Companies weak in ESG more likely to be hit with scandals and lose market value: Moody’s

COMPANIES with a weak record in managing environmental, social and governance (ESG) risks are more likely to be hit with scandals or controversies linked to their business conduct, which, in turn, leads to stock market losses, financial intelligence firm Moody’s Analytics has said.

And this negative impact on companies’ financial results and value will be felt over the short term and in a return horizon of one year, the firm said. It bases these conclusions on the findings of two studies it did, the results of which were released on Thursday (Jun 23).

In an analysis of 3,468 public companies between January 2015 and January 2019, Moody’s research team found that a company with one such incident will lose 0.4 per cent of its market value, on average, over 2 months.

The loss gets bigger as the number of controversies goes up: Companies shed 0.7 per cent of their value when hit by two or more incidents, and 1.4 per cent for 4 or more controversies.

And the losses are higher the more severe these controversies turn out to be.

But there are controversies and there are controversies. The study found that companies hit by environmental or governance-related scandals — such as a chemical spill or a corruption case — suffered losses which were quite small and not statistically significant on average.

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In contrast, companies mired in social controversies, such as exploiting child labour, will run up large, statistically significant losses.

As for long-term effects, Moody’s research showed that negative-valuation effects on companies were persistent when multiple scandals occurred. When 3 or more of such incidents happen in a month, the companies’ value, on average, would drop 1.2 per cent over a year; the decline in value worsens to 6.5 per cent when there are 5 or more negative incidents.

However, a severe controversy did not lead to worse returns for companies over a return horizon of 1 year.

Moody’s report said: “A possible explanation for this finding is that firms that experience a controversy of the highest severity often have a history of previous ESG controversies, which may mute the stock return impact.”

Overall, moderate-to-severe ESG events would generate abnormal stock market losses of between 1.3 per cent and 7.5 per cent over 12 months.

As the median market capitalisation of companies in Moody’s sample was US$11.7 billion, it works out to a loss of about US$400 million over 1 year for a typical-sized firm in the study.

The authors of the study wrote: “ESG performance matters strongly for firms’ value, with ESG events leading to large, negative, abnormal returns. This finding remains robust for firms of all sizes, and holds particularly for firms in the energy and natural resources, consumer products, finance and construction sectors.”

Doug Dwyer, the managing director at Moody’s Analytics who led the research, said in a statement on Thursday that companies exposed for unethical business conduct can incur “reputational damage with significant financial and legal repercussions”.

However, the researchers also found in their second study that companies can actively manage these risks by improving their ESG risk-management culture.

Analysing 4,324 companies that had received a credit rating from Moody’s Investors Service, this second study found that companies with a history of ESG-related scandals were more likely to be hit again by similar controversies.

This was especially true of larger companies, given their more complex structures that inhibit improvements or changes.

However, the study also showed that companies that establish better ESG policies, as indicated by an improved score on Moody’s own ESG scoring system, lowered their risk of being caught in similar controversies again.

The scoring system, known as the Moody’s ESG Assessment Score, measures the extent to which companies integrate sustainability into their strategies, risk management and operations, from the perspective of both business and stakeholder exposure.

Moody’s said: “Companies whose Moody’s ESG Assessments improved were likely to experience about 15 per cent fewer ESG controversies, going forward, than those that did not.”