ESG rating adjustment and capital market pricing efficiency: Evidence from China

Abstract

Environmental, social, and governance (ESG) ratings serve as an important reference for investors, enabling them to assess the fundamental information of companies and make investment decisions, thereby enhancing capital market pricing efficiency. Frequent adjustments to ESG ratings will bring incremental information to the capital market. However, the mechanism of this information affecting capital market pricing efficiency remains unclear. Therefore, this paper empirically investigates the impact of ESG rating adjustments on capital market pricing efficiency. It explores the underlying mechanisms, using Chinese A-share listed companies from 2010 to 2023 as a case study. The findings reveal a significant negative relationship between ESG rating adjustments and capital market pricing efficiency. Specifically, the greater the degree of ESG rating adjustment, the more pronounced the phenomenon of asset mispricing, leading to a reduction in capital market pricing efficiency. This conclusion holds robust after conducting a series of endogeneity and robustness tests. Mechanistic analysis suggests that ESG rating adjustments exacerbate the degree of information asymmetry and diminish analyst forecast quality, which in turn impairs asset pricing efficiency. Heterogeneity analysis further indicates that the negative impact of ESG rating adjustments on capital market pricing efficiency is more pronounced in non-state-owned firms, firms with no significant internal control deficiencies, firms operating in polluting industries, and firms located in the eastern and central regions.