The rise of ESG rating agencies and management of corporate ESG violations

Abstract

In recent years, firms have increasingly come under scrutiny from environmental, social, and governance (ESG) rating agencies which systematically assess and publicize ESG-related information to diverse stakeholders. This study aims to investigate whether firms exhibit a heightened incentive to avoid ESG-related regulatory violations once they come under the coverage of ESG rating agencies. Analyzing data spanning from 2000 to 2018 and considering the coverage provided by four prominent ESG rating agencies to U.S. firms, we leverage the staggered initiation and intensity of this coverage. Our findings reveal a negative correlation between ESG violations and the commencement and extent of coverage by ESG rating agencies. This relationship is particularly pronounced for firms characterized by lower levels of corporate monitoring as indicated by fewer analysts providing coverage, limited media attention, weaker ESG commitments, and less disparate ESG ratings. Taken together, our study sheds light on the monitoring role of ESG rating agencies, illustrating their significance in incentivizing managers to mitigate ESG violations.