ESG index reconstitutions and stock returns: Does culture have a role?

In this study, we examine how cultural dimensions, specifically future orientation and institutional collectivism, affect the relationship between the sustainability activities of firms and their stock returns. We measure sustainability performance by the firms’ inclusion in and exclusion from the FTSE4GOOD Developed Market and Emerging Market Indices. The univariate analyses show that investors in more future-oriented and more collectivistic developed countries react positively to the sustainability index inclusion, whereas investors in countries with lower levels of these cultural traits, whether developed or emerging, do not react significantly. The abnormal returns around the announcement of index reconstitutions are further examined using regression analyses that control for firm characteristics and year fixed effects. The effects of cultural dimensions are found to be similar across countries regardless of development level. It is observed that institutional collectivism increases abnormal returns around ESG index inclusion announcements, while the effect of the future orientation is insignificant. Both cultural dimensions are found to reduce abnormal returns around index exclusions although the effect is more pronounced in developed countries and in the days prior to the announcement. These findings suggest that inconsistent results in the literature regarding the relationship between ESG performance and firm value could be explained by cultural differences.