The Impact of ESG Scandals on Firms

Figure 1: Julia Roberts as Erin Brockovich, (2000).

In a small cupboard under our family stairs resides a framed poster of Julia Roberts as Erin Brockovich. Sometimes when searching for other forgotten belongings, I was confronted by my namesake. Occasionally, I held onto the thought long enough to watch the film, engrossed by the goliath achievement of Brockovich. A single mother of three who took legal action against a giant corporation, PG&E, which was dumping pollutants into the local water system, damaging the health of 634 locals. I was thoroughly gripped, at least for a day or two before the film retook its position as ‘that poster under the stairs’. 

When COVID-19 hit I, like many of my friends, moved back into my family home. In unpacking, reorganising, and admittedly procrastinating, I was confronted with Brockovich again. In the space of a day, I binged both Erin Brockovich (2000) and Dark Waters (2019), a film focusing on the Robert Bilott lawsuit against DuPont. In this film, Mark Ruffalo plays Bilott, who works to expose DuPont for not only releasing harmful amounts of fluoride into local water but for also manufacturing unregulated chemicals used in non-stick pans. Following this binge, I came away with many thoughts. Firstly, America seemed to have a surprising number of movies about companies polluting water supplies. Secondly, both lawsuits required significant effort to expose the malpractice of companies. Lastly, despite these high profile scandals, both companies still exist and have continued to be involved in subsequent scandals. In PG&E’s case, their electrical equipment was found to repeatedly be a source of California wildfires, and DuPont has continued to dabble with harmful chemicals in fertilizer.

So why, despite legal action, reputational damage, and fines, do companies continue to make the same mistakes and profit? Is it that Environmental, Social, and Governance (ESG) scandals make no impact, or worse, increase firm value? In 2016, Amal Aouadi and Sylvain Marsat conducted a study into this very question. In their investigations of over 4000 firms, it was discovered that firms that experienced an ESG scandal, counter-intuitively did better than their competitors.

‘Companies with ESG scandals reported an increase in firm value.’ 

Before we begin, what does ESG mean? ‘E’ stands for environmental principles, including anything from office energy usage to the carbon emissions released when producing the energy needed to keep the lights on. ‘S’ stands for social principles, which encompasses the labour along the supply chain to the diversity of board members. An infamous of companies getting their ‘S’ principles wrong, is the use of forced Uyghur labour in their supply chain process. Last, and often the most overlooked, is ‘G’ for governance. This mainly looks at how the company is run, its structure, and its policies. When it goes wrong, the consequences are often hefty fines. Take Rolls-Royce who were fined £671m in 2017 for failing to prevent its subsidiaries in China, India and other markets from engaging in bribery.

Figure 2: an illustration of ESG principles

ESG scandals increase the firm’s market value

Aouadi and Marsat’s study found that ESG scandals were associated with greater firm value. Why? Well, a possible hypothesis presented was that stakeholders and consumers did not care enough to cancel contracts or change user patterns and all press is good press. Upon further inspection, companies that experienced the most market value impact were high-attention firms (generally larger) in countries with greater press freedom. The majority of issues that they studied were environmental breaches; disregarding social and governance breaches.

There are a few snags with Aouadi and Marsat’s study. The first is, as always, the counterfactual. There is no way to measure what a firm’s market value might have been had there been no ESG controversy. Aouadi and Marsat’s attempt to overcome this problem was to assume that problem companies would have followed the same paths as their competition, with the only difference being an ESG scandal. This attempts to isolate the difference in market value between firms that did and did not have scandals. This implies that the only difference in companies is the ESG scandal. This is unlikely.

Ghost of ESG Past: ‘Dieselgate’

One of the most famous Environmental ESG scandals to date was the Volkswagen Emissions scandal in September 2015 – dubbed ‘Dieselgate’. The scandal involved the Volkswagen Group (VW) being exposed by the US Environmental Protection Agency (EPA) for installing illegal emission manipulation devices. In 2016, the EPA filed a complaint against VW, alleging that each motor engine had computer algorithms attached which made the vehicles perform differently when in use than when tested for emissions.

