Investor Reliance on ESG Ratings and Stock Price Performance

Abstract

We exploit a quasi-natural experiment, the change in Sustainalytics' ESG rating methodology, which reassesses risk and inverts the rating scale, to examine how reliance on ESG ratings impacts stock returns. The change in the ESG rating influences stocks' returns but this is mainly due to retail investors' misinterpretation about the change in the ratings scale. Sophisticated investors, such as 13F institutions and short sellers, take advantage of individual investors' blind trust in ratings by taking the opposite side of their trades. We find no effect on mutual funds' portfolio rebalancing or investor flows. Firms react to the change in their ESG rating and subsequent abnormal returns by issuing or repurchasing shares.

Keywords: Corporate Social Responsibility, ESG Rating Agencies, Sustainable Investments, Socially Responsible Investing, ESG, Investment, Stock Price

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