Sustainability in Asset Pricing: The Role of ESG Scores in G7 Economies

This study examines the association between a country-specific environmental, social, and governance (ESG)-sorted portfolio return spread and firm-level excess returns in Group of Seven (G7) countries by adding this variable to the Fama–French five-factor model. The analysis uses data from Refinitiv Workspace for 1465 publicly traded firms from 2010 to 2022. The ESG(t − 1) factor is constructed as the annual return difference between high- and low-ESG portfolios formed using one-year-lagged ESG scores for each country, with the model estimated separately for each market. Results indicate that the beta-adjusted market component and the size factor are positive and statistically significant across all countries. The ESG(t − 1) coefficient is insignificant in Canada, Germany, and Italy; negative in France, Japan, and the United Kingdom; and positive in the United States. These findings suggest that the relationship between the ESG factor and excess returns is neither unidirectional nor homogeneous across developed markets. Nevertheless, the estimated coefficients alone do not establish that ESG risk is priced. The principal contribution of this study is to demonstrate, within a country-specific framework, that the ESG-based return relationship varies across G7 countries. These results suggest that investors should adapt ESG-based portfolio strategies to specific country contexts to enhance decision-making and risk assessment.