ESG Arbitrage and Environmental Outcomes in REITs

This study examines the role of environmental materiality in the environmental, social and governance (ESG) strategies adopted by real estate investment trusts (REITs) in the US. Due to the large investment required to improve environmental performance, REITs may undertake strategic ESG efforts by focusing more on the social and governance pillars than the environmental pillar. Our study finds that these strategic ESG practices of REITs, measured by strategic ESG scores, are associated with better revenue growth, higher profitability and larger asset expansion. The long–short portfolios, which long stocks with higher strategic ESG scores and short stocks with lower strategic ESG scores, generate positive risk-adjusted returns of 0.558% (0.821%) per month under an equal-weighted (value-weighted) scheme. Stocks with higher strategic ESG scores are also associated with higher long-term valuations, as measured by Tobin’s Q and buy-and-hold returns, and larger institutional ownership. The strategic ESG practices, however, have adverse environmental consequences, resulting in increased greenhouse gas emissions and environmental damage costs.