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

May 2024

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 facing widespread exclusions by institutional investors. The portfolio of excluded firms have significantly superior performance (alpha) of about 5%. Looking at the time of exclusion, we note that while theory suggest that an increase in the cost of capital should drive the stock price down substantially, we find little evidence of that. In fact, stock prices are increasing while the fund is dumping its stake. The implied corporate cost of being excluded is small, as shown by the few firms that take action to reverse their exclusion. The cost is not trivial, though, as we evaluate the incentives for getting the exclusion revoked, and find that companies with low ESG scores at the time of exclusion (scope for improvement), and higher revenue growth (investment needs) are more likely to get their exclusion revoked. In fact, firms that get off the exclusion list do not have superior performance going forward.

Keywords: ESG; Ethical investing; Exclusion; Cost of Capital

JEL Codes: G10; G11; G20


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