What Aouadi and Marsat failed to consider in their study was how a company’s response to scandals also impacts its value as a firm. According to Harvard Business Review, the response to the scandal is more important than the actual content of the scandal. In the initial aftermath of the VW scandal, people clearly seemed to think they dealt with it well (enough). In a poll conducted into the U.S. general public in 2015, it was found that 50% of consumers still had a ‘positive or very positive’ impression of VW. Only 7.5% had ‘very negative impressions’. The majority of words used to describe VW were also surprising. When asked what words came to mind when VW was mentioned, the respondents stated ‘reliable’ or ‘affordable’, only 2.8% mentioned ‘emissions scandal’ or ‘liar’. VW’s scandal preceded Toyota’s recall over accelerator issues in 2010 and GM’s recall in 2014 over faulty ignitions. The accumulating scandals showed to consumers that changes were unlikely to happen. Julie Hennessy argued that the poll results could be explained by the growing expectation of consumers to expect bad news. Considering this, it is less surprising that ESG Scandals had little impact on firm reputation.

As for market value – the same can be argued. According to google share prices, VW was already experiencing a crash from April 2015 until October 2015. However, Dieselgate was not publicly announced until September. This suggests that not only did the ESG scandal have very little impact on market value, but it may have contributed to a recovery of the share price. VW also handled the crisis in a way that appealed to consumers. They admitted guilt immediately. They also complied with external investigations and the then CEO, Martin Winterkorn, resigned.

Despite the minimal impact of the scandal on firm value, the legal ramifications of Dieselgate still plagues VW years later. In April 2020, VW reached settlements with 200,000 out of the 260,000 claimants in a class-action lawsuit and in May 2020, the German Federal Court of Justice ruled that VW car owners were entitled to damages. VW will pay 620 million euros, which is getting off lightly considering they had originally set aside 830 million euros to cover the costs of settlements with all participants of the class action. 

In fact, recently Dieselgate made the news again. With four former employees of VW going on trial on the 16th of September in a German district court. All four employees claim that they knew nothing of the manipulation or had informed their superiors. However, the prosecutors contend that they had failed to raise the issue properly in favour of maximising profits and their performance-related bonuses. The charges leveled against these employees include organized commercial fraud and tax evasion, both of which can be punished with up to 10 years in jail in Germany. So whilst this ESG scandal had a positive correlation to an increased firm market value, the legal and social ramifications of VW’s activities were clearly substantial.

Ghost of ESG Present

As Bo Burnham sings, the world is changing.¹ Aouadi and Marsat’s study is out of date. In the last six years, over 1,000 climate-change related cases have been brought to courts worldwide. At the same time, more than 1,100 companies have made commitments to Net Zero targets. ESG scandals are becoming much more prominent in the headlines, so much so that the Financial Times has its own platform (spearheaded by icon Gillian Tett) titled ‘Moral Money’.

The global pandemic has also caused widespread disruption to the status-quo, allowing space for momentous social, economic, and political change. The climate crisis has exposed problems in previous business approaches and forced companies to confront the reality of stranded assets. For example, the falling cost of clean-technology and the rising cost of fossil fuel puts oil and gas assets at risk. In the run up to the climate change Conference of the Parties (COP-26), governments are under pressure to meet their Nationally Determined Contributions (NDCs) as set out by the Paris Agreement, 2015.

Bo Burnham’s Netflix Special Inside (written during the chaos of the pandemic), identifies how companies demonstrate their alignment with environmental and social sustainability. He satirises how brands align themselves with ESG issues in order to increase appeal and profit. There is truth in this, ESG is beginning to pay more and more (which of course has led to ‘greenwashing’). 

Figure 3: Scene from Bo Burnham’s Netflix Special ‘Inside’ (2021)

The rise of current ESG attention has been likened to the earlier ‘fads’ of socially responsible investing in the 1980s where anti-apartheid portfolios underperformed. However, a difference in the current wave of ESG is an increase in regulation. Companies are legally required to consider social responsibility under s172 of the Companies Act 2006 and the UK Modern Slavery Act 2015. Most recently, the House of Lords is in its second round of debating the proposed Modern Slavery (Amendment) Bill which would levy fines to companies for non-compliance.

