Does sustainability improve financial performance? An analysis of Latin American oil and gas firms

Abstract

The growing concern about environmental, social, and governance (ESG) issues raises questions about the presence of financial incentives that naturally offset —at least partially— the higher operating costs stemming from ESG-related investment policies in the oil and gas sector, which is characterized by its strong environmental impact. Building on Campbell and Shiller's present value decomposition and using an instrumental variables-based methodology to address measurement errors in ESG scores, in this paper we analyze the effects of corporate ESG performance on expected dividend growth and discount rates for oil and gas firms in Latin America (Latam). On the one hand, our results suggest that ESG policies developed by oil and gas firms in Latam are related to lower medium-term discount rates. On the other hand, ESG practices adopted by oil and gas companies are also related to lower future dividend growth. These findings suggest that the lower discount rates resulting from active ESG policies at least partially offset the costs derived from the green transition of the oil and gas sector in Latam, meaning that the efforts made by oil and gas companies to improve their ESG performance, together with public initiatives aimed at covering a portion of the costs derived from corporate ESG policies, can make some unexploitable oil reserves in Latam become viable.