“Do High-Ability Managers Choose ESG Projects that Create Shareholder Value?"

“Do high-ability managers choose ESG projects that create shareholder value? Evidence from employee opinions,” written by Kyle Welch and Aaron Yoon, was published in Review of Accounting Studies in 2022. Firm managers have been facing increasing external pressure to distribute firm resources to ESG efforts. As ESG efforts generally do not prioritize shareholders’ interest, it is a complex task for senior managers who must determine what ESG projects to select and the amount of ESG investment needed. The paper uses Glassdoor employee ratings of senior managers to measure manager ability and MSCI ESG Ratings to measure firm ESG performance. The paper examines the role of senior managers’ ability in allocating firm capital to ESG practices and finds that high-ability managers, in fact, allocate ESG resources in the desired way that increases shareholder value.

Firm managers have been pressured to allocate resources and capital for ESG performance. Yet, such efforts seem contrary to the traditional managing system of prioritizing shareholder value creation and are motivated by conflicting theories with different shareholder value implications. Simply put, the selection of ESG engagement may seem unintuitive. However, with the rising demand for sustainability efforts, the opinion on ESG efforts and reporting has changed. ESG was viewed as a passing fad in the past, yet such resource allocation has become a significant task for the managers as investors have signaled to commit to ESG efforts.

Senior managers face a complicated dilemma in allocating ESG resources for many reasons. First, there are no hard and fast rules in ESG performance, and such performance is hard to define, quantify and measure. Second, the shareholders request firms to disclose ESG efforts, yet such disclosure may trigger a negative market reaction, while lacking such disclosure may result in market penalization of firms. Third, the differing opinion between shareholder and stakeholder value further complicates the consequences of ESG efforts for firm value. While the shareholders view ESG performance as less efficient due to incompatibility with traditional value creation, the stakeholders consider ESG efforts as departing from the conventional value system yet normatively correct actions. Both value advocates agree that ESG investing comes at the expense of shareholder value.

Recent research has shown numerous positive impacts of ESG returnings: excess returns, obtaining better resources, attracting higher-quality employees, better market products and services, mitigating the likelihood of negative regulatory, legislative, or fiscal actions, etc. However, there is still a mixed relationship between ESG efforts and firm value. Other research has found that sustainability-related investments are inefficient due to managers’ incentive to extract private benefits or serve their own political beliefs and agendas. Sustainability investment also creates a disadvantage in a competitive market by disproportionately raising a firm’s cost. To resolve all the stated dilemmas, many corporate leaders have called for ending shareholder primacy by replacing the corporation’s role redefined around stakeholders.

The paper finds that firms with high ESG and senior manager ability significantly outperform those with low scores in both dimensions, proving that having high-ability senior managers is necessary for firms to enhance shareholder value with ESG engagement, as their decision generates incremental returns. Firms with high ESG performance and managerial ability exhibit superior future accounting performance and greater earning surprises compared to other firms.