Unveiling The Consequences of ESG Rating Disagreement An Empirical Analysis of The Impact On The Cost of Equity Capital
Unveiling The Consequences of ESG Rating Disagreement An Empirical Analysis of The Impact On The Cost of Equity Capital
Chiara Mio, Marco Fasan, Francesco Scarpa, Antonio Costantini & Aoife
Claire Fitzpatrick
To cite this article: Chiara Mio, Marco Fasan, Francesco Scarpa, Antonio Costantini & Aoife
Claire Fitzpatrick (21 May 2024): Unveiling the consequences of ESG rating disagreement:
an empirical analysis of the impact on the cost of equity capital, Accounting in Europe, DOI:
10.1080/17449480.2024.2350955
Article views: 50
ABSTRACT Recent academic research exhibits considerable disagreement among ESG ratings from
different agency providers. The consequences of this disagreement on the market are still under-
explored; thus, we investigate whether this disagreement impacts the cost of equity capital. Using a
sample of 23,201 firm-month observations from January 2019 to March 2021, we find that ESG
disagreement positively moderates the negative relationship between the average ESG score and cost of
equity. By disentangling the aggregate ESG score, we find that the moderating effect of this
disagreement does not hold for any pillar. Furthermore, the association between ESG rating
disagreement and cost of equity is more pronounced in the presence of high analyst information
uncertainty. Overall, our findings highlight that ESG rating disagreement jeopardizes investors’
confidence in ESG ratings and weakens the role of these ratings in reducing the cost of equity, pointing
to the need to improve convergence across agency providers.
1. Introduction
The rise of sustainable investments has led to an increased demand for and use of ESG ratings or
scores (Abhayawansa & Tyagi, 2021; Widyawati, 2020). These ratings are formulated by agency
providers by drawing on public and/or private data and information, and are widely regarded as a
proxy for assessing a firm’s ESG performance. Depending on the agency providers, ESG ratings
are intended to assess the social and environmental impacts of companies or their exposure to
sustainability-risk and opportunities. ESG ratings enable users, primarily investors, to make
well-informed decisions regarding companies’ capabilities in managing ESG-related risks,
impacts, and opportunities (Christensen et al., 2022; Serafeim & Yoon, 2023).
In line with the growth of the ESG rating market, a large number of agency providers have
emerged and established themselves as key players in the field (Avetisyan & Hockerts, 2017;
Billio et al., 2022). While the abundance of ESG ratings is not per se a negative issue, academic
research reveals the substantial divergence in the ESG scores provided by different agencies to
the same firms (Billio et al., 2021; Capizzi et al., 2021; Chatterji et al., 2016; Dorfleitner et al.,
2015; Gibson Brandon et al., 2021). This disagreement may have adverse consequences for users
and rated companies. It complexifies integrating sustainability information into investment
decisions, creates confusion, undermines confidence in ESG ratings, and decreases firms’ incen
tives to become more sustainable (Berg et al., 2022). A similar issue can be observed in the
context of corporate sustainability reporting. Stolowy and Paugam (2023) note that the landscape
of sustainability reporting is characterized by confusion and lack of compatibility, where the
possibility of convergence is limited by the diversity of the definitions and concepts of sustain
ability, existence of competing standard-setting organizations, and organizations promoting sus
tainability practices.
While there are several studies documenting the lack of convergence in ESG ratings and
examining the causes (e.g. Berg et al., 2022; Billio et al., 2021; Chatterji et al., 2016; Christensen
et al., 2022; Kimbrough et al., 2022), the literature on the broader economic effects of ESG rating
disagreement is still limited (Christensen et al., 2022; Gibson Brandon et al., 2021; Kimbrough
et al., 2022; Serafeim & Yoon, 2023). Overall, existing evidence suggests that this disagreement
is relevant to market participants. While Gibson Brandon et al. (2021) reveal that environmental
rating disagreement is positively related to stock returns, Christensen et al. (2022) provide evi
dence that ESG disagreement is associated with higher stock return volatility and larger absolute
price movements, and Kimbrough et al. (2022) find that ESG disagreement is positively associ
ated with disagreement and uncertainty in the capital market. Serafeim and Yoon (2023) find that
the ability of ESG ratings to predict future ESG news is much weaker in the presence of signifi
cant ESG disagreement, which is consistent with disagreement hindering the predictive value
and usefulness of ESG ratings. Despite this evidence, the consequences of ESG disagreement
on the cost of equity are not fully understood. The cost of equity is the required rate of return
given the market’s perceptions of a firm’s riskiness. If ESG ratings and the lack of convergence
between ESG agency providers affect the perceived riskiness of the firms, then equity financing
costs should be affected to the extent to which ESG ratings disagree.
