The impact of ESG ratings on company-level information asymmetry in financial markets

• Applicant: Professor Dr. Sebastian Utz
• Subject Area: Accounting and Finance
• Term: since 2024
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 548918623

This project addresses the question of whether environmental, social, and governance (ESG) ratings influence information asymmetry in financial markets by investigating how the bid-ask spread of a company changes after the release of the company’s ESG rating in a quasi-natural experimental setting. This project adds to the academic literature by showing causal evidence of the link between ESG ratings and company information asymmetry. It also enriches discussions among academics, regulators, and practitioners regarding which types of ESG ratings could improve the efficiency of financial markets by providing information unknown without these ESG ratings. While asymmetric information is a prominent pillar in modern theories of corporate finance, empirical investigations assessing the impact of ESG ratings on information asymmetry are challenging. This is because credible exogenous information is scarce, and there are relatively few natural experiments related to ESG that result in significant shifts in the information environment. Therefore, empirical research on asymmetric information in the context of ESG, and sustainable finance in general, is still in its early stages of development. In particular, the question of whether the release of third-party ESG ratings (and if yes, which quality of ESG ratings) has a causal effect on information asymmetry has not been answered empirically to date. The unique empirical setting of the proposed project allows us to investigate the general differential effect on bid-ask spreads between companies that received an ESG rating in a release (treatment) and control companies (i.e., companies without a released ESG rating) in a difference-in-differences setting. Additional tests (1) analyze the impact of various characteristics on the magnitude of the differential effect, (2) address the potential concerns that the differential effect is not causal, and (3) study how a higher or lower level of divergence among ESG ratings from different providers impacts information asymmetry after the release of an additional ESG rating. Finally, the project applies an event study to investigate the stock market reaction of the treated companies after the ESG rating release. The target of the project is the submission of a series of papers to international highly-ranked peer-reviewed journals. The main implication of this project is to gain a better understanding of whether ESG ratings can mitigate frictions in capital markets. Depending on the findings, the project provides evidence for the usefulness of uniform and standardized rules for compiling ESG ratings and their role as proxies for reducing market frictions, enhancing liquidity, and increasing company values. Therefore, the results of the project are also relevant for companies since they could consider disclosing value-relevant ESG information to increase company value.

• DFG Programme: Research Grants
• International Connection: Switzerland
• Cooperation Partner: Professorin Dr. Julia Meyer