Relationship Between ESG-Ratings and Stock Performance of Chinese Public Companies During COVID-19
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Table of contents 2
Introduction 4
1. Literature review and methodology 8
1.1. Historical notes on COVID-19 in China 8
1.2. Literature review 9
1.3. Data and Methodology 12
1.3.1. Data sampling 12
1.3.2. Industries’ profiles: Stock trends, ESG-regulation, and expert comments 14
1.3.3. Methods 16
2. Empirical Results and disscussion 20
2.1. The Chinese market 20
2.2. Chinese Industries 22
2.2.1. The Manufacture industry 22
2.2.2. The Raw materials industry 24
2.2.3. The IT industry 25
2.2.4. The Healthcare industry 27
2.3. Summary of the industry-level analysis 28
2.4. Comparison of the results to existing findings 29
3. Practical Implications 32
3.1. Stakeholder analysis 32
3.1.1. Stakeholders’ identification 32
3.1.2. Stakeholder evaluation 36
3.1.3. Stakeholder matrix 44
3.2. Recommendations for ESG-firms and its stakeholders 44
3.2.1. A firm’s point of view 45
3.2.2. Stakeholders’ point of view 49
Conclusion: 55
List of Literature 57
Appendixes 65
Appendix 1. Descriptive statistics (for control variables) 65
Appendix 2. Correlation of variables 66
Introduction 4
1. Literature review and methodology 8
1.1. Historical notes on COVID-19 in China 8
1.2. Literature review 9
1.3. Data and Methodology 12
1.3.1. Data sampling 12
1.3.2. Industries’ profiles: Stock trends, ESG-regulation, and expert comments 14
1.3.3. Methods 16
2. Empirical Results and disscussion 20
2.1. The Chinese market 20
2.2. Chinese Industries 22
2.2.1. The Manufacture industry 22
2.2.2. The Raw materials industry 24
2.2.3. The IT industry 25
2.2.4. The Healthcare industry 27
2.3. Summary of the industry-level analysis 28
2.4. Comparison of the results to existing findings 29
3. Practical Implications 32
3.1. Stakeholder analysis 32
3.1.1. Stakeholders’ identification 32
3.1.2. Stakeholder evaluation 36
3.1.3. Stakeholder matrix 44
3.2. Recommendations for ESG-firms and its stakeholders 44
3.2.1. A firm’s point of view 45
3.2.2. Stakeholders’ point of view 49
Conclusion: 55
List of Literature 57
Appendixes 65
Appendix 1. Descriptive statistics (for control variables) 65
Appendix 2. Correlation of variables 66
Modern systemic economic and financial crises are characterized with a higher and more persistent uncertainty arising simultaneously from multiple sources1. As a result, the process of investment decision-making is substantially complicated, since investors need to account for such hardly predictable parameters as duration of a crisis, its spreading effects, material damage (potential and actualized) and so forth. In reality, however, it is sheerly doubtful - if possible at all - to approximate these variables, and to correctly identify all sources of uncertainty. More to it, an investor is likely to experience anxiety2, producing a state of fear, which in turn jeopardizes a rational decisionmaking process3.
The latter, in particular, leads an investor to make habit-based decisions, rather than those predicated on a diligent scrutiny of all relevant information. This state of fear is richly documented with regards to financial market participants during the Great Depression4, Global Financial Crisis5, and recently COVID-19. Nowadays, there is even a special market index, indicating the fear of the financial market6.
It is in this context that an investor, faced with a systemic crisis, has four broad alternatives to choose from. First, he can withdraw from the market selling his assets. Second, he can try to use traditional and contemporary portfolio management instruments, such as Markowitz technique (the above-mentioned habit-based decision). Third, he can try to mitigate the crisis effects by hedging, employing his expertise and mathematically advanced modeling. Fourth, he can try to re-allocate assets toward assets that provide protection from extreme losses during crises.
In this research, I focus on the latter alternative in the context of the recent COVID-19 crisis. However lucrative such an alternative seems, it is of great dispute among academics and practitioners as to what assets form such an opportunity in a given crisis. More to it, being identified as an asset to be increased in value in one politically economic context, is not necessarily leading to the exact same opportunity in others, as I richly show in the literature review section. Pandemic COVID-19, in this regard, was not an exception.
The amount of literature that tried to see what assets could protect investors’ financial resources during an early COVID-19 stage has increased tremendously in the last three years. Interestingly, many researchers have posed the question with regards to ESG-activity of a firm; in particular, could ESG-engaged firms provide higher stock returns during COVID-19, and a systemic crisis in general?
Needless to say, ESG in itself is controversial even out of crisis context: some argue it does provide more value7, while others don’t8, oftentimes denoting by a term “greenwhasing”9 10. This controversy is only amplified when we are trying to understand whether or not ESG involvement protects a firm during an economic turmoil, since such aspects as regulation development, investors’ behavior differ across countries, as well as inside a country’s economy. Hence, we see researches, covering various countries and various industries point to highly heterogeneous conclusions.
