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.
Household Finance
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 a...
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