Analyzing the Effect of ESG Language on the Risk and Return of Sin Stocks (thesis)

Abstract

This paper examines the effect of Environmental, Social, and Governance (ESG)-related language on the returns and associated risk for firms situated in sin stock industries. Specifically, this paper strives to answer the question of whether or not tone contained within ESG reports and ESG-related words in annual reports are associated with excess stock returns, volatility, and idiosyncratic risk of select firms in the gambling, alcohol, smoking, and pharmaceutical industries. I select firms on the basis of inclusion in two exchange-traded funds and conduct textual analysis on the disclosures provided by these firms. I find a statistically significant relationship between the percentage of ESG words in annual reports and both the volatility and idiosyncratic risk of the companies in the sample. Additionally, I find that both idiosyncratic risk and volatility decrease as the tone of the language contained in ESG reports becomes more positive. Overall, this paper extends the extant research on ESG disclosures by providing empirical evidence that markets respond to the qualitative information contained in ESG disclosures for firms in sin stock industries.