Thus, this research deals with a problem of investing during an economic turmoil; in particular, does ESG activity provide higher stock returns during economic turmoil? Despite of the fact that this problem has been addressed by an increasing number of researchers, the focus has yet been predominantly on the developed markets - Europe, US, Japan. Unsurprisingly, academics have pointed out:
...
The latter, in particular, leads an investor to make habit-based decisions, rather than those predicated on a diligent scrutiny of all relevant information. This state of fear is richly documented with regards to financial market participants during the Great Depression4, Global Financial Crisis5, and recently COVID-19. Nowadays, there is even a special market index, indicating the fear of the financial market6.
It is in this context that an investor, faced with a systemic crisis, has four broad alternatives to choose from. First, he can withdraw from the market selling his assets. Second, he can try to use traditional and contemporary portfolio management instruments, such as Markowitz technique (the above-mentioned habit-based decision). Third, he can try to mitigate the crisis effects by hedging, employing his expertise and mathematically advanced modeling. Fourth, he can try to re-allocate assets toward assets that provide protection from extreme losses during crises.
In this research, I focus on the latter alternative in the context of the recent COVID-19 crisis. However lucrative such an alternative seems, it is of great dispute among academics and practitioners as to what assets form such an opportunity in a given crisis. More to it, being identified as an asset to be increased in value in one politically economic context, is not necessarily leading to the exact same opportunity in others, as I richly show in the literature review section. Pandemic COVID-19, in this regard, was not an exception.
The amount of literature that tried to see what assets could protect investors’ financial resources during an early COVID-19 stage has increased tremendously in the last three years. Interestingly, many researchers have posed the question with regards to ESG-activity of a firm; in particular, could ESG-engaged firms provide higher stock returns during COVID-19, and a systemic crisis in general?
Needless to say, ESG in itself is controversial even out of crisis context: some argue it does provide more value7, while others don’t8, oftentimes denoting by a term “greenwhasing”9 10. This controversy is only amplified when we are trying to understand whether or not ESG involvement protects a firm during an economic turmoil, since such aspects as regulation development, investors’ behavior differ across countries, as well as inside a country’s economy. Hence, we see researches, covering various countries and various industries point to highly heterogeneous conclusions.
Thus, this research deals with a problem of investing during an economic turmoil; in particular, does ESG activity provide higher stock returns during economic turmoil? Despite of the fact that this problem has been addressed by an increasing number of researchers, the focus has yet been predominantly on the developed markets - Europe, US, Japan. Unsurprisingly, academics have pointed out:
...
In our modern times, when systematic crises appear more frequently with debilitating economic effects that stretch farther geographically and industrially than we would expect them to, an investor is faced with a difficult problem. How to decrease the losses on his investments. One way do so is through finding assets that are anticipated to increase in value during the crisis. ESG firms have become a prominent candidate for having a capacity to provide higher value and stock returns during crisis. COVID-19 in this respect appears as a relevant context to conduct research.
In the current research, however, there is neither a consensus over the question, nor sufficient geographical and industrial coverage. In my research, I tested two hypotheses for the Chinese firms, participating in ESG. To do that, I extracted financial performance indicators, the raw stock returns and ESG-scores from Wind database for Chinese A-shares firms. Moreover, I created 4 subsets, comprising the firms of four rapidly developing and economically important industries of China: the healthcare, the raw materials, the manufacture and the IT. Then I built regression models with a dependent variable of stock returns for 2020, the independent ESG-scores (and separate ESG-pillars) at the end of 2019, and the control variables of traditional financial performance indicators. Each model was tested and adjusted for homoscedasticity, multicollinearity and residual autocorrelation.
After conducting regression analysis, I can affirm with a sufficient degree of confidence that on average the Chinese stock market provided higher stock-returns during 2020 were the firms engaged in ESG prior to COVID-19. There are, however, differences across industries: Among the 4 industries analyzed, the raw materials, the manufacture and the healthcare showed a significant relationship between ESG and stock returns during 2020, while the IT-industry did not. More to it, S and G pillars were showing a positive significant relationship, while E-pillar was not. For all industries, except for the raw materials, the introduction of control variables reduced the strength of the relationship between ESG-score and stock returns. This logically suggests that ESG score alone was not able to account for higher stock returns, and traditional financial performance indicators should not be neglected when we speak of stock performance during a crisis.
The practical implications thus are structured heterogeneously, taking into account cross- regional, cross-sectorial and cross-temporal differences of Chinese market. The recipients of recommendations were identified via stakeholder analysis. As a result, two sets of recommendations were then given: from an ESG-active firm’s perspective and from its stakeholders ’ perspective.
The first set of recommendations is relevant for middle/top management teams of ESG- active firms. Recommendations are given primarily for the four industries analyzed, but at times are relevant for any industry in China. The most pro-active actions need be undertaken with regards to such stakeholders as the ministries of China, institutional investors, top-management team and B2G clients, while individual investors, international business, local communities and B2B clients need be actively monitored and managed. The least active actions are recommended for employees and activist groups.
