15th May 2023 – Chinese firms’ environmental, social, and governance (ESG) performance could see a substantial increase under foreign ownership, according to a new study by Professors of Economics, Brian Viard and Zhang Gang, at Cheung Kong Graduate School of Business. Their research paper, titled “Financial Deregulation and ESG: Impacts and Mechanisms,” discovered that Chinese firms with access to foreign capital through the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect Programs, experienced a significant increase in their ESG performance.
he Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connect Programs are cross-border investment channels that allow international investors access to a pre-selected subset of firms publicly listed in China.
After the launch of the Shanghai Connect program in 2014, companies did not see an immediate increase in their ESG ratings relative to unconnected firms. However, ESG ratings climbed by 1.3% year-on-year compared to unconnected firms. ESG ratings on the Shenzhen Connect program increased by 4.6% upon entry in the Connect program and then grew by 2.2% per year. The study also finds evidence of spillover effects within the value chain. A non-Connect supplier to a Connect firm increases its ESG ratings after its partner entered the program.
The increase in ESG ratings does not appear to reflect greenwashing. Firms on both the Shanghai and Shenzhen Connect programs filed more applications for “green” patents and lowered their total carbon emissions gradually over time.
The study then asks why firms improved their ESG performance. There are two main theories for why firms might respond to foreign investment with improved ESG performance. Foreign investors might exert pressure on the firms to improve because they intrinsically value such performance. Or firms might increase their performance to signal their trustworthiness to the investors. The study finds evidence consistent with both. Foreign investors respond to higher ESG ratings by increasing their shareholding consistent with the signaling theory. At the same time, greater foreign investment in a stock tends to lead to increases in ESG ratings. The effects are therefore self-reinforcing.
The ESG scores and three sub-ratings were obtained from Bloomberg which began publishing the scores in 2020. The Bloomberg ESG database covers more than 11,800 companies worldwide, comprising 88% of global equity market capitalization.