The Power of ESG Ratings on Stock Markets

42 Pages Posted: 10 Mar 2021

See all articles by Carmelo Latino

Carmelo Latino

Leibniz Institute for Financial Research SAFE

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Leibniz Institute for Financial Research SAFE; Ca Foscari University of Venice

Aleksandra Rzeźnik

York University, Schulich School of Business

Date Written: March 2, 2021

Abstract

This paper studies the impact of environmental, social, and governance (ESG) ratings on investors’ preferences and stock prices. We exploit a change in ESG rating methodology that non-linearly shifted ESG ratings for firms as a natural experiment. We show that the ‘pseudo’-changes in the ESG ratings induced by the change in methodology are unrelated to potential fundamental changes in firm’s sustainability. Yet, we find that an exogenous change in a stock’s ESG rating exerts a transitory price pressure and alters the composition of stock ownership. Individual investors are especially sensitive to the ‘pseudo’-changes in the ESG ratings. They (dis)invest in stocks that they misconceive as ESG (down-) upgraded. Short sellers act as arbitrageurs and take the other side of retail investors’ trades. Overall, we find that a one standard deviation quasi-increase in the ESG ratings translates into 1pp drop in stock monthly abnormal return.

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

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

Suggested Citation

Latino, Carmelo and Pelizzon, Loriana and Rzeźnik, Aleksandra, The Power of ESG Ratings on Stock Markets (March 2, 2021). SAFE Working Paper No. 310, Available at SSRN: https://ssrn.com/abstract=3801703 or http://dx.doi.org/10.2139/ssrn.3801703

Carmelo Latino

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Loriana Pelizzon (Contact Author)

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Leibniz Institute for Financial Research SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

Aleksandra Rzeźnik

York University, Schulich School of Business ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3
Canada

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