The second set of recommendations shifts to stakeholders’ perspective, outlining the recommended actions toward ESG-active firms of China. Here the main group for which the subject of this research is directly linked is investors: again, of two types. The most rigorous analysis of relevant empirical findings is given. Additionally, for governmental agents, non-ESG firms, international business, B2B and B2G there are recommendations given. The nature of recommendations is less direct, compared to the group of investors, but still provides untrivial insights into how these stakeholders may utilize the empirical findings of ESG-returns relationship in their decision-making process.
The results of this research are inherently retrospective, dealing only with the 2020 phase of COVID-19 in China. There is of course no guarantee that the same industrial patterns of ESG-returns will come out in the future. To partly reconcile the issue, cross-country and cross-temporal comparative analyses were conducted, and recommendations were compiled with additional comments on historicity issues. However, the recommendations are constructed to leverage historical and evolutionary findings for contemporary analysis. Thus, the results and recommendations are relevant beyond COVID-19 crisis, but of course are not exhaustive: any professional agent must conduct a case-by-case analysis of ESG-Returns relationship for his/her own context. This research, however, may become an important reference point of such a relationship in the Chinese market and four crucial industries of China.
Specifically for investors, they are left without a guarantee that the same kind and degree of the ESG-returns relationship would occur in either normal times or another crisis. Nonetheless, they are more aware of an evolutionary trajectory that this relationship has trodden in the Chinese market and its four industries in such a debilitating context as COVID-19 of 2020. And this information becomes indispensable in any sophisticated decision-making process of today.
In the current research, however, there is neither a consensus over the question, nor sufficient geographical and industrial coverage. In my research, I tested two hypotheses for the Chinese firms, participating in ESG. To do that, I extracted financial performance indicators, the raw stock returns and ESG-scores from Wind database for Chinese A-shares firms. Moreover, I created 4 subsets, comprising the firms of four rapidly developing and economically important industries of China: the healthcare, the raw materials, the manufacture and the IT. Then I built regression models with a dependent variable of stock returns for 2020, the independent ESG-scores (and separate ESG-pillars) at the end of 2019, and the control variables of traditional financial performance indicators. Each model was tested and adjusted for homoscedasticity, multicollinearity and residual autocorrelation.
After conducting regression analysis, I can affirm with a sufficient degree of confidence that on average the Chinese stock market provided higher stock-returns during 2020 were the firms engaged in ESG prior to COVID-19. There are, however, differences across industries: Among the 4 industries analyzed, the raw materials, the manufacture and the healthcare showed a significant relationship between ESG and stock returns during 2020, while the IT-industry did not. More to it, S and G pillars were showing a positive significant relationship, while E-pillar was not. For all industries, except for the raw materials, the introduction of control variables reduced the strength of the relationship between ESG-score and stock returns. This logically suggests that ESG score alone was not able to account for higher stock returns, and traditional financial performance indicators should not be neglected when we speak of stock performance during a crisis.
The practical implications thus are structured heterogeneously, taking into account cross- regional, cross-sectorial and cross-temporal differences of Chinese market. The recipients of recommendations were identified via stakeholder analysis. As a result, two sets of recommendations were then given: from an ESG-active firm’s perspective and from its stakeholders ’ perspective.
The first set of recommendations is relevant for middle/top management teams of ESG- active firms. Recommendations are given primarily for the four industries analyzed, but at times are relevant for any industry in China. The most pro-active actions need be undertaken with regards to such stakeholders as the ministries of China, institutional investors, top-management team and B2G clients, while individual investors, international business, local communities and B2B clients need be actively monitored and managed. The least active actions are recommended for employees and activist groups.
The second set of recommendations shifts to stakeholders’ perspective, outlining the recommended actions toward ESG-active firms of China. Here the main group for which the subject of this research is directly linked is investors: again, of two types. The most rigorous analysis of relevant empirical findings is given. Additionally, for governmental agents, non-ESG firms, international business, B2B and B2G there are recommendations given. The nature of recommendations is less direct, compared to the group of investors, but still provides untrivial insights into how these stakeholders may utilize the empirical findings of ESG-returns relationship in their decision-making process.
The results of this research are inherently retrospective, dealing only with the 2020 phase of COVID-19 in China. There is of course no guarantee that the same industrial patterns of ESG-returns will come out in the future. To partly reconcile the issue, cross-country and cross-temporal comparative analyses were conducted, and recommendations were compiled with additional comments on historicity issues. However, the recommendations are constructed to leverage historical and evolutionary findings for contemporary analysis. Thus, the results and recommendations are relevant beyond COVID-19 crisis, but of course are not exhaustive: any professional agent must conduct a case-by-case analysis of ESG-Returns relationship for his/her own context. This research, however, may become an important reference point of such a relationship in the Chinese market and four crucial industries of China.
Specifically for investors, they are left without a guarantee that the same kind and degree of the ESG-returns relationship would occur in either normal times or another crisis. Nonetheless, they are more aware of an evolutionary trajectory that this relationship has trodden in the Chinese market and its four industries in such a debilitating context as COVID-19 of 2020. And this information becomes indispensable in any sophisticated decision-making process of today.
