© Jakob Utgård. Last updated 29 Sep 2026

Sustainable finance is the integration of environmental, social and governance considerations into financial decisions, including which shares and bonds to buy, which firms to lend to, and how to exercise the rights that come with ownership. Environmental considerations cover climate, pollution and resource use; social considerations cover the treatment of workers, communities and customers; governance covers how the firm is controlled, including board composition, executive pay and shareholder rights. ESG (environmental, social, governance) has become the name for the whole field, but is often used as a term for the management of sustainability risks to the investment, and not the business impact on the world.

Investor strategies

Investors who are concerned with sustainability have two main strategies to make their investments more sustainable, screening and active ownership.

Screening of investments. A central idea in sustainable finance is to invest in the most sustainable companies, avoiding the least sustainable companies, or both (Kempf & Osthoff 2007). Negative screening involves excluding companies, industries, or sectors that are considered harmful to society or the environment from investment portfolios. Typical examples of negative screening are excluding companies in coal, oil and gas sectors, tobacco or alcohol, weapons or gambling, or companies that have been caught to systematically break human rights or labour rights. Positive screening involves selecting companies or sectors that contribute positively to sustainability. Typical examples include investing in renewable energy, innovative and green technology, the circular economy, companies that contribute to solving important social issues, or companies that are particularly good in diversity, human rights or other important issues.

Active ownership is investors using their ownership rights and position to influence corporate behaviour on sustainability (ESG) issues. In active ownership, investors engage directly with companies to improve their sustainability performance (Dimson et al. 2015).

Shareholder engagement involves direct communication between investors and company management or boards to discuss concerns and encourage improvements in ESG practices. This dialogue may focus on issues such as climate change, labour rights, executive compensation, or diversity on the board. Investors might ask companies to adopt more sustainable business practices, improve disclosure on ESG-related risks, or set specific targets, such as reducing greenhouse gas emissions.

Voting in shareholder meetings. When investors own shares in a company, they are entitled to vote at shareholder meetings. These votes can relate to executive compensation, director elections, mergers, acquisitions, or ESG proposals. Investors who prioritize sustainability can use their votes support ESG resolutions and influence corporate policies in alignment with their sustainability principles.

Investors can file shareholder resolutions—proposals that are submitted to be voted on at a company’s annual general meeting. These resolutions can request specific actions or policy changes on ESG issues. Shareholder resolutions can pressure companies by raising awareness of issues and signalling widespread investor support (even if the resolution in the end is not supported by a majority).

Sustainability in debt

Green bonds and loans

Most attention in sustainable finance goes to shares, but most external finance for firms comes from debt (bonds or loans). A green bond is an ordinary bond that the issuer commits to spend on defined environmental projects, with reporting on where the money went and what it achieved. The Green Bond Principles and, in the EU, the European Green Bond Standard set out what counts, and most issuers obtain a second party opinion from a specialist reviewer. Green loans work the same way in the bank market. Flammer (2021) finds that firms issuing green bonds subsequently improve their environmental performance and attract long term investors, and that the market reacts positively to issuance, which suggests the bonds carry information rather than merely relabel debt. Whether they are cheaper is contested, the yield discount that green bonds command over comparable ordinary bonds, is small and not always present.

Sustainability linked instruments

A sustainability linked bond or loan finances the firm in general rather than a project, but its interest rate moves with the firm’s performance on agreed key performance indicators, typically emissions, with a margin reduction for meeting the target and an increase for missing it. Sustainability linked loans have spread quickly among Norwegian firms because they fit ordinary bank lending. Their weakness is that the KPIs and the size of the margin step are negotiated between borrower and lender, and both parties have an interest in targets that will be met.

Banks and climate risk

Banks are also changing on their own account. Climate has become a physical risk to the assets banks lend against, from flooding, drought and storms, and a transition risk, the loss of value in assets whose business model does not survive a low carbon economy, often called stranded assets. Central banks and supervisors run climate stress tests and expect banks to measure and manage the carbon exposure of their loan books, and institutional investors report that climate risk already shapes their portfolio decisions (Krueger, Sautner and Starks 2020).

Does sustainable finance pay?

Sustainable investments

The question in the business case chapter was whether sustainability pays for firms, and the short answer was that the relationship between sustainability and financial performance is on average slightly positive but highly conditional. Another question is whether investing in sustainable firms earns a higher return, and here the logic of asset pricing gives a different answer. If many investors prefer green assets, they bid up their prices, and an asset bought at a high price yields a lower expected return. In equilibrium, green assets should earn less than brown ones, and investors who hold them accept the lower return as the price of their preference (Pástor, Stambaugh and Taylor 2021). Green assets can outperform for a period while preferences are shifting toward them, since the shift itself raises their prices, but that is a one time gain rather than a permanent premium. Consistent with this, Bolton and Kacperczyk (2021) find that firms with higher emissions have earned higher returns, a carbon premium that compensates investors for holding them.