This study contributes to the debate on the economic consequences of the lack of convergence
among ESG ratings by examining the impact of ESG rating disagreement on the cost of equity. Pre
vious studies have consistently documented that firms with better ESG performance face significantly
lower constraints to obtaining financing in the capital markets (Cheng et al., 2014) and exhibit lower
costs of equity capital (Dhaliwal et al., 2011; El Ghoul et al., 2011). Therefore, we hypothesize that the
same relationship holds for firms scored by multiple ESG agency providers. We expect a negative
relationship between a firm’s average ESG rating and its cost of equity capital. Next, we conjecture
that this relationship is contingent upon the level of ESG rating disagreement. Drawing on the litera
ture on the influence of information uncertainty on investor risk perceptions (Erickson et al., 2012; He
et al., 2013; Zhang, 2006), we hypothesize that the ESG rating disagreement positively moderates the
negative relationship between the average ESG rating and cost of equity capital. More specifically, we
conjecture that the beneficial effects of the ESG ratings on the cost of equity capital are less
pronounced in firms with higher ESG rating disagreement.
To test our hypotheses, we used a pooled panel regression with control variables, fixed effects,
and standard errors clustered at the firm level. We conducted our analyses on a sample of 1,278
European firms that have ESG ratings from at least two of a pool of major rating agencies (i.e.
Sustainalytics, RobecoSAM, Refinitiv, and Bloomberg) between January 2019 and March 2021,
yielding a total of 23,201 firm-month observations.
Accounting in Europe 3
Our focus on European firms has a twofold justification. First, we intend to fill a gap in the
literature that is not addressed by the extant studies that examined similar questions related to
ESG rating disagreement and cost of equity using US samples (Avramov et al., 2022; Gibson
Brandon et al., 2021). Second, the EU is a unique research setting, due to the proliferation of
regulation on ESG-related issues – such as the Corporate Sustainability Reporting Directive
(CSRD), EU Taxonomy for sustainable activities, and proposal of ESG rating regulation –
which has contributed to increasing investors’ attention on the ESG performance of European
companies.
Our results corroborate existing evidence that firms with higher ESG scores have a lower cost
of equity capital, even in the presence of multiple ESG ratings. We also find that ESG rating dis
agreement positively moderates the ESG rating-cost of equity relationship. As hypothesized, our
results suggest that the negative relationship between the average ESG rating and cost of equity
capital is weaker when firms have high ESG rating disagreement. In our additional tests, we find
that the cost of equity has a negative relationship with the individual environmental, social, and
governance scores and that the level of disagreement is not a significant moderator for any indi
vidual pillar. Furthermore, we find that the association between ESG rating disagreement and
cost of equity is more pronounced in the presence of high analyst information uncertainty and
that ESG disagreement is a significant moderator only for firms that operate in environmentally
sensitive industries.
Overall, our study makes timely contributions to different streams of research. First, this study
corroborates prior evidence on the value-relevance of ESG scores for market participants. We
document that in the case of firms rated by multiple providers, the cost of equity is negatively
related to the average ESG score. This implies that investors carefully consider the existence of
multiple ratings for the same firm, and that they monitor and use the average score to assess a
firm’s level of risk. Second, we contribute to the academic debate on the economic consequences
of ESG rating disagreement (Avramov et al., 2022; Christensen et al., 2022; Gibson Brandon et al.,
2021; Kimbrough et al., 2022; Serafeim & Yoon, 2023). Our study reveals the moderating effect of
the ESG rating disagreement on the relationship between the average ESG score and cost of equity;
thus, our findings support the view that ESG disagreement is perceived by investors as valuable
information on the uncertainty surrounding the measurement and value relevance of a firm’s sus
tainability actions that leads to undermining their confidence in ESG ratings. Finally, our study has
some implications for the recent debate on the lack of convergence in sustainability reporting
(Stolowy & Paugam, 2023), providing evidence on the adverse consequences that may follow
from the persistence of the state of confusion and incompatibility in the measurement of sustain
ability issues and supporting recent regulatory initiatives (e.g. the EU Corporate Sustainability
Reporting Directive and the International Sustainability Standards Board) aimed at strengthening
standardization and comparability in sustainability reporting.
