CKGSB: Foreign Investment Boosts ESG of Chinese Firms
Chinese companies' environmental, social, and governance (ESG) performance could significantly improve as a result of foreign ownership, according to a recent study by economists Brian Viard and Zhang Gang at the Cheung Kong Graduate School of Business (CKGSB).
The research paper, titled "Financial Deregulation, ESG Ratings, and their Impact," revealed that companies in China that gained access to foreign capital through the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect Programmes witnessed a noteworthy increase in their ESG performance.
The Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect Programmes are cross-border investment channels that provide international investors with access to a specific subset of publicly listed Chinese companies.
Following the launch of the Shanghai Connect programme in 2014, there was no immediate increase in the ESG ratings of connected companies compared to unconnected ones.
However, over time, the ESG ratings of Shanghai Connect companies increased by 1.3% annually relative to unconnected firms. For the Shenzhen Connect programme, ESG ratings rose by 4.6% upon entry into the programme and continued to grow at a rate of 2.2% per year thereafter.
The study also suggests that there were spillover effects within the value chain, whereby non-Connect suppliers to Connect firms saw their ESG ratings increase after their partners entered the programme.
There is no evidence of greenwashing involved in the increase in ESG ratings. The study found that firms listed on both the Shanghai and Shenzhen Connect programmes submitted more applications for "green" patents and gradually reduced their total carbon emissions over time.
The study delves into the reasons behind the improved ESG performance of Chinese firms after receiving foreign investment. Two main theories are proposed: first, foreign investors may place intrinsic value on ESG performance and thus pressure firms to improve; second, firms may enhance their ESG performance to signal their trustworthiness to investors.
The study provides evidence that supports both theories. Foreign investors tend to increase their shareholding in response to higher ESG ratings, which is consistent with the signalling theory. At the same time, greater foreign investment in a stock leads to a boost in ESG ratings, creating a self-reinforcing effect.
The ESG scores and sub-ratings were obtained from Bloomberg, which began publishing them in 2020. The Bloomberg ESG database includes over 11,800 companies worldwide, which accounts for 88% of global equity market capitalisation.
Click here to download the research paper
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