In recent years, firms have increasingly come under scrutiny from environmental, social, and governance (ESG) rating agencies which systematically assess and publicize ESG-related information to diverse stakeholders. This study aims to investigate whether firms exhibit a heightened incentive to avoid ESG-related regulatory violations once they come under the coverage of ESG rating agencies. Analyzing data spanning from 2000 to 2018 and considering the coverage provided by four prominent ESG rating agencies to U.S. firms, we leverage the staggered initiation and intensity of this coverage. Our findings reveal a negative correlation between ESG violations and the commencement and extent of coverage by ESG rating agencies. This relationship is particularly pronounced for firms characterized by lower levels of corporate monitoring as indicated by fewer analysts providing coverage, limited media attention, weaker ESG commitments, and less disparate ESG ratings. Taken together, our study sheds light on the monitoring role of ESG rating agencies, illustrating their significance in incentivizing managers to mitigate ESG violations

This study investigates the imbalance of ESG investing across its environmental (E), social (S), and governance (G) pillars. We find that E plays a more significant role in influencing the imbalance level, and mutual funds prioritize mitigating E risks over S and G risks, which is more pronounced in funds with higher sustainability ratings. Moreover, our findings indicate that investors respond to ESG imbalance, with the level of imbalance showing a negative impact on fund flows, especially for funds with higher sustainability ratings. However, this negative relationship is mitigated as climate change concerns increase. Furthermore, we find that political ideology plays a role in the ESG imbalance, with the imbalance of funds in blue states being more driven by lower environmental considerations compared to those in red states. Additionally, we observe that the ESG imbalance is positively associated with various fund risks. Our study offers implications for policymakers and stakeholders in the asset management industry regarding ESG investing practices

This paper analyzes the asset pricing and portfolio implications of an important barrier to sustainable investing: uncertainty about the corporate ESG profile. In equilibrium, the market premium increases and demand for stocks declines under ESG uncertainty. In addition, the CAPM alpha and effective beta both rise with ESG uncertainty and the negative ESG-alpha relation weakens. Employing the standard deviation of ESG ratings from six major providers as a proxy for ESG uncertainty, we provide supporting evidence for the model predictions. Our findings help reconcile the mixed evidence on the cross-sectional ESG-alpha relation and suggest that ESG uncertainty affects the risk-return trade-off, social impact, and economic welfare

This paper examines how increased competition among environmental, social, and governance (ESG) rating agencies relates to ESG rating quality. We exploit the entry of Sustainalytics as a new ESG rating agency in 2010. We conduct a difference‐in‐differences analysis and provide three main findings. First, we find that higher competition decreases incumbents' ESG rating disagreements of the same scope. The negative relation between competition and ESG rating disagreement persists for same‐scope rating metrics not covered by Sustainalytics, suggesting that neither learning nor herding drive the results. The relationship between competition and rating disagreement strengthens for firms with more ESG disclosures, which generally require more effort to analyze. Second, we find that incumbents' ratings of ESG concerns are more strongly associated with future negative ESG news for firms additionally covered by Sustainalytics. This finding is consistent with competition improving ratings' ability to predict future negative ESG incidents. Third, we find that incumbents evaluate more difficult‐to‐measure outcome metrics for firms covered by Sustainalytics, consistent with competition inducing more effort. Overall, our findings suggest that competition serves as an implicit disciplining mechanism of ESG rating agencies' quality

Financial analysts closely follow a firm’s operations and assess the risks that it faces. In this paper, we examine whether analysts incorporate ESG risks into their stock recommendations and target prices. Specifically, we use a unique firm-day level dataset on negative ESG risk incidents to proxy for unobservable risk assessments of analysts. We find that analyst outputs predict future ESG incidents, suggesting that analysts incorporate ESG risks into their models. Our results are robust to controlling for ESG incidents that firms experienced in the past, and are stronger in more transparent information environments, and in the presence of more guidance on ESG issues from the Sustainability Accounting Standards Board. Importantly, we find that analysts incorporate ESG risks through adjusting discount rates rather than cash flow estimates. Overall, our results highlight the ability of financial analysts to synthesize and integrate ESG risks into their research

We develop a continuous-time model in which an ESG investor hires a manager to run a project and incentivizes the manager to fulfill ESG responsibilities. The manager’s private efforts and ESG investing determine the project’s cash flow and ESG performance subject to random shocks. We derive the optimal contract and its implementation after introducing carbon credits following the cap-and-trade program in practice. We provide comparative static analysis and empirical implications. The results demonstrate that ESG investing enhances contract efficiency. The more significant the carbon emission reduction, or the less the cost of ESG investing, the higher the contract efficiency, the average q, the marginal q, and the optimal investment–capital ratios, implying that ESG investing mitigates inefficiencies arising from information asymmetry and enhances investment values. Our model predictions are partially verified by empirical facts

We show that banking relationships promote corporate environmental, social, and governance (ESG) policies. Specifically, banks are more likely to grant loans to borrowers with ESG profiles similar to their own and positively influence the borrower’s subsequent ESG performance. Their influence is more pronounced when (1) banks have significantly better ESG ratings than borrowers and (2) borrowers are bank dependent. We exploit M&A among lenders as a source of quasi-exogenous variation in the lender’s ESG standard to alleviate endogeneity concerns. Overall, our study presents the first evidence on the interplay between responsible bank lending and borrowers’ ESG behavior

We study the equilibrium effects of the “S” dimension of ESG under imperfect competition. ESG policies are pledges made by firms that constrain managers to treat their stakeholders better than market conditions alone dictate. Moderate policies limit market power and prompt managers to be more competitive; aggressive polices backfire, both for adopting firms and intended beneficiaries. In contrast to the “shareholder primacy” paradigm, competition in ESG policies under the “stakeholder capitalism” paradigm is a panacea for market power, delivering the first-best outcome in equilibrium. We discuss drivers behind the recent rise in ESG, ESG-linked compensation, and disclosure practices

We examine whether firms' ESG performance is influenced by bondholder preferences. We argue that insurance companies have unique incentives to monitor bond issuers' ESG performance because insurers face enhanced exposures to ESG shocks in their balance sheets and trading operations. Consistent with this argument, we find that firms with higher bond ownership by insurance companies are associated with higher future ESG ratings. To address potential identification concerns, we test changes in bond issuers' ESG ratings following the initial bond investment by insurance companies. We find that firms' ESG performance improves after insurance companies' initial bond investment. We also find that this improvement in ESG performance is concentrated in firms with greater reliance on bond financing and investment capital from insurance companies. Our study underscores the importance of bond ownership structure in influencing corporate ESG performance

This paper explores how banks’ environmental, social, and governance (ESG) activities affect their lending during financial crises. We use a sample of European listed banks with available ESG scores from 2002 to 2020 and consider the global financial crisis of 2007–2009 and the European sovereign debt crisis of 2010–2012. We estimate a two-step system GMM dynamic panel data model and also address potential endogeneity with instrumental variable (IV) and difference-in-difference (DiD) estimations. We find that lending falls to a lesser extent for banks with higher ESG scores during crisis times. Our findings are robust to using alternative ESG rating providers. An investigation of the different potential channels shows that, during crises, banks more engaged in ESG activities are less affected in terms of credit risk, asset risk, and profitability. They also face a lower reduction in market funding, allowing them to downsize to a lesser extent during crises, and their deposit rates do not increase as much as in less ESG-engaged banks. A deeper investigation reveals that our findings mainly hold for banks focused on traditional lending and deposit activities and are essentially driven by the environmental pillar component of ESG scores and the global financial crisis of 2007–2009