The expected returns of ESG excluded stocks. Shocks to firms costs of capital? Evidence from the World's largest fund

Erika Berle, Wanwei (Angela) He and Bernt Arne Ødegaard

March 2023

We investigate the link between ESG-based portfolio exclusions and the expected returns of excluded firms. The exclusions of Norway's "Oil Fund," the world's largest SWF, provide a sample of stocks that face widespread exclusions by institutional investors. The portfolio of excluded firms have significantly superior performance (alpha) of about 5%. Excluded stocks have a return premium, as predicted by e.g. Pastor (2021). Investigating the corporate reactions to exclusion, we find that companies with low ESG score at the time of exclusion (scope for improvement), and higher revenue growth (investment needs) are more likely to get their exclusion revoked, which we interpret as evidence of dynamics: Firms improve their ESG to revoke exclusions and achieve lower cost of capital. In fact, firms that get off the exclusion list do not have superior performance going forward.

Keywords: ESG investing; Exclusion; Cost of Capital

JEL Codes: G10; G11; G20


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