Tilting the Wrong Firms? How Inflated ESG Ratings Negate Socially Responsible Investing under Information Asymmetries

62 Pages Posted: 14 Jun 2022 Last revised: 15 Feb 2024

See all articles by Dennis Bams

Dennis Bams

Maastricht University - Department of Finance; Open University Heerlen

Bram van der Kroft

Massachusetts Institute of Technology (MIT)

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Date Written: February 14, 2024

Abstract

We use granular ESG information to show that portfolio tilting distorts the aggregate formation of sustainable assets when socially responsible investors use ESG ratings under information asymmetries. We find that ESG ratings are unrelated to sustainable performance as they solely capture sustainable aspirations that, on average, do not improve subsequent sustainable performance. We uncover that socially responsible investors tilt their portfolios toward highly ESG-rated but not more sustainable firms. Using exogenous variation in ESG ratings, we observe that this portfolio tilting lowers capital costs and increases long-term growth rates of highly ESG-rated firms regardless of their sustainable performance.

Keywords: Portfolio tilting, divestment, socially responsible investing (SRI), capital costs, firm commitments

JEL Classification: G11, M14, Q56

Suggested Citation

Bams, Dennis and van der Kroft, Bram, Tilting the Wrong Firms? How Inflated ESG Ratings Negate Socially Responsible Investing under Information Asymmetries (February 14, 2024). Available at SSRN: https://ssrn.com/abstract=4126986 or http://dx.doi.org/10.2139/ssrn.4126986

Dennis Bams

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

Open University Heerlen ( email )

Netherlands

Bram Van der Kroft (Contact Author)

Massachusetts Institute of Technology (MIT) ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

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