The Determinants of ESG Ratings: Rater Ownership Matters

Abstract

Ratings on environmental, social, and governance (ESG) are largely obscure but have become widely used by investors. We show that firms held by the same owners as the rater (“sister firms”) receive higher ESG ratings. Exogenously created sister firms through acquisitions reveals causality for the common ownership effect. Sister firms receive higher ratings when the common owners have larger stakes in the ESG rater. Notwithstanding their higher initial ratings, sister firms have worse future ESG outcomes. These findings suggest that the quality of ESG ratings can be undermined by conflicts of interest and have important implication for practitioners and regulators.