Our findings should be of interest to managers and policymakers as they highlight that solving
the divergence among ESG rating providers is urgent to enable investors to make informed
decisions in regards ESG-related risks, impacts, and opportunities. This disagreement may jeo
pardize a firm’s efforts to achieve good ESG performance and compromise the usefulness of
ESG scores; therefore, firms are suggested to care about and monitor the universe of ESG
ratings, rather than engaging in cherry-picking strategies, while policymakers should more effec
tively regulate to improve the reliability, comparability, and convergence of ESG ratings.
The remainder of the paper is organized as follows. We review the literature and develop our
hypotheses in Section 2 and present the research design in Section 3, and sample selection and
descriptive statistics in Section 4. The main results are reported in Section 5, while Section 6 pre
sents the additional analyses, and Section 7 presents the robustness checks. We discuss the con
tributions and implications for research and practice in Section 8.
4 C. Mio et al.
H1: A firm’s average ESG rating is negatively related to its cost of equity capital.
dimensions) and commensurability (i.e. disagreement in measuring the same construct) (Chat
terji et al., 2016). Additionally, the ESG performance metrics, information sources, and weight
ings generally vary across agencies (Billio et al., 2021; Capizzi et al., 2021; Dimson et al., 2020).
Berg et al. (2022) identify and quantify three distinct sources of disagreement among ratings:
measurement divergence, scope divergence, and weight divergence. Measurement divergence
(contributing 56% of ESG disagreement) refers to a situation where rating agencies measure
the same attribute using different performance indicators. Scope divergence (contributing 38%
of ESG disagreement) refers to the situation where ratings are based on different sets of attri
butes. Finally, weight divergence (contributing 6% of ESG disagreement) emerges when
rating agencies take different views on the relative importance of ESG attributes. Billio et al.
(2024) find that divergences in ESG ratings are primarily driven by differing accounting
methods.
Analyzing the role of firm-level characteristics, Gibson Brandon et al. (2021) find that ESG
rating disagreement tends to be more prevalent for the largest firms and firms without credit
ratings. Additionally, corporate ESG disclosure has an influence on ESG disagreement, but its
role is still controversial: while Christensen et al. (2022) reveal that disagreement among ESG
data providers is more pronounced for firms with high levels of ESG disclosure, Kimbrough
et al. (2022) show that voluntary ESG disclosure, especially when of higher quality, is associated
with reduced disagreement.
The lack of convergence between ESG agency providers challenges the usefulness and
reliability of ESG scores, and may obfuscate investors’ and other stakeholders’ understanding
of firm ESG performance (Berg et al., 2022). Since ESG rating disagreement reflects
information uncertainty about ESG performance (Kimbrough et al., 2022), we expect the
lack of convergence has the potential to jeopardize the value-relevance of ESG ratings in
reducing the cost of equity capital. Thus, we propose ESG rating disagreement as a
potential moderator of the relationship between a firm’s average ESG rating and cost of
equity capital.
Finance and accounting scholars have widely explored investor behavior under conditions of
information uncertainty, generally conceived as ‘ambiguity with respect to the implications of
new information for a firm’s value’ (Zhang, 2006, p. 105). In general, investors tend to be
averse to uncertainty, and this aversion grows with the level of uncertainty (Williams, 2015).
For instance, previous studies suggest that investors demand a higher cost of capital in the pres
ence of earnings forecast dispersion (Erickson et al., 2012; He et al., 2013), accounting restate
ments (Hribar & Jenkins, 2004), or accounting quality uncertainty (Larson & Resutek, 2017).
Lambert et al. (2012) show that the cost of capital is driven solely by the average amount of
uncertainty that investors assess and that this uncertainty is measured by the precision with
which they can assess firm value. Zhang (2006) demonstrates that stocks with higher information
uncertainty experience higher price drift. Furthermore, investors faced with uncertainty base
their decisions on the worst-case scenario (i.e. following maximum expected utility) (Bird &
Yeung, 2012). Therefore, an increase in information uncertainty about firm value causes inves
tors to demand a higher premium (i.e. higher cost of capital) to compensate for the rise in uncer
tainty/risk in regards the firm’s fundamentals.
Previous studies document that ESG rating disagreement is relevant for market participants,
influencing stock prices (Gibson Brandon et al., 2021) and generating uncertainty in the
capital market (Christensen et al., 2022; Kimbrough et al., 2022).
Collectively, all these arguments suggest that ESG rating disagreement is likely to jeopardize
the value-relevance of ESG scores. In the presence of high ESG rating disagreement investors are
likely to perceive high information uncertainty on ESG performance, and consequently, to
demand a higher rate of return. In summary, the ESG rating divergence can be interpreted as
6 C. Mio et al.
H2: The level of ESG rating disagreement positively moderates the average ESG rating-
cost of equity relationship. Specifically, the higher the ESG rating disagreement, the
weaker the negative relationship between a firm’s average ESG rating and its cost of
equity.
