Shedding light on the relationship between ESG ratings and systematic risk

The role of environmental, social and governance (ESG) factors is growing in importance in finance studies. However, the relationship of this role with systematic risk is largely controversial and underinvestigated. We study this relationship considering a 17-year time span from 2005 to 2021 using a sample of all active constituent companies of the NYSE, with a final dataset of 791 firms for a total of 7,177 firm-year observations. The findings indicate that the relationship between overall ESG score and systematic risk takes an inverted U-shape. These results are solid considering ESG components at both an aggregate and disaggregate level. When companies invest little in ESG, they could be viewed as having more funds to allocate in, presumably, more rewarding projects and are more flexible and less risky, at least in the short term. However, beyond a certain threshold, more attention to sustainability facets results in lower systematic risk. These findings are also supported by checking them through different robustness tests.