News and Insights

The State of Play

Article | 12 February 2018

Investing using environmental , social and governance (ESG) principles is gaining momentum from retail and institutional investors. In this article, we give some context to the present state of play in investing with consideration of ESG issues, by looking at the history and background of various approaches. We then examine the evidence surrounding the link between stock prices and ESG characteristics of companies, with particular emphasis on Australian equities.

A bit of history

In the 1930’s, Adolf A. Berle (a lawyer and economist, author of ‘The Modern Corporation and Private Property’) and E. Merrick Dodd (also a lawyer, and one of the founders of modern stakeholder theory) debated the question ‘To whom are corporations accountable?’. They had two opposing views. Berle stated:

“all powers granted to a corporation or the management of a corporation … are necessarily … only for ratable benefit of all the shareholders as their interest appears”

Berle is arguing that the only responsibility for company management is to the interests of shareholders. Companies should follow ESG practices if, and only if, they end up increasing shareholder returns. Dodd had an opposing view:

“there is in fact a growing feeling not only that business has responsibilities to the community but that our corporate managers who control business should voluntarily and without waiting for legal compulsion manage it in such a way as to fulfil those responsibilities.”

He is arguing directly for corporate responsibility, and for companies to be aware of their place within and contribution to broader society. Dodd sees the corporation as more than simply a profit centre.

Dodd’s view did not become mainstream. Milton Friedman was quoted in the New York Times in 1970:

“the social responsibility of business is to increase its profits”

The purpose of business is not to provide employment, eliminate discrimination, avoid pollution, help the community or make life better for workers. The core of capitalism is to return the capital to shareholders.

Most investors today probably have a more nuanced view. It is impossible to isolate profit seeking enterprises from the communities in which their profits are made. So, views on corporate approaches to ESG can be summarised in two ways. The first is that ESG is a cost: ESG considerations divert management away from focusing on profits. The second is that ESG is value-enhancing: companies that integrate ESG into their culture will maximise shareholder value in the long run.

As investors, it is important to understand which view one should subscribe to. Part of this process should involve examining the evidence supporting each view. Do companies with better ESG practices have better returns? As stock market investors should we consider a focus on ESG as a positive or negative for the stocks in our portfolios?

Responsible investment

Responsible Investment (RI) is an approach to investing that aims to incorporate ESG factors into investment decisions, to better manage risk and generate sustainable, long term returns. Investor motivations vary, ranging from an alignment with personal/client values, to a belief that it will contribute to returns. It might be a combination of the two. Regardless, recent growth of RI assets has been strong, especially in Australia, where it is estimated more than $500 billion of assets are allocated using RI.

Table 1 Growth of SRI assets by region 2014 - 2016

Source: Global Sustainable Investment Review, figures in USD billions

RI can take a number of forms. Some approaches use screens to identify ESG opportunities and risks, others invest using themes, and yet others invest directly into communities with a specific goal in mind.

Responsible investment approach table

Source: Responsible Investment Association Australasia

Without doubt, investors are moving with their feet. RI is becoming hard to ignore.

Measuring performance

Measuring the performance of RI strategies is difficult. This is in part because the ESG characteristics of firms are hard to measure. An ESG assessment is often qualitative, so two investment analysts might reach different conclusions. This can make accurately constructing a benchmark difficult.

Academic studies have been examining the link between RI strategies and performance since the early 1970s. Dr Paul Docherty from Monash University recently collated 120 academic papers that focused on RI and performance. He found no compelling evidence for RI strategies:

Reporting positive returns 21%
Reporting neutral returns 53%
Reporting negative returns 26%
Mean effect 0.05%
Median effect -0.03%

Source: Dr Paul Docherty, Monash University

Australian studies are similarly mixed. Perhaps, though, the relationship between ESG and stock returns is more nuanced. Lins et al. (2017) reports that during the global financial crisis firms with high ESG scores (by their measurement) had stock returns that were 4-7% higher than firms with low ESG scores. The trust between a listed business and their investors, built through a mutual acknowledgement of the broader role that companies play in society, seems to pay off during periods of market stress.

We performed a similar study in relation to Australian equities. Together with Dr Paul Docherty, we compiled a comprehensive corporate governance database that covers the ASX 300 since 2001 (originally constructed by staff at the University of Newcastle). Combined governance scores for each company are calculated using a consistent method, taking data from their annual reports. Companies that are no longer listed are included for completeness. We split the market into five portfolios, allocating the companies to portfolios in order of best governed to worst governed. We found that the best time to own well-governed companies (using our measure) is during down markets:

Brooke et al

Well-governed companies return 93 basis points more than poorly governed companies during months in which the market goes down. All our results pass standard statistical tests. We are not simply investing in growth or momentum or any other factor during these periods. For more details, see Brooke et al. at

Our results evidence a positive relationship between governance and equity returns in Australia. Investors may improve their returns if they consider corporate governance as part of their process.


Brooke, P., Docherty, P., Psaros, J., Seamer, M., ‘Internal Governance Characteristics, Time-Varying Agency Costs and Stock Prices’, forthcoming

Lins, K. V., Servaes, K., and Tamayo, A., ‘Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis, Journal of Finance, Vol. LXXII, No. 4, August 2017

2016 Global Sustainable Investment Review, published by the Global Sustainable Investment Alliance

Responsible Investment Benchmark Report 2017 Australia, published by the Responsible Investment Association Australasia

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Gary Adamson

Gary Adamson

Chief Executive Officer – Platypus Asset Management