The role of size effects in moderating the benefits of sustainable investing

Using an extensive sample of environmental, social, and governance (ESG) ratings, we reexamine the corporate social responsibility (CSR) factor premium in the developed equity markets between 2007 and 2019 and show that its extent is contingent upon size effects. Consistent with the novel market equilibrium, we contend that the exponential growth of socially responsible investment (SRI) has rendered the risk-adjusted returns of large CSR-leading firms in line with or even below their lagging counterparts. In line with the neglected effect, greater market segmentation, lower market efficiency, and lower investor awareness of CSR enable us to observe the former market equilibrium in the smaller corporation partition, where CSR-lagging firms exhibit lower returns than leading ones. We thus theorize a two-stage CSP–CFP relationship, where size effects are considered a relevant moderator. This contention is robust to portfolio and panel regression settings. However, our partly contradicting results with the existent literature emphasize the divergence in ESG ratings across rating agencies. JEL Classification M14; G11; G15