[Journal of Financial Reporting] Corporate Sustainability: A Model Uncertainty Analysis of Materiality

For three decades, academic scholars have explored the interplay between corporate sustainability and financial performance. A potential major break-through came in 2016 when Khan, Serafeim, and Yoon published a study that used the guidance from the Sustainability Accounting Standards Board (SASB) that enabled the formation of scales of sustainability measures, to predict stock returns. Their publication has been widely regarded as demonstrating a real connection between corporate sustainability and financial performance. The Journal of Financial Reporting recently published an article co-authored by Andrew King, Questrom Professor of Management and Professor of Strategy & Innovation, that calls the 2016 study into question.

“We show that the original estimate of returns (300-600 additional basis points per year) is a statistical artifact caused by mismeasurement of corporate sustainability.  Despite exhaustive analysis, we found no reliable link between corporate sustainability and future stock return.” 

Andrew King
Questrom Professor of Management
Professor of Strategy & Innovation

King and his co-author Luca Berchicci, Associate Professor of Entrepreneurship at Rotterdam School of Management, performed a “model uncertainty analysis”, an analysis that tests the accuracy of a given model by quantifying the variability of the output that is due to the variability of the input. King and Berchicci reproduced the estimates from the 2016 study, but “show it is both fragile to changes in assumptions and unrepresentative of results from most reasonable models.” The analysis further infers that it is difficult to achieve accurate guidance on materiality, especially for one particularly popular source of data on corporate sustainability.