negative ESG event—more retail investors sold its stock than bought it. Similarly, Occidental Petroleum saw a sell-off after announcing increased clean energy investments despite being a positive ESG event because it coincided with a stock price drop.
In his class on ESG investing, Watts uses an extreme example: “It would be very pro-ESG to raise your employees’ salaries by 500 percent,” he says. “But the stock price is going to drop significantly. No investor is going to like that.”
The paper titled "Retail Investors and ESG News" contributes significantly to understanding ESG investing dynamics. It contrasts previous studies based on hypothetical surveys or limited asset classes by analyzing actual investor behavior across various equity investments. While earlier evidence was mixed regarding retail investors' interest in ESG information at the cost of financial returns, Watts’ study shows they do care about ESG events mainly concerning their portfolio impact.
“There’s been a tremendous amount of debate circling around these issues," Watts comments. "This is a simple exercise: Are people consuming this information through the news and trading around that? We’re trying to infer what people really seem to care about."
The authors also compared investor activity surrounding ESG-related news with traditional financial disclosures such as analyst forecasts and dividend announcements versus earnings announcements or management guidance. Overall findings indicate greater responsiveness towards earnings announcements; however similar reactions occur between equally impactful ESG events and earnings reports.
Quoting Alex Edmans from London Business School within their work: “ESG is both extremely important and nothing special.” They argue bans against considering ESG may be “misguided” violating fiduciary obligations while asserting claims suggesting many retail investors prioritize non-financial reasons might also prove “inadvisable.”
Watts believes politicization has fueled unnecessary debates among state legislatures alongside financial regulators regarding handling of these issues: “The term ESG has become weaponized,” he said.“If we just accepted that this stuff is not very special—we wouldn’t have many debates.”
Alerts Sign-up