We provide the first evidence that conflicts of interest arising from commercial ties lead to bias in environmental, social, and governance (ESG) ratings. Using the acquisitions of Vigeo Eiris and RobecoSAM by Moody's and S&P as shocks to the commercial ties between ESG rating agencies and their rated firms, we show that, after their acquisitions by the credit rating agencies (CRAs), ESG rating agencies issue higher ratings to existing paying clients of the CRAs. This effect is greater for firms that have more intensive business relationships with the CRAs, but weaker for firms with more transparent ESG disclosures or higher long‐term institutional ownership. The upwardly biased ESG ratings help client firms issue more green bonds and enable the CRAs to maintain credit rating business. Finally, the upwardly biased ESG ratings are less informative of future ESG news. Overall, the business incentives of rating providers appear to engender ESG rating bias

We examine how natural disasters affect the corporate environmental, social, and governance (ESG) disclosure policies of firms located close to disaster areas. We study firms located in counties neighboring those impacted by natural disasters and find that, on average, these firms increase their ESG disclosure transparency over the period subsequent to the disaster. Given that our sample firms are located outside of the area directly impacted by the disaster, the changes in disclosure transparency after the disaster are consistent with managers increasing their preference for transparency as their risk salience increases. Further, we find that firms with a higher percentage of local institutional ownership are more likely to increase ESG disclosure after experiencing nearby disasters. The findings suggest that managers strategically react to a change in investors' risk perception by increasing ESG disclosure

We study the association between environmental, social, and governance (ESG) government risk management and firm-level IPO underpricing between 2008 and 2018. Examining 7446 IPOs issued in 36 countries, we find that IPO underpricing tends to be lower in countries with higher ESG Government Ratings. When we uniquely examine the environmental, social, and governance pillars, we find that underpricing tends to be lower in countries with stronger risk management practices in each of these areas. Additional analysis indicates that the negative impact of ESG ratings on IPO underpricing is more pronounced in countries with more transparent financial disclosures, higher liability standards, and stronger shareholder protections

We collect a novel dataset on images in Environmental, Social, and Governance (ESG) reports using deep learning and artificial intelligence (AI), to test hypotheses arising from experimental literature that visual impression management enhances audience perception. We further combine AI and manual methods to contrast images that lack information content (“generic images” evoking broad ESG themes) against images with information content (“specific images” depicting firm-specific ESG activities). We hypothesize and find that firms (1) operating in socially problematic industries (e.g., “sinful”, polluting, or controversial industries), (2) issuing less extensive textual ESG disclosures, and (3) experiencing poor ESG performance tend to use more images, especially generic images, consistent with strategic motivations. We then examine the impact of image usage on stakeholders, observing unduly enhanced perception in retail traders but seldom in institutional investors. We observe that ESG award committees reward specific images and penalize generic images. Our results show that ESG report visual impression management affects stakeholders in the real world, though its impact can be overcome by attention and expertise

This paper develops and tests an equilibrium model of active fund management with ESG considerations. Heterogeneous sustainability preferences lead fund managers to intensify information acquisition on assets across the ESG spectrum, broadening the scope of active management. This information channel enhances price informativeness, lowers discount rates, and increases portfolio deviation from benchmarks. The model predicts a negative and concave ESG-expected return relation, stronger for green assets and weaker for brown assets. Using data on U.S. mutual funds and stocks from 2007–2021, we find supporting evidence based on price informativeness and the implied cost of equity capital

We consider a network of equity mutual funds characterized by different levels of compliance with Environmental, Social, and Governance (ESG) aspects. We measure the impact of portfolio liquidation in a stress scenario on funds with different ESG ratings. Fire-sales spillover from portfolio liquidation propagates from one fund to another through indirect contagion mediated by common asset holdings. The analysis is conducted quarterly from March 2016 through June 2018 using daily data from different sources at the fund and firm levels. Our estimation strategy relies on a network analysis where funds are not taken as stand-alone entities but are interconnected components of a unified system. We find evidence that the relative market value loss of the High ESG ranked funds is lower than the loss experienced by the Low ESG ranked counterparts in the time span with lower volatility. In the higher-volatility period there is not always a clear dominance of one class over another. Results are robust when controlling for size and for feedback effects, and for different model specifications. Our analysis offers new insights to both asset managers and policymakers to exploit the aggregate effect of portfolio diversification related to the system as a whole

We examine whether and, if so, how retail consumers change their shopping in response to firm‐specific negative environmental, social, and governance (ESG) news. Using an event study methodology, we do not find significant changes in consumer foot traffic in response to negative ESG news, on average. However, the average consumer reacts negatively when such news is covered by national or global media outlets, which elevates consumer awareness. In addition, we provide evidence of the heterogeneity in responses to negative ESG news across consumer groups. Consumers in more ESG‐conscious counties, as measured by county ESG preferences, income, education, and political ideology, reduce store visits in response to negative ESG news. In contrast, consumers in the least ESG‐conscious counties increase their visits in response to negative ESG news. These opposing reactions explain the insignificant average consumer response to negative ESG news. Furthermore, the ESG‐conscious consumers' negative reaction is, at most, modest, dissipating within six weeks. Overall, our findings suggest that firms face divergent responses to ESG activities from different consumer groups, underscoring the divisive nature of ESG issues

Using SASB’s materiality framework, prior research finds alpha for the portfolio of firms with improving ratings on material ESG issues. We replicate this finding and provide a fundamentals-based perspective on why the materiality portfolio outperforms. Our basic premise is that changes in material ESG issues reflect fundamental firm characteristics. More financially established firms—firms with larger size, lower growth, and higher profitability relative to their sector—are more likely to not only create material strengths but also resolve material weaknesses in their ESG scoring. This fundamental link dictates that one should comprehensively control for fundamental determinants of stock returns before attributing portfolio outperformance to improving material ESG scores. Indeed, we find that the materiality portfolio does not generate alpha after we account for its exposure to profitability and growth factors. Our evidence underscores the issue of correlated omitted fundamental factors in the debate of ESG alpha. Data Availability: Data are available from the sources cited in the text

Socially responsible (SR) institutions tend to focus more on the environmental, social, and governance (ESG) performance and less on quantitative signals of value. Consistent with this difference in focus, we find that SR institutions react less to quantitative mispricing signals. Our evidence suggests that the increased focus on ESG may have influenced stock return patterns. Specifically, abnormal returns associated with these mispricing signals are greater for stocks held more by SR institutions. The link between SR ownership and the efficacy of mispricing signals only emerges in recent years with the rise of ESG investing, and is significant only when there are arbitrage-related funding constraints

Few studies investigate whether ESG mitigates the harmful effects of changes in firms’ external environments. We evidence that ESG mitigated the impact of COVID-19 work-from-home and workplace prescriptions amongst several other pandemic-related government regulatory interventions, even when controlling for firm size. In a novel approach, we apply scrutiny of firms to restrict our cross-national sample to only firms with no cross-border trade, that is, explicitly domestically focused operational processes irrespective of the endpoint of corporate sales, enhancing methodological robustness. Consequently, we isolate an ESG effect. Results indicate the existence of a premium during the onset of each analysed national pandemic experience, particularly pronounced for those corporations that had achieved more substantiative ESG-based preparation and development before the onset of the COVID-19 pandemic