ESG Rating Events and Stock Market Reactions

Abstract

This paper examines the effect of Environmental-, Social- and Governance- (ESG) rating events on returns and risks of stocks based on a large sample of US firms and their MSCI ESG ratings. Using event study methodology, we find that markets react with significant negative abnormal returns to downgrades in environmental and in social scores. ESG rating changes thus seem to provide new value-relevant information to market participants. Further, applying a difference-in-differences approach, we assess whether and how changes in ESG rating impact the risks associated with stocks by examining downside, systematic and total risk. Our findings suggest that rating changes already materialize shortly after the rating event. Upgrades in environmental scores significantly moderate downside risk, whereas upgrades in governance scores seem to mitigate systematic risk. Therefore, by improving the firm’s ESG profile, managers can mitigate value-relevant risks of their firms in short-term.