Another difference in current ESG trends is the monetary incentive. As U.S. attorney Jonathan Park points out ‘as the regulatory framework improves, the degree to which the market will reward companies implementing genuine ESG-conscious strategies with access to cheaper capital will likely only increase in the future’. As companies improve in ESG consideration, it becomes cheaper for them to raise money which they can use to turn a profit. Another indication of increasing ESG value is the rise in ESG exchange-traded funds (ETFs). According to Bloomberg Intelligence, around $1 Trillion is expected to enter ESG ETFs globally. In comparison to the 80s fad of ESG investing, there is a lot more regulation and crucially a lot more capital.

Figure 4: Global Projection of ESG Assets Under Management, Bloomberg Intelligence, (2021)

Ghost of ESG Future: Hyundai 

Hyundai Engineering & Construction Co Ltd, an entity of the Hyundai Group, has recently been placed on Norges Bank’s observation list for possible portfolio exclusion. The Fund’s official decision was released on the 1st of July, stating that Hyundai had earned its spot on the list for ‘unacceptable […] gross corruption’. The decision, based on a report from the Council of Ethics, exposed 13 cases of bid-rigging and illegal price-fixing. Moreover, it has emerged that the company had been bribing a local politician in Indonesia to prevent protests over the construction of a Hyundai power plant. The protests were set to be over concerns to air pollution and loss of local livelihoods.  The same politician had also recently been sentenced to five years in prison for another corruption case involving Hyundai paying the politician off through intermediaries over land rights in Indonesia. As a result, Hyundai has been placed under observation for potential exclusion from the fund.

Does this punishment fit the crime? Is exclusion from a fund enough to change a corporation’s behaviours? Probably not. Norges Bank holds very few shares in Hyundai, therefore selling shares would not make much impact either. The shares would just transfer ownership to shareholders who are likely apathetic. As we have seen, legal accountability and social pressure can be effective mechanisms for personal accountability- but real corporate accountability will probably come from financial pressure. 

In 2021, Norges Bank exposed Kirin Holdings Ltd, a Japanese brewery company, for involvement in Myanmar’s Government-led human rights abuses. Following the Bank’s decision to place Kirin on watch for portfolio exclusion, the brewery exited its joint venture agreement in Myanmar. For Kirin, there were no great financial or legal repercussions to Norges’ decision, only country-specific impact to its supply chain. However, on the 7th of September, a legal precedent was set when French cement company Lafarge was alleged to be complicit with crimes against humanity in Syria despite claiming to not be aware. The French Court of Cassation stated that “one can be complicit in crimes against humanity even if one does not have the intention of being associated”. This came after Lafarge kept its factory open in Northern Syria despite the outbreak of war, in order to maximise profit.  

Another problem going forward is misleading ESG data. For example, the MSCI’s (Morgan Stanley Capital International) ESG profile on Hyundai shows that the company’s entity is ‘average’ and does not show any indications of corporate corruption.

Figure 5: Hyundai Engineering & Construction Co. Ltd’ ESG Profile compiled by MSCI.

One of the reasons for this is that MSCI is comparing Hyundai’s entity to its competitors. Just because a company has done more sustainable initiatives than its counterparts, does not mean that the company is involved in ‘good’ ESG practices. For example, one of Hyundai’s largest competitors POSCO International, was excluded from Norges Bank’s Portfolio over ‘severe environmental damage’ in 2015. Another factor could be that indices are laggard themselves and rely on internal-company sourced data. This data is not likely to show the full picture as it is self-reported. 


Rather than focusing on punishments, the incentives of good ESG practices might go further. Especially considering how financial incentives were enough for companies like PG&E to not alter their practices despite ESG controversy. It seems financial services recognise that ESG is everywhere. So much so that nearly every financial conference and roadshow has a talk – anecdotally leading to the immense boredom of one managing director I spoke to.

Unlike the Pre-2015 cases of PG&E, ESG scandals now firmly impact firm value negatively. ESG methodologies also have an influence, partly out of the new alignment with investor objectives but also because of the financial incentives of working with ESG firms. Whether this is driven by investors believing that ESG scandals have a detrimental effect on companies or investors believing other investors have these objectives, so buy fewer stocks and the self-fulliling cycle fulfils itself. 

Leave a Reply