What Do We Learn From Ratings About Corporate Social Responsibility (CSR)?
97 Pages Posted: 30 Apr 2018 Last revised: 3 Dec 2019
Date Written: December 1, 2019
One in four dollars is estimated as of 2018 to be professionally managed with a socially responsible mandate in the United States. Alongside this huge demand for socially responsible investments, there is growing interest from investors in incorporating environmental and social ratings into their portfolio choices. However, it is not clear how informative these ratings are or whether they are, in fact, distorted by greenwashing. Using a natural experiment around the tightening of Federal Trade Commission (FTC) regulations on greenwashing, I offer the first evidence that links greenwashing to ratings inflation. Controlling for firm size, I find that environmental and social ratings are largely uninformative about future corporate bad behavior (lawsuits, news, and regulatory penalties). In addition, without controlling for firm size, I find that better environmental ratings predict more future bad behavior. This is of concern because it undermines the signaling value of these ratings. To understand these empirical results, I develop a model where the rating agency may underinvest in precision and where firms have incentives to window dress and engage in greenwashing. Finally, I show empirically that controlling for greenwashing improves the quality of the ratings.
Keywords: stakeholders, socially responsible investing, corporate social responsibility, rating agency
JEL Classification: G11, G24
Suggested Citation: Suggested Citation