Unveiling the consequences of ESG rating disagreement: an empirical analysis of the impact on the cost of equity capital

ABSTRACT

Recent academic research exhibits considerable disagreement among ESG ratings from different agency providers. The consequences of this disagreement on the market are still under-explored; thus, we investigate whether this disagreement impacts the cost of equity capital. Using a sample of 23,201 firm-month observations from January 2019 to March 2021, we find that ESG disagreement positively moderates the negative relationship between the average ESG score and cost of equity. By disentangling the aggregate ESG score, we find that the moderating effect of this disagreement does not hold for any pillar. Furthermore, the association between ESG rating disagreement and cost of equity is more pronounced in the presence of high analyst information uncertainty. Overall, our findings highlight that ESG rating disagreement jeopardizes investors’ confidence in ESG ratings and weakens the role of these ratings in reducing the cost of equity, pointing to the need to improve convergence across agency providers.

Keywords:

• ESG
• rating
• disagreement
• information uncertainty
• cost of equity capital

Acknowledgments

The authors acknowledge the research support from the EIBURS project ESG-credit and TranspArEEnS project ‘Mainstreaming Transparent Assessment of Energy Efficiency in ESG Ratings’. Aoife Fitzpatrick gratefully acknowledge research support from Prof. Loriana Pelizzon and the Leibniz Institute for Financial Research SAFE. The usual disclaimer applies.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Similar to the case of Bollore, for other firms in our database Bloomberg provides only the scores for the individual E, S, and G pillars, without giving the aggregate ESG score. For our analyses, we only used the ESG scores directly provided by Bloomberg since we did not deem it appropriate to manually calculate the missing scores.

2 We employ firm fixed effects to address some of the endogeneity prevalent when using ESG ratings; however, we acknowledge endogeneity cannot be entirely ruled out in our analysis.