3. Research Design
3.1. Test of H1
We estimate a pooled panel Ordinary Least Square (OLS) regression model with control vari
ables, fixed effects, and standard errors clustered at the firm level.
To test H1, which hypothesizes that greater average ESG rating leads to a lower cost of equity
capital, we estimate the following main model:
See Appendix A for variable definitions. AVE COEi,t represents cost of equity capital for firm i
at time t. AVE COEi,t is a proxy for the cost of equity which is the average between the cost of
equity obtained from the CAPM model and the implied cost of equity obtained from the Easton’s
(2004) model of the Earnings-price (EP) ratio. We use this proxy as a universally accepted
measure of cost of equity capital does not exist. The CAPM (Lintner, 1965; Sharpe, 1964)
equates the cost of equity of a firm to the risk-free interest rate plus the firm’s beta times the
market risk premium, while the EP ratio is given by the ratio between forecasted earnings per
share and stock price. We capture the CAPM directly from Refinitiv. The average ESG rating
(ESG AVERAGEi,t ) is equal to the average of all the ESG scores for firm i at time t from the
agency providers included in our analysis.
Control variables are denoted by gi,t ; Xi,t represents the fixed effects, while 1i,t is the error
term. Specifically, we control for the level of ESG rating disagreement (ESG_DISAGREE
MENT), number of ESG ratings (ESG_NUM), beta (BETA), book-to-market ratio (BTM), firm
leverage (LEVERAGE), average long-term growth forecast (LONGTERMGROWTH), firm size
(SIZE), analyst coverage (ANALYSTCOVERAGE), forecast dispersion (FORECASTDISPER
SION) and mean earning per share forecast (EPS). We also employ fixed effects for time and
firm level. Time fixed effects are taken at the monthly level as it is the frequency of the data
as well as firm and industry fixed effects.
The number of ESG ratings is controlled because our dataset contains firms with varying
numbers of ESG ratings (2, 3, or 4). The number of ESG ratings could act as an additional
source of information uncertainty; therefore, disentangling this effect from ESG disagreement
is important. Beta is used to control for a firm’s sensitivity to market volatility; Sharpe (1964)
and Lintner (1965) find that a firm’s beta is positively associated with cost of equity. BTM is
controlled for as firms with higher BTM are predicted to earn higher returns (Duong et al.,
2021; El Ghoul et al., 2011; Fama & French, 1992), and if stocks with high BTM are mispriced
below their true value, then they will earn an abnormally high implied risk premium (Gebhardt
et al., 2001). We subsequently control for firm leverage as leveraged firms earn higher stock
returns, and thus, investors require a higher risk premium for firms with greater leverage
(Duong et al., 2021; Fama & French, 1992; Gebhardt et al., 2001). Generally, larger firms can
Accounting in Europe 7
provide investors with more information than smaller firms, thus reducing information asymme
try and cost of equity; therefore, we control for firm size (El Ghoul et al., 2011; Gebhardt et al.,
2001; Sharfman & Fernando, 2008). Analyst coverage is also controlled for as it reduces infor
mation asymmetry and thus cost of equity (Bowen et al., 2008; Gebhardt et al., 2001). We
include forecast dispersion in our set of controls since firms with lower forecast dispersion gen
erally have lower information asymmetry, and thus, lower cost of equity (Bowen et al., 2008;
Dhaliwal et al., 2006). Finally, we control for long-term growth forecasts since firms with
high expected forecasts can expect stock prices that are valued too high, and thus, low
implied risk premium (Duong et al., 2021; Gebhardt et al., 2001).
We focus on b1 to test H1. If the average ESG rating reduces a firm’s cost of equity capital,
then b1 will be significantly negative.
3.2. Test of H2
To test H2, which hypothesizes that ESG rating disagreement moderates the relationship
between average ESG score and cost of equity capital, we run a moderated regression analysis,
which includes the interaction term (ESG_INTERACTION) between ESG rating disagreement
(ESG_DISAGREEMENT) and average ESG rating (ESG_AVERAGE):
In moderated regression analysis with continuous variables, as in Equation (2), the interpretation
of coefficients significantly differs from that in purely additive multiple linear regression models
(Jaccard et al., 1990). In Equation (2), the regression coefficients for ESG_AVERAGE and ESG_
DISAGREEMENT reflect conditional relationships: β1 reflects the influence of ESG_AVERAGE
on AVE_COE when ESG_DISAGREEMENT equals zero, and β2 reflects the influence of ESG_
DISAGREEMENT on AVE_COE when ESG_AVERAGE equals zero.
