The diminishing alpha potential of ESG

A significant number of institutional investors publicly express the belief that corporate stakeholder relations are associated with (intangible) firm value in a manner that the financial market fails to understand. We investigate whether stakeholder information predicted risk-adjusted returns due to errors in investors’ expectations and ultimately ceased to do so as attention for such information increased. Using a sample of S&P 500 and Russell 3000 constituents over the period 1992-2009, we provide evidence that stakeholder information originally helped to capture risk-adjusted stock returns due to errors in investors’ expectations about firms’ future earnings. Various measures of stakeholder relations were positively associated with long-term risk-adjusted returns, earnings announcement returns, and analysts’ long-term forecast errors over the period 1992-2004. As attention for stakeholder issues became more widespread, subsequently, these relationships either weakened or disappeared. The change in errors in investors’ expectations does not appear to be caused by a weakening association between firms’ stakeholder relations and their’ future earnings. The results are consistent with the idea that increased investor attention for stakeholder issues eventually eliminates mispricing.

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