Air quality, ESG ratings, and stock returns

Abstract

In this study, we empirically examine the effect of air pollution on stock returns in the Korean stock market. Using the Ordinary Least Squares (OLS) and the Two-Stage Least Squares (2SLS) analyses with air pollution in China as an instrument, we find that higher levels of air pollution leads to lower market-adjusted returns. At the same time, we argue that an increase in air pollution leads to higher market-adjusted returns when firms have high overall ESG, environmental, and social ratings. Another finding is that the outbreak of coronavirus disease enhances air quality in South Korea, and the effect of air pollution becomes insignificant since the covid-19 takes away investors’ attention. Our study provides evidence that there’s an incentive for firms to establish better ESG structures to confront upcoming climate change.