Sell-Side Analysts’ Assessment of Operational Risk: Evidence from Negative ESG

Abstract

Financial analysts closely follow a firm’s operations and assess the risks that it faces. Operational risks have value implications to firms, and as such are expected to be reflected in analysts’ outputs. In this paper, we examine whether analysts incorporate assessments of operational risks. We use firm-day level data from RepRisk about negative operational incidents that are classified into environmental, social, and/or governance issues. We find that analyst outputs predict negative ESG incidents, suggesting that analyst outputs contain information that is predictive of these events. Our results are robust to controlling for negative ESG incidents that firms experienced in the past, and are stronger in more transparent information environments, and in the presence of more guidance on ESG issues from Sustainability Accounting Standards Board. Finally, we find that these ESG risks are incorporated into analyst outputs through adjustments to discount rates rather than to cash flow estimates. Overall, our results highlight the ability of financial analysts to synthesize and integrate operational risks, and in particular ESG-related risks, into their research outputs.