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

Sep 2022

We investigate the consequences of ESG-based portfolio exclusions on 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) about 5%. The sheer magnitude of these excess returns shows that excluded stocks have a return premium, as predicted by e.g. Pastor et. al (2021). Companies with low ESG 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; G20


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