ESG Performance, Corporate Financial Outcomes, and Idiosyncratic Risk : A Critical Review and Empirical Assessment within the S&P 500 Index

Abstract

Esta tesis investiga la relación entre el desempeño ESG, los resultados financieros corporativos y el riesgo idiosincrático. Integra las dimensiones de rentabilidad y riesgo, introduciendo la Prima Idiosincrática de Capital (IEP) como medida directa de la compensación por riesgo específico de la empresa. Bajo el marco del modelo DCF, el ESG influye en la valoración al modificar el riesgo idiosincrático y sistemático, afectando tanto el riesgo de los flujos de caja como el coste del capital. La tesis adopta un enfoque integrado en un perfil de ESG–Riesgo–Rentabilidad, evitando tratar ESG como un factor aislado. El análisis empírico se basa en datos de empresas del SP 500 (2004–2023), utilizando Refinitiv, Bloomberg y FactSet. Se aplican regresiones de panel y modelos de valoración de activos (CAPM, Fama-French, Carhart), donde el riesgo idiosincrático se mide mediante rendimientos residuales y volatilidad utilizando retornos diarios. Los resultados muestran que el desempeño ESG es financieramente relevante: reduce la volatilidad específica de la empresa, mejora la estabilidad financiera e influye en los rendimientos esperados mediante la valoración del riesgo idiosincrático, especialmente tras el Acuerdo de París. Finalmente, la tesis aporta evidencia robusta a largo plazo, introduce el riesgo idiosyncratico, (IEP), como innovación clave y demuestra que el ESG mejora los retornos ajustados al riesgo, respaldando además la estandarización de la divulgación ESG.This thesis investigates the relationship between ESG performance, corporate financial outcomes, and idiosyncratic risk. It integrates both return and risk dimension and introduces the Idiosyncratic Equity Premium (IEP) to assess whether firm-specific risk is priced. A thorough literature review is conducted to define and examine current explicit and implicit valuation channels under the lens of the discounted cash-flow (DCF) model. Firm value changes only through risk-adjusted discounting in the DCF model. ESG affects valuation by altering, firm specific (idiosyncratic) risk, and market wide (systematic) risk, which affects firm valuation, according to the DCF model through cash flow risk and the cost of capital, respectively. We do not treat ESG metrics as a standalone factor, but we jointly analyze the relation among ESG, financial performance, idiosyncratic risk and risk with respect to asset pricing. In this way, the thesis fully integrates ESG-Risk-Return framework. The IEP is introduced as an idiosyncratic quantifiable factor which measures directly compensation for fir-specific risk. This factor goes beyond standard idiosyncratic volatilities measures as it decomposes return shock into firm-specific shocks, market risk and microstructure components especially important for price discovery in equity markets. Based on SP 500 firms, large–scale panel data is examined (2004–2023), using Refinitiv, Bloomberg, and FactSet data. This provides robust inference across market regimes, as the data set sample is divided into three different economically meaningful sub-samples. In this manner, ESG relevance is explicitly treated within the pre-2015 and post- 2016 period. Methodology includes panel regressions and asset pricing models (CAPM, Fama-French, Carhart). Idiosyncratic risk is measured via residual returns and volatility. Empirical results demonstrate that ESG performance is a financially material driver of both risk and asset pricing. It reduces firm-specific volatility, improves financial stability, and crucially affects expected returns through the pricing of idiosyncratic risk, especially in the post-Paris regulatory environment. Including ESG pillars as explicit explanatory variables augments granularity with respect to regime shifts and relevant economic context. Provides integrated ESG-riskperformance analysis, introduces IEP, and delivers robust long-term empirical evidence. ESG improves risk-adjusted returns and hence can be used as a risk-management overlay. The case supports ESG disclosure standardization. It is a financially material driver that reduces firm-specific risk and influences expected returns through the pricing of idiosyncratic risk.