Why is Corporate Virtue in the Eye of The Beholder? The Case of ESG Ratings

Abstract

Despite the rising use of environmental, social, and governance (ESG) ratings, there is substantial disagreement across rating agencies regarding what rating to give to individual firms. As what drives this disagreement is unclear, we examine whether a firm's ESG disclosure helps explain some of this disagreement. We predict and find that greater ESG disclosure actually leads to greater ESG rating disagreement. These findings hold using firm fixed effects, and using a difference-in-differences design with mandatory ESG disclosure shocks. We also find that raters disagree more about ESG outcome metrics than input metrics (policies), and that disclosure appears to amplify disagreement more for outcomes. Lastly, we examine consequences of ESG disagreement and find that greater ESG disagreement is associated with higher return volatility, larger absolute price movements, and a lower likelihood of issuing external financing. Overall, our findings highlight that ESG disclosure generally exacerbates ESG rating disagreement rather than resolving it.

ESG Disclosure, REIT Debt Financing and Firm Value

“…the opposite results or mixed findings that ESG/CSR activities can add value to firms but only under certain conditions (e.g., Buchanan et al, 2018;Servaes & Tamayo, 2013). Interestingly, Gillan et al (2021) point out that the mixed evidence is partially due to the measurement problem of a firm's ESG performance, consistent with the findings of Christensen et al (2021).…”

“…As suggested by Gillan et al (2021), the ESG literature on how ESG factors are related to a firm's market value or firm performance presents largely mixed evidence. While many studies show that there is a positive relationship between ESG performance and firm value or performance (e.g., Flammer, 2015), others document 15 Some typical environmental and social risks for commercial properties include extreme weather events, climate changes, and natural disaster.…”

“…But It's More Partisan Than Ever.". 16 See Gillan et al (2021) for an excellent review on ESG/CSR research in corporate finance. They also explain the differences between ESG and CSR in that ESG tends to be a more expansive term than CSR.…”

“…To incorporate the ESG issues in their decision-making, stakeholders must be able to accurately capture ESG related information disclosed by firms. However, recent research suggests that ESG criteria are hard to define and there is substantial disagreement across ESG data providers on what ESG rating to give to individual firms (e.g., Christensen et al, 2021). Without the consistency and transparency from an effective, standardized ESG disclosure framework, investors and lenders might be misled by various ESG ratings and face significant risks when making investment or lending decisions.…”

“…Previous literature based on non-REIT firms presents mixed results on the relations. Some studies find evidence that firms experience negative abnormal returns or have lower likelihood to issue external financing when they disclose more ESG related information (e.g., Christensen et al, 2021;Jacobs et al, 2010). Others document a positive relationship between ESG (or CSR) disclosure and firm performance or financing activities (e.g., Dhaliwal et al, 2011;Plumlee et al, 2015).…”