Why investors invest in sustainability?

If sustainability is not more profitable for investors, why do they invest in sustainability? The evidence says mainly because they want to. Riedl and Smeets (2017) find that investors in socially responsible funds are driven by social preferences and by the wish to signal them, and that most expect lower returns; Hartzmark and Sussman (2019) show that money flowed into funds when Morningstar began publishing sustainability ratings, regardless of return. Institutional investors add two motives, a long horizon that makes climate and regulatory risk material to them, and pressure from the beneficiaries whose money they manage (Dyck et al. 2019). Surveys of professional investors find that most now use sustainability information for financial reasons, to manage risk and identify well run firms, rather than in the expectation of higher returns as such (Edmans, Gosling and Jenter 2024).

Does sustainable finance deliver sustainability?

The “theory” behind sustainable finance is that if enough investors refuse to hold a firm’s shares or bonds, the remaining investors must be paid more to hold them, so the firm’s cost of capital rises and it invests less, and the reverse holds for firms the investors favour (Heinkel, Kraus and Zechner 2001). Over time, more money should flow to more sustainable firms and projects. The empirical question is how large the effect is, and the answer from the best studies is that at the scale of today’s sustainable investing it is very small. Berk and van Binsbergen (2021) calculate that even large scale divestment moves the cost of capital of the excluded firms by a few basis points, too little to change any investment decision. The reason is that capital is abundant and mobile. When one investor leaves, another is willing to buy at a slightly lower price.

Screening versus active ownership

This has led to a rethinking of the choice between selling and staying. Selling a share removes the investor’s influence over the firm. Owning a share and using the vote, the meeting with management and the shareholder resolution keeps that influence. Broccardo, Hart and Zingales (2022) show that investors who care about outcomes achieve more through voice than through exit, because exit requires almost everyone to act to move prices while voice can succeed with a majority of votes. Hartzmark and Shue (2023) suggest that steering capital toward firms that are already green yields little, since those firms have little left to improve, whereas the large reductions are available in brown firms, which is exactly where sustainable investors have withdrawn. The implication is that the strategies that matter most are the ones that reach firms with problems rather than the ones that avoid them.

The evidence on engagement is consistent with this. Dimson, Karakaş and Li (2015) studied several thousand engagements by a large institutional investor and found that successful engagements, about a fifth of the total, were followed by better operating performance and better share returns, while unsuccessful ones had no effect. Flammer’s (2021) green bond results, above, show that use of proceeds instruments can carry information and precede real improvement. Beyond these, the evidence thins out. Kölbel et al. (2020) review the mechanisms of investor impact and conclude that engagement has demonstrated effects, that the cost of capital channel is weak at current scale, and that the impact claimed for most sustainable funds rests on mechanisms that have never been measured. Schlütter et al. (2024) find that the impact investing literature itself rarely measures impact, relying on the investee’s reported outputs rather than on outcomes that would not otherwise have occurred.

Comprehension questions

1. What is the difference between negative and positive screening?
2. Describe the three forms of active ownership discussed in the chapter
3. What are green bonds, and why is there a risk that they are used for greenwashing?
4. Why can ESG ratings for the same company differ considerably between rating agencies?
5. What do we overall know about whether sustainable investments are profitable, and whether they actually make companies more sustainable?

Exercise: The Oil Fund as a responsible investor

The Government Pension Fund Global combines exclusion with active ownership, and publishes the details online.

a) Open the fund’s list of excluded companies and choose one company. Was it excluded on product criteria or conduct criteria? Do you think the exclusion is likely to change the company’s behaviour?

b) Use the fund’s voting records to find a shareholder resolution on climate or human rights at one of the fund’s large holdings. How did the fund vote, and how did it explain its vote?

c) Return to the DNB Klima Index example at the start of the chapter. A friend asks whether she should choose it over DNB Global Index for her monthly savings. What would you advise??

References

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Berk, J. B., & van Binsbergen, J. H. (2021). The impact of impact investing. SSRN working paper no. 3909166. https://doi.org/10.2139/ssrn.3909166

Bolton, P., & Kacperczyk, M. (2021). Do investors care about carbon risk? Journal of Financial Economics, 142(2), 517–549. https://doi.org/10.1016/j.jfineco.2021.05.008

Broccardo, E., Hart, O., & Zingales, L. (2022). Exit versus voice. Journal of Political Economy, 130(12), 3101–3145. https://doi.org/10.1086/720516

Dimson, E., Karakaş, O., & Li, X. (2015). Active ownership. Review of Financial Studies, 28(12), 3225–3268. https://doi.org/10.1093/rfs/hhv044

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