Effects of ESG ratings on financial performance and the role of rating agencies

Recent findings show that good ESG performance is linked to good financial performance. This study challenged current findings by introducing the role of ratings agencies in the relationship. This paper investigates the effect of ESG on stock performance on European large cap firms, by controlling for size, financial leverage and sales growth. The financial data and ESG scores of 78 publicly traded companies from Eurostoxx50, CAC40 and BEL20 were retrieved for the period 2010-2021 and 2019-2021, yielding 936 and 234 observations respectively. ESG scores were collected from three different rating agencies: Bloomberg, Refinitiv and Morningstar. RStudio was used to run pooled effects regression with cluster-robust standard errors to control for heteroskedasticity and autocorrelation. In addition, to refine the study, the same analysis was performed by first separating the sample by the different sectors and subsequently by analysing the effect of ESG on one-year lagged returns (computed at time t+1). The descriptive analysis provides insight on the discrepancies between the rating agencies. Our panel regression results indicate that ESG may be an asset creating value or may be detrimental to the company depending on the choice of the rating agency. While ESG disclosure score from Bloomberg and ESG score from Refinitiv are in favor of a negative effect on returns, Sustainalytics ESG risk score from Morningstar and ESG combined score from Refinitiv are more in favor of a positive effect. The results are therefore ambiguous. Adding the business sectors to the analysis elucidates on the differences across the seven sectors analysed. Moreover, analysing the relationship on one-year lagged returns, emphasized the negative effect on returns discovered for ESG from Bloomberg and Refinitiv. Further, the robustness analysis, which analysed the same regressions but by controlling for time and by considering an alternative dependent variable, confirmed our results.