ESG rating agencies and investors’ reactions to earnings news

Abstract

We examine the effect of environmental, social, and governance (ESG) information provided by rating agencies on investors’ reactions to earnings news. Based on ESG ratings provided by three major rating agencies, we present evidence that firms’ earnings response coefficients (ERCs) are positively correlated with the initiation of coverage, intensity of coverage, and rating dispersion of ESG rating agencies. Our evidence further suggests that the positive effect of ESG information on ERCs is more pronounced for firms that operate within a weaker information environment. In addition, ESG rating agencies tend to play a more important role in strengthening the stock market reaction to positive earnings news than that to negative earnings news. We also document that the main effects are stronger for firms that have higher-quality ESG ratings and are covered by ESG rating agencies facing more intense competition. Collectively, our results support the view that the ESG information made available by ESG rating agencies significantly enhances the stock market reaction to earnings news by aiding investors’ assessment of firms’ future financial performance and earnings sustainability.