with Sebastian Hanson
This paper studies the impact of environmental, social, and governance (ESG) investing on the real economy. Using within industry-year variation, I show that 1.) firms with high ESG ratings have low marginal revenue products of capital (MRPK), while, 2.) firms with high sales per tCO2 emission have high MRPKs. This implies that reallocating capital to firms with high ESG ratings lowers allocative efficiency while reallocating capital to greener firms increases it. I further document that 3.) capital investment by firms with high ESG ratings is less sensitive to Tobin’s Q, 4.) capital allocation decisions of ESG mutual funds are not sensitive to the MRPK of their portfolio firms. Motivated by these facts, I structurally estimate a dynamic investment model featuring convenience yields on ESG assets and a CO2 externality. I use the model to explore the implications of ESG investing for misallocation of capital, aggregate total factor productivity, and as a tool for climate change mitigation. I simulate a counterfactual economy where capital investors internalize the CO2 emission instead of ESG convenience yields.