The study explores the relationship between a firm's adoption of climate change as a corporate social responsibility (CSR) mission and investor returns. Climate change is driving innovation in resource management and energy production, leading many organizations to integrate environmental sustainability into their CSR strategies. However, industries like petroleum face a dilemma: adapt to renewable energy or risk obsolescence. The UNGC, with over 10,000 members, is a prominent platform for corporations to demonstrate CSR commitment by adhering to ten principles including environmental responsibility. Prior research has examined historical, operational, and governance aspects of UNGC firms but lacked analysis of the performance impact of UNGC membership, particularly concerning the Climate Change Champions initiative. This study aims to fill this gap in the literature, focusing on the portfolio performance of UNGC-CCC firms, representing a fourth-generation SRI screening approach that combines sustainability and shareholder activism, and examining whether their proactive engagement in climate change mitigation positively or negatively impacts financial performance.

Existing literature on environmentally responsible corporate policies and financial performance shows mixed results. Some studies find no penalty for green energy companies, even suggesting superior performance. However, others highlight the potential negative impact of climate change on firm value due to threats to asset value. Previous studies on SRI strategies, particularly divestment from fossil fuels, often show no decrease in risk-adjusted returns using first-generation negative screening approaches. Second-generation studies often indicate market penalization of negative environmental performance, but less frequently reward positive performance. This study contributes to the literature by analyzing a third and fourth-generation SRI portfolio, specifically focusing on UNGC-CCC firms which demonstrate a significantly higher commitment to social responsibility than other UNGC members. The authors argue that UNGC-CCC firms represent a natural experiment, as the decision to join is voluntary, and thus provides insights into the causality between CSR commitment and financial performance. This contrasts with many CSR studies, where researchers lack control over the independent variable.

The study employs a modified portfolio study using an event study approach, with the UNGC joining year as a reference point. This allows for the examination of long-term effects and comparison with matched non-UNGC competitors. Panel regression tests are conducted over 15 years, minimizing the impact of firm-specific events due to portfolio diversification. The study uses two main models: Equation (1) examines the direct effect of UNGC-CCC membership on cumulative abnormal returns (CARs) while controlling for financial, governance, regional, and governance factors; Equation (2) employs a difference-in-differences approach, examining the effect of UNGC membership after joining, controlling for the same factors as Equation (1). The sample includes 117 unique UNGC-CCC firms, with 115 active members. Competitor firms were selected based on Capital IQ data, matching firms based on various operational and financial similarities. Four different asset pricing models are used to estimate CARs: CAPM, Fama-French three-factor, Fama-French five-factor models, and return on assets (ROA). Monthly share price data was collected from Capital IQ for the period 2000-2015. Abnormal returns are measured using three methods: relative to the UNGC joining date, in time blocks, and in calendar time. The study tests hypotheses regarding differences in financial operating performance (H1), abnormal return performance (H2), and the impact of UNGC-CCC membership on long-term abnormal return performance (H3).

The study finds that UNGC-CCC firms exhibit higher ROA and ROC than their competitors, suggesting improved operating performance. However, gross margins are significantly lower. In terms of market performance, the UNGC-CCC portfolio exhibits a lower risk premium and similar Sharpe Ratios compared to competitors. Analysis of operating expenses reveals a significant decrease after joining UNGC, indicating real operational changes rather than greenwashing. Regarding investment performance, the UNGC-CCC portfolio shows positive CARs in the period leading up to UNGC membership, a slight decline shortly after, and then sustained positive returns for several years. Panel regression results indicate that UNGC membership itself has no significant effect on risk-adjusted returns. However, a significant positive effect on portfolio performance is observed *after* a firm joins UNGC, highlighting the causal relationship. Interestingly, a negative effect is observed after controlling for UNGC membership, suggesting potential mispricing of the UNGC portfolio. This mispricing might arise because standard asset pricing models do not account for investor preferences (tastes) and disagreement over future payoffs, as proposed by Fama and French (2007).

The findings suggest that the market may be underpricing UNGC-CCC firms due to investor preferences and disagreement regarding future payoffs. The positive effect of UNGC membership observed *after* joining indicates that the decision to adopt sustainable practices results in improved performance. This resolves the causality issue often debated in the CSR literature. The lower risk profile of UNGC-CCC firms is consistent with the 'aversion to unethical behavior' discussed by Renneboog et al. (2008), suggesting investors are willing to accept lower returns for the ethical benefits. The study's findings have significant implications for asset pricing models, highlighting the need to incorporate investor preferences and disagreement into valuation frameworks. The results support the argument that incorporating ESG factors into investment strategies is not only ethically sound but can also lead to improved financial outcomes.

This study provides novel evidence on the financial performance of UNGC-CCC firms, demonstrating a positive long-term impact of UNGC membership on portfolio performance. The results suggest that standard asset pricing models may be inadequate for evaluating companies with strong CSR commitments and highlight the importance of incorporating investor preferences into valuation models. Future research could explore the specific mechanisms through which UNGC-CCC membership enhances financial performance, and investigate the generalizability of these findings to other regions and industries.

The study utilizes proprietary data from S&P Capital IQ, which may limit the generalizability of the findings. The sample size, while substantial, might not fully represent all UNGC-CCC firms globally. Additionally, while efforts were made to match UNGC-CCC firms with competitors, inherent limitations in matching methodologies could exist. Further, the focus is on publicly traded firms, potentially overlooking valuable insights from private sector companies.