ESG rating changes and stock returns

Abstract

We analyze the impact of MSCI ESG rating score changes on stock returns for U.S.-listed firms. Consistent with ESG’s importance for long-term value, we find that stock prices adjust over a prolonged period of time. Specifically, we find that it takes the market multiple months to reflect changes in numerical ratings. Using holding periods of six months, decreases in ratings are followed by annualized negative abnormal returns of approximately 3 %. Our results are not driven by significant firm-level ESG news events. We find evidence that part of the effect is driven by relatively salient aspects of ESG. In line with this, we find that only E rating changes are important for six-month returns while S and G changes do not have a discernible impact. We consider two mechanisms through which ESG rating changes could impact stock returns. We find that institutional investors changing their holdings around rating changes is the primary mechanism that drives our results, with sustainable index revisions having a secondary effect. Our results suggest that ESG rating changes are relevant for capital markets.