The economic impact of ESG ratings
This report examines the impact of ESG ratings on fund holdings, stock returns, and firm behaviour. The study finds that only MSCI ESG ratings can explain the holdings of US ESG funds, and slow, gradual responses in ownership suggest that fund managers mainly use ESG ratings to comply with ESG mandates.
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OVERVIEW
ESG ratings are a primary source of information for investors interested in such integration. This research investigates the effects of ESG ratings, focusing particularly on MSCI ESG ratings.
Impact of ESG ratings on fund holdings
US ESG funds are found to be mainly reliant on MSCI ESG ratings instead of other major ESG ratings. Downgrades in the MSCI ESG rating decrease firm ownership by ESG funds, and vice versa. However, such changes affect ownership gradually, indicating the usage of ESG ratings primarily to comply with ESG mandates, rather than to derive updates on firms’ fundamentals.
Impact of ESG ratings on stock returns
The slow and persistent response in stock returns is found for ESG rating changes. Downgrades lead to an annualised abnormal return of -2.37%, while upgrades lead to a weaker positive effect.
Impact of ESG ratings on corporate behaviour
ESG ratings were found not to affect firms’ subsequent capital expenditure significantly. However, firms adjust their ESG practices, only in the governance dimension, after rating changes. This indicates the effectiveness of the reform channel.
Discussion and conclusion
This study provides empirical support to theoretical models that predict an impact of ESG performance on stock prices. Regarding the holdings of dedicated ESG funds, it provides evidence that there is a part of the market that consequently adjusts holdings to changes in ESG ratings.
However, the study finds no evidence for the growth channel where “green” firms grow faster due to a reduced cost of capital. Regarding the reform channel, the findings suggest that ESG investing encourages picking the low-hanging fruit: firms don’t improve their ‘environmental’ and ‘social’ management practices, but they do improve their ‘governance’ practices following downgrades.
In conclusion, this study suggests that while ESG rating changes have a visible impact on financial markets, their impact on the real economy is only limited. This picture could change in the future if more investors become more serious about ESG integration.
