Investor Reliance on ESG Ratings and Stock Price Performance

We exploit a quasi-natural experiment, the change in Sustainalytics’ environmental, social, and governance (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 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. Our results highlight the potential for blind reliance on ESG ratings that can generate mispricing and inefficiencies, especially among less informed market participants.

This paper was accepted by Camelia Kuhnen, finance.

Funding: This work was supported by Growing Resilient, INclusive and Sustainable (GRINS) [GRINS PE00000018 - CUP H73C22000930001]; European Commission as part of ESG UPTAKE project [101145727]; and Progetti di ricerca di Rilevante Interesse Nazionale (PRIN) as part of the National Recovery and Resilience Plan (PNRR) [CUP H53D23002190006 and CUP H53D23008390001]. L. Pelizzon thanks the Leibniz Institute for Financial Research SAFE and the European Investment Bank Institute for EIBURS Project “ESG-Credit.eu-ESG Factors and Climate Change for Credit Analysis and Rating” for financially sponsoring this research.

Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.08288.