ESG Investing : Creating Intangible Value : Why ESG Metrics May Fail to Capture the Total Contribution of Corporate Sustainability to Value Creation
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This paper aims to understand how Environmental, Social, and Governance (ESG) accountability metrics influence 1) firm's profits and 2) value. The study is a cross-sectional analysis of S&P 500 companies in the US. This study specifically studies 1) the relationship between ESG metrics and Free Cash Flow and 2) the relationship between ESG metrics and Market Capitalization. I find that ESG accountability, specifically Environmental and Employee accountability is correlated with profit creation in the form of free cash flow, while, a significantly negatively correlation is found between the "Community" factor and profit creation. Meanwhile, the value equation yields no such significant results between ESG metrics and market capitalization. Therefore, I conclude that while ESG factors drive profits in large US firms, ESG metrics fail to be accounted for in market performance measures as evident in the market capitalization equation. These findings have two main implications. First, a failure to account for value creating ESG assets will continue to result in the eroding value of firms in the US. Second, the inability of the market to price ESG factors results in imperfect information that creates problems for decision-making for investors and company leaders alike. Therefore, the study concludes that while ESG factors have been an important step in quantifying sustainability accountability in the market system, they nevertheless fall short in providing key sustainability data needed for decision making and are not reflected in market-based measures of firm performance. Therefore, in order for sustainability initiatives to be accounted for, they must be integrated within existing accounting systems and must require material disclosure of sustainability information.