Lee, Darren David and Robert W. Faff. "The Corporate Sustainability Discount Puzzle." Working Paper, University of Queensland Business School, 2007.

This study compares the returns of equal-weighted portfolios of sustainable companies with portfolios composed of sustainability laggards for the 1998-2002 time period. The sustainability ratings are taken from the Dow Jones Sustainability Index (DJSI - seeks to identify the top 10% of sustainability companies globally). Two laggard portfolios are formed - one composed of companies matched to the DJSI portfolio, the other an unmatched portfolio composed of firms in the Dow Jones Global Index. Financial data is sourced from Compustat, and returns are calculated in U.S. dollars. Alphas are computed using a one-factor CAPM model, and also a six-factor model that, in addition to the Fama & French factors, adjusts country and industry as well.

Finds that the sustainability portfolio "neither outperforms or underperforms the DJGI Broad equity market." Interestingly, however, the laggard portfolios had statistically significant superior performance.

The study also finds important differences in the characteristics of sustainable leaders and laggards. Results of the regression show that firms with high sustainability ratings tended to have lower valuations and higher market capitalizations during this time period.

The study also examines idiosyncratic risk using both CAPM and the six-factor model. Even after adjusting for industry, country, and size factors, the sustainability laggards had 18-23% more idiosyncratic risk than the leaders.

Concludes that "a CSP pricing factor is incorporated into security prices, which is associated with a firm's level of idiosyncratic risk, which is not captured by current pricing models."