ESG rating disagreement and the cost of equity financing

Abstract

Sustainable finance has become an important theme in corporate finance research, with ESG ratings serving as a key indicator for assessing firms’ sustainability practices. A persistent challenge, however, is the substantial divergence of ratings across agencies. This paper investigates the impact of ESG rating disagreement on the cost of equity financing. We find that greater divergence in ESG ratings is associated with higher equity financing costs. Further cross-sectional analysis reveals that this effect is more pronounced for firms with weaker corporate governance, lower levels of ESG disclosure standardization, and non-state-owned enterprises. Mechanism test indicates that ESG rating disagreement increases cash flow volatility, which in turn raises the firms’ cost of equity financing. Importantly, we also find that the development of the digital economy helps mitigate these adverse effects.