Garz and Volk (2007)

Garz, Hendrik, and Claudia Volk. "What Really Counts: The materiality of extra-financial factors." WestLB Research, February 2007.

The authors note that "approaches that take so-called extra-financial information into account...are relatively new and are not yet generally accepted." They seek in this report to demonstrate the relevance of extra-financial factors in investment analysis.

The report presents summary results of a series of 198 cross-sectional regression analyses using WestLB's extra-financial variables as independent variables and a variety of financial factors as dependent ones. This is supplemented with comparison of means for paired portfolios formed on financial variables (e.g., high valuation and low valuation).

The universe studied consists of 540 publicly-traded European companies. The non-financial data is taken from the firm's 'Extra-Financal Risk Navigator', which the authors characterize as a "classical 'triple bottom line' rating system." Ratings are based on 120 indicators based on the SiRi database, and include both common criteria (applied to all companies in the universe) and sector-specific criteria.

Main findings:

- Of the 198 regressions, 27 "had the expected had the expected economically plausible sign, and at the same time were highly statistically significant" (t value > 1.96). The strongest results by far were in the area of risk.

- "The link to other financial variables (share price performance, valuation, profitability, growth) is much less pronounced, and only in a few cases do we have reason to believe that it goes beyond mere statistical coincidence."

- Surprisingly, given past findings on relationship between ESG variables and growth, the authors report that "our triple bottom line variables appear to be completely useless in systematically explaining the differences between companies' growth rates."

- A positive relationship between extra financial ratings and credit ratings is observed. See Goss and Roberts (1997) for further research in this area.