Goodwill Capital, Relationship-specific Capital, and Corporate Sanctions: An Empirical Study of the Russian Invasion of Ukraine 

By | June 30, 2022

 Whether environmental, social, and governance (ESG) policies enhance shareholder value has been the subject of debate for decades. There are three views on ESG investments. The first view argues that ESG activities enhance shareholder value because they are productive investments in “reputation” or “goodwill” capital (hereafter as “goodwill capital” view). ESG activities reduce transaction costs in the marketplace because they engage with stakeholders to develop long-term and reliable relationships. The value of goodwill capital is vulnerable to depreciation should firms engage in opportunistic behaviors.  

The second view argues that ESG investments destroy shareholder value because they serve the private interests of corporate executives (hereafter as “consumption of private benefit” view). Managers can implement ESG initiatives to advance their personal agenda, e.g., prestige, visibilities, or personal ties with stakeholders. Similarly, managers can use ESG policies to obtain higher compensation. In 2020, approximately half of S&P100 companies used ESG metrics to determine CEO compensation.  

The third view argues that ESG initiatives can be investments of public relations to satisfy a growing demand for doing good in society by stakeholder groups including customers, institutional investors, local communities and governments (hereafter as “public relation” view). ESG initiatives serve as investments to window dress a corporation’s ESG metrics and improve public relations. This view is consistent with two major trends in recent decades. First, shareholder activism on ESG initiatives is growing rapidly. In 2019, 300 mutual funds with ESG mandates received an aggregate of $20 billion in net inflows, which was fourfold larger than in 2018. Second, the rise of social media empowers individuals and stakeholders to exert considerable influence on company behaviour. 

In our recent paper, we attempt to disentangle these competing hypotheses and examine the role of goodwill capital and relationship-specific capital on a firm’s decision to withdraw from Russia. Our measure of goodwill capital is ESG scores which is widely used in the literature. We also use the existence of a major business relationship in Russia as our measure of relationship-specific capital. To quantify if a firm withdraws from Russia, we use a dummy variable to identify whether the firm reduces its current or future operations in Russia after the invasion.  

Given that the Russian invasion is a material event and will reshape global ESG practices, we add to a growing body of research to investigate the impact of the invasion on stock returns and corporate policies. Our paper sheds light on the relevance of goodwill capital investments from a “moral” perspective which is less readily examined in prior studies. The Russian invasion triggered nearly unanimous condemnation from the western world. In the United Nations’ General Assembly resolution to condemn the Russian invasion on March 2, 2022, 141 countries condemned the invasion, or 78% of all countries participating in the vote. This unanimity from international communities exerts “moral” pressure on companies to withdraw from Russia. This event offers a unique opportunity to investigate whether firms with more goodwill capital, as proxied by ESG scores, are more likely to withdraw from Russia than those with less goodwill capital. In addition, this event allows us to examine whether investors react less negatively to firms with more goodwill capital in terms of higher ESG scores. 

Our results indicate that a firm’s decisions to withdraw from Russia is affected by its goodwill capital and whether the firm has a major business relationship in Russia as measured by Factset Revere. The likelihood of withdrawing from Russia increases by 4.1% for firms with more goodwill capital (as measured by one standard deviation increase in ESG score); and by 19.2% for firms with a major business relationship in Russia. For firms with both a major business relationship in Russia and more goodwill capital, this likelihood increases by 25.6%. 

The cost of withdrawal from Russia is large. We find that the average five-day cumulative abnormal stock return around withdrawal announcements is –1.32%, or an average decline in market value of US$0.91 billion. The aggregate decline in market value of 432 sample firms around withdrawal announcements is US$393.1 billion, which exceeds the GDP of, e.g., Denmark or Norway in 2020. Firms with more goodwill capital suffer less (or perform relatively better) around withdrawal announcements. The corresponding drop in market value is only –0.46%, or an average decline in market value of US$0.32 billion. Moreover, firms with more goodwill capital also suffer less and experience less negative abnormal return prior to withdrawal announcements.  

Overall, our results are more consistent with the goodwill capital view. They all point to the same direction that goodwill capital is relevant for a firm’s decision to withdraw from Russia, a truly costly action. However, the cost of withdrawal is smaller for firms with more goodwill capital, suggesting that goodwill capital operates and enhances shareholder value. 

Siu Kai Choy is a Lecturer in Accounting and Finance at the Business School of King’s College London.  

Tat-Kei Lai is an Associate Professor of Economics at the IESEG School of Management and a member of Lille Economie Management (UMR 9221, CNRS).  

Kam-Ming Wan is an Associate Professor of Finance at the Hanken School of Economics.  

This post is adapted from the authors’ paper, “Goodwill Capital, Relationship-Specific Capital, and Corporate Sanctions: An Empirical Study of The Russian Invasion of Ukraine”, available on SSRN.  

The views expressed in this post are those of the authors and do not represent the views of the Global Financial Markets Center or Duke Law.  

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