High ESG scores cause stock analysts to issue overly optimistic earnings forecasts that lead to the eventual underperformance of green firms.
Ethical investment ratings act as a psychological trap for market professionals. Analysts consistently overestimate the profit potential of companies with top environmental and social scores. This enthusiasm inflates stock prices beyond their realistic value and leads to lower returns for investors later. The widely held belief that ESG is a proxy for lower risk ignores the reality of market mispricing. Portfolio managers often pay a premium for virtue that the underlying business cannot actually justify.
The ESG Premium: Analyst Optimism, Market Mispricing, and Factor Integration
SSRN · 6727017
This study investigates whether Environmental, Social, and Governance (ESG) performance constitutes a systematic risk factor priced in stock returns and examines the behavioral mechanism through which ESG affects the stock prices. By constructing an ESG factor within the Fama-French five-factor framework using U.S. data from 2002 to 2022, we find that low-ESG firms earn higher returns than high-ESG firms, and the inclusion of this ESG factor significantly reduces model alphas. More importantly,