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

Abstract

This paper uncovers global ESG rating inflation that negates the societal impact of socially responsible investing under information asymmetries. Refinitiv, MSCI IVA, and FTSE ESG ratings are inversely related to sustainable performance because firms’ promises of sustainable performance improvements do not realize up to 15 years in the future. Consequently, socially responsible investors accidentally tilt their portfolios toward firms with high ESG ratings but low sustainable performance. We causally show that this provides cost of capital incentives for firms to inflate their ESG rating. Therefore, the portfolios of socially responsible investors are less sustainable than the market.

Keywords: Cost of capital, portfolio tilting, socially responsible investing (SRI), promised to realized sustainable performance

JEL Classification: G11, M14, Q56