Investor Reliance on ESG Ratings and Stock Price Performance

Abstract

We exploit a quasi-natural experiment, the recalibration of Sustainalytics’ environmental, social, and governance (ESG) rating methodology, to study the implications of investor reliance on ESG ratings on stock returns, absent any change in firms’ underlying ESG fundamentals. A one standard deviation decline in the change in ESG rating generates an abnormal monthly return of 1%. This effect is largely due to retail investors’ blind reliance on ratings, whose behavior exerts transitory price pressure. We do not find a similar effect on mutual fund investment behavior or investor flows but affected firms repurchase shares in response to the stock price decline.

Keywords: Corporate Social Responsibility, ESG Rating Agencies, Sustainable Invest- ments, Socially responsible investing, ESG, Portfolio choice

JEL Classification: G11, G12, G23, G59, M14, Q5