The causation dilemma in ESG research

Many claim doing good eventually leads to doing well. What if it were not so simple?

Research from Zach Williams and Heather Apollonio highlights transparency and investor perception may be playing a bigger role than previously thought in « The causation dilemma in ESG research ».

They found that companies with full ESG ratings and robust sustainability disclosures did enjoy higher stock returns, yet the actual level of those ratings showed no link to performance.

Their conclusions include:

• Firms with a complete set of sustainability rating from various agencies saw significantly higher abnormal stock returns than firms with no ESG rating coverage.
• However, a higher ESG score did not translate into higher returns among rated firms: being rated mattered, being rated « good » vs « bad » did not.
• Companies disclosing more ESG information were associated with higher returns, regardless of whether the news they disclosed was positive or negative.
• The overall ESG-financial relationship remains positive but puzzling: there is a positive link between ESG engagement and returns, but causation is ambiguous.
• The authors explicitly frame the murky causal link between ESG performance and financial performance as a key finding: the inconsistent results across prior studies likely stem from this unresolved causality dilemma.

This study shows the outperformance of sustainability-focused firms might be due to factors like engagement or reduced investor uncertainty, rather than ESG excellence directly driving profits.

Transparency itself was rewarded by the market: simply being open about sustainability and showing the company cares about it matched better stock performance, more so than the actual content of the ESG activities.

The authors note two key limitations in their analysis: they did not account for materiality and did not control for underlying management quality, meaning the causation question remains open.

It is quite plausible that well-run companies tend to excel at both sustainability and profitability, making it look like « ESG drives performance » when in fact a third factor drives both.