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Environmental, social, and governance (ESG) investing has grown in popularity, but its true impact on companies' financial performance is still widely debated. In recent years, some investors have argued that ESG practices can boost long-term corporate success, while others view it as little more than a marketing tool that doesn’t influence financial outcomes at all. Still another group contends that ESG practices could divert corporate resources without generating extra revenue. Stephen Christophe and Jim Hsieh, finance professors at the Costello College of Business at George Mason University, offer a more nuanced perspective by examining how short sellers—those who bet against companies—respond to ESG-related news.
Their academic paper, co-authored by Hun Lee of Villanova University, was published in Journal of Business Research.
This paper is unique in making the distinction between a company’s short-term ESG signals and its long-term ESG reputation. This distinction provides deeper insights into how ESG information influences short sellers' decisions and overall market behavior. As the authors explain, “We’re trying to distinguish between short-term and long-term ESG information because short sellers tend to act differently depending on the type of news.”
For the first part of the research, the authors find that short sellers’ trading activity was consistent with the combined concept of "recency” and “negativity” biases. That is, shorting activity increased significantly in stocks of companies that experience negative short-term ESG news.
Then, the authors examined whether the stock prices of this sub-group of companies declined following aggressive short selling. Interestingly, the authors find that the answer is no. Rather, they show that subsequent price decline was concentrated in the cases where short sellers focused on companies that had a strong long-term ESG reputation but suddenly got hit by bad short-term ESG news. The aggressive short selling in this particular group often produces accurate predictions about future stock performance, demonstrating that short sellers are either ahead of the curve in understanding ESG-related data or exploit other investors’ under-reaction to the negative short-term news.
To conduct the study, the authors used data from Truvalue Labs, a platform that collects and analyzes daily news on corporate ESG activities. The platform categorizes news into two types: long-term ESG data and short-term news. To track investor responses, the research team matched this daily ESG data with monthly short selling activity, covering 117,149 firm-month observations from January 2012 to December 2020.
The research team’s findings have significant implications for both investors and policymakers. The study found that shorting companies with strong long-term ESG reputations that are hit by negative short-term news can lead to abnormal returns—profits that exceed the market average. The documented returns above the market return could as high as 1.23 percent per month for those who adopted this strategy. This insight challenges the belief that ESG is either purely a marketing strategy or a long-term play, showing that short-term ESG news can have major security market consequences.
In addition, policymakers could use these trends to identify companies engaging in "greenwashing"—where businesses exaggerate their ESG efforts to appear more responsible than they truly are. By monitoring how short sellers respond to ESG news, regulators may be able to spot discrepancies between a company’s public ESG stance and its actual practices. The authors emphasize, “Policymakers can use short sellers’ reactions as a signal for ESG issues within companies. The reactions of short sellers can serve as early warning indicators.”
Therefore, the authors suggest that companies should not try to rest on their ESG laurels, but instead develop a strategy of rapid response when facing short-term reputational risks. “The companies want to get back to their long-term reputation as soon as possible, because once they suffer from a negative impact in the short-term, their stock price is going to drop significantly. On the other hand, if they can quickly align their short-term ESG goals with their long-term reputation, the short sellers will try to close their positions and the companies will recover soon after.”
This study adds to the growing body of research demonstrating that ESG data is not just a trend but a critical aspect of how markets operate. By understanding how short sellers react to ESG information, market players can make more informed decisions in this increasingly important area of finance.