Costly controversies: the negative financial impact of ESG fallouts

In late 2022, Teleperformance, a global leader in customer service outsourcing, faced a major ESG controversy when allegations surfaced about poor working conditions and employee mistreatment at several of its call centers. The news quickly spread, leading to public outrage and a significant backlash from investors. On November 10, 2022, Teleperformance stock fell by 33.9% (and by 8.5% over 10 days), erasing billions of dollars in market value. In the months that followed, the stock price recovered, but later was hit by a structural decline linked to AI. At the time of the controversy sentiment plummeted as analysts downgraded the stock, highlighting concerns over potential legal repercussions, reputational damage and increased regulatory scrutiny. This incident stresses the critical need for investors to consider ESG controversies in their risk assessment and investment strategies.

The nature of ESG controversies

ESG controversies refer to events or ongoing situations in which company operations and/or products have a negative environmental, social and/or governance impact. They can include oil spills, product safety issues, data breaches, workplace harassment and accounting scandals among others. Controversies are not without consequences for investors as they can lead to negative publicity, legal issues and reputational damage, all of which can severely impact a company's financial health and market performance.

Impact on financial performance reflected both in stock prices and bond spreads

In addition to the Teleperformance case highlighted above, multiple academic studies (including Elamer and Boulhaga in 2024; Nirino et al in 2021 and de Franco in 2020) have shown considerable negative impact on companies’ financial performance (considering multiple performance measures including Tobin’s Q, return on assets and return on equity) due to ESG controversies. Shakil in 2021, and Bang et al, in 2023, indicate a strong negative relationship between ESG controversies and stock prices, with controversies leading to increased volatility. Additionally, as Petkevich et al demonstrated in 2024, ESG controversies lead to higher bond spreads and financing costs, as bondholders demand a higher risk premium for the companies involved in such controversies. This adverse effect is long-lived and is particularly pronounced in bond issues with higher credit risks and greater information asymmetry.

Broker research from the Bank of America in 2023 further confirms this finding by demonstrating that share prices drop significantly in the first 10 days and continue to underperform for the following 12 months. More specifically, the broker considered 23 material controversy cases in Europe and 34 in the US, where share prices were impacted by more than 10% on the day of the controversy. Results then showed that the average relative share price drops by 9.1% in Europe and by 6.0% in the US in the following 10 days of the controversy. Bond spreads also deteriorate, nonetheless bonds take less time to recover than share prices. Similarly, Velazquez and Oliver, in 2023, found that stocks underperform between 2.08% and 5.39% in the six months following the incident, when aggregating over 10000 incidents for more than 1500 companies.

Share price of company with ESG controversy vs MSCI ACWI Index

Source: Societe Generale

Mitigating risks through ESG practices

Elamer and Boulhaga in 2024 and Brighi et al, in 2023, found that robust ESG practices can significantly mitigate the negative impacts of controversies. However, as Nirino et al, in 2021 reported, the negative effects of controversies on performance are only marginally alleviated, meaning that the joint effect of ESG practices and controversies still has a negative overall effect on the companies’ financial performance. However, in the long run, Elamer and Boulhaga stress that companies with strong ESG frameworks and proactive measures have the potential to transform controversies into future growth opportunities and to enhance reputation. Shakil, in 2021, found that effective corporate governance and board diversity, for example, play a crucial role in reducing ESG-related risks for companies.

After the event, robust ESG practices can help mitigate negative news effects, however having these practices in place can also serve as a means to avoid controversies which might harm financial performance.

The added value of proactive ESG screening for investors

In this regard, investors should adopt proactive ESG screening of their portfolios to identify and address potential controversies that they might be exposed to. De Franco in 2020, for example, found that integrating ESG considerations into investment decision making can help to avoid pitfalls associated with high-risk stocks and that excluding high-controversy stocks from investment universes yields higher long-term returns, especially in Europe and the US. Stocks that undergo severe controversies significantly underperform both their benchmarks and other portfolios consisting of stocks with low levels of controversy or no controversy at all, highlighting the financial benefits of active ESG screening. Moreover, engaging with companies is also a powerful tool for risk management by driving change in corporate behavior to prevent future controversies.

(1) Relative performance of stocks with versus without controversies, Euro Stoxx 600; (2) Relative performance of stocks with versus without controversies, Euro S&P 500

Source: Bank of America

Conclusion

It is clear that ESG controversies harm financial performance. Incorporating ESG controversies into investment decision making can therefore help investors to mitigate financial risks. Indeed, investors who actively monitor portfolios for ESG issues can avoid significant losses and contribute to broader societal and environmental goals. As the Teleperformance case demonstrates, ignoring ESG controversies can lead to severe financial repercussions and damage investor confidence. Find out more in our articles: ‘costly controversies: focusing on material controversies’ and ‘costly controversies: case studies’.

References

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Carmine de Franco. The Journal of Investing, ESG Special Issue 2020,

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De Winne, Rudy; Petkeviciute, Aiste. ESG Controversies: How Do They Affect Market Returns and Individual Asset Choices? Behavioural Finance Working Group Conference (2022)

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Jeongseok Bang, Doojin Ryu, Robert I. Webb. ESG controversy as a potential asset-pricing factor. Finance Research Letters, Volume 58, Part A (2023)

Mohammad Hassan Shakil. Environmental, social and governance performance and financial risk: Moderating role of ESG controversies and board gender diversity. Resources Policy, Volume 72 (2021)

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Velazquez & Oliver, 2023, https://clarity.ai/research-and-insights/esg-risk/measuring-esg-risk-esg-controversies-lead-to-a-2-to-5-stock-underperformance-after-six-months/