Do ESG Ratings Deliver on Their Promises? Evidence from the U.S. Stock Market.

Abstract:
Using 2293 publicly traded U.S. companies between 2005 and 2021, this paper evaluates seven prominent ESG ratings and examines the misalignment between ESG ratings from three major perspectives: (i) data sources, (ii) assessed risk themes, and (iii) weighting schemes, and then introduces the practice of integrating multiple ESG ratings when investing. This paper explores the cross-sectional asset pricing implications of ESG rating and ESG rating misalignment using the mean and dispersion of all available ESG ratings as proxies. In terms of investor preferences for ESG stocks, this research reveals that stocks with higher ESG misalignment and lower ESG ratings might earn positive risk-adjusted returns. In addition, this paper investigates the specific dimensions and shows that misalignment in the social dimension drives this relationship the most. The findings assist investors, asset managers, and regulators in comprehending the functioning mechanism of ESG ratings and advise them incorporate more ESG ratings into their decision-making processes.