Non-linear ESG effects on Jensen’s Alpha: Evidence from a CAPM-based framework

This study examines the relationship between a firm’s ESG performance, measured through Refinitiv ESG Scores, and its abnormal return relative to market risk (i.e., Alpha), using the Capital Asset Pricing Model (CAPM) as the benchmark for expected returns. Alpha is estimated under twelve alternative specifications, combining different estimation windows (3 and 5 years), return frequencies (daily, weekly, and monthly), and both ESG and non-ESG market benchmarks. The analysis is conducted on a sample of non-financial firms listed in the S&P 500 over the period 2015–2024. To assess the shape of the ESG-Alpha relationship, the empirical analysis relies on both a linear regression model and a quadratic specification. Across all the alternative Alpha estimation methodologies, the linear model provides evidence of a significant negative relation between ESG performance and Alpha, while the quadratic model reveals that this relationship can be better explained by a U-shaped function. More specifically, below a certain ESG score threshold, firms with weaker ESG performance tend to exhibit higher abnormal returns relative to the CAPM benchmark, while above that threshold, which occurs when the estimated Alpha reaches zero, the negative relationship gradually weakens and eventually turns positive. These findings suggest that the marginal ESG performance effect on Alpha may differ based on different levels of ESG scores, further supporting a non-linear approach.