The coefficient b3 represents an interaction effect such that it estimates the change in the slope
of cost of equity capital on average ESG rating given a one-unit change in ESG rating disagree
ment. Therefore, the interaction term allows to depict the marginal effect of average ESG rating
on the cost of equity capital of a firm conditional on the level of ESG rating disagreement. In
sum, we focus on b3 to test H2. If the negative relationship between average ESG rating and
cost of equity is less strong in the presence of a high level of ESG rating disagreement, then
b3 will be significantly positive.
regulatory landscape, ESG ratings have ‘an increasingly important impact on the operation of capital
markets and on investor confidence in sustainable products’ (European Commission, 2023, p. 1).
To capture ESG rating divergence, we only included firms that have ESG ratings from at least
two of the above-mentioned rating agencies, leaving a sample of 1,278 European firms. The
dataset is an unbalanced panel dataset, taken at a monthly frequency between January 2019
and March 2021. This was done to capture the full scope of ESG rating divergence as Sustaina
lytics updates its ESG ratings on a monthly frequency and RobecoSAM makes sporadic quarterly
updates.
We obtained financial and cost of equity data from Refinitiv while ESG ratings were collected
from Refinitiv and Bloomberg.
Thus, the main sample with all necessary information includes 1,278 unique firms, with
23,201 firm-month observations from January 2019 to March 2021. Table 1 provides a break
down of sampled firms by country (Panel A) and industry (Panel B).
Pearson correlations
(1) Mean (2) StdDev (3) Sustainalytics (4) Bloomberg (5) RobecoSAM
ESG pillar
Sustainalytics 70.465 24.611
Bloomberg 42.800 10.993 0.350
RobecoSAM 48.890 29.221 0.6 0.427
Refinitiv 62.607 17.334 0.598 0.506 0.647
Average correlation 0.522
Environmental pillar
Sustainalytics 67.456 24.699
Bloomberg 31.117 20.447 0.334
RobecoSAM 51.629 27.877 0.571 0.379
Refinitiv 58.995 24.729 0.565 0.434 0.577
Average correlation 0.477
Social pillar
Sustainalytics 70.152 24.902
Bloomberg 29.868 17.615 0.280
RobecoSAM 50.396 27.969 0.51 0.244
Refinitiv 67.743 19.524 0.514 0.236 0.574
Average correlation 0.393
Governance pillar
Sustainalytics 66.368 26.783
Bloomberg 60.816 12.425 0.271
RobecoSAM 45.750 30.377 0.485 0.248
Refinitiv 57.895 21.469 0.356 0.426 0.382
Average correlation 0.361
Notes: Table 2 presents descriptive statistics of the four agency providers’ ESG ratings for our sample.
Table 3 presents the descriptive statistics for the main sample, which consists of 23,201 firm-month
observations. The mean and standard deviation of ESG_AVERAGE are 56.42 and 21.04, respectively,
indicating considerable variation in firm ESG ratings. The disagreement among ESG ratings measured
by ESG_DISAGREEMENT has a mean and median of 16.41 and 15.56, respectively, with a standard
deviation of 9.03, indicating a substantial ESG disagreement across the entire dataset.
Table 4 presents the Pearson and Spearman correlations for the full sample. As expected
ESG_AVERAGE is positively and significantly correlated with ENV_AVERAGE, GOV_AVER
AGE, and SOC_AVERAGE. The results indicate that ESG_DISAGREEMENT is negatively
and significantly associated with AVE_COE. However, ESG_DISAGREEMENT is negatively
and significantly correlated to ESG_AVERAGE, suggesting that firms with higher ESG rating
dispersion have lower ESG scores.
Table 5 presents the mean values of our model variables per the number of ESG ratings a firm
has. Of all, 762 firms have 2 ratings, 568 firms have 3 ratings, and 123 firms have 4 ratings. The
cost of equity remains constant at approximately 7% across all three categories, while ESG_DI
SAGREEMENT and ESG_AVERAGE increase with the number of ratings.
5. Results
5.1. Results for Tests of H1
We now turn to examining H1 regarding whether a firm’s average ESG rating play a role in redu
cing the cost of equity capital. Table 6 presents the results of our tests based on Equation (1)
Table 3. Descriptive statistics.
N Mean Std. Dev. 1st Quartile Median 3rd Quartile
AVE_COE 23703 6.459591 51.28409 4.552526 6.331319 8.643405
ESG_AVERAGE 24342 56.42169 21.04338 40.31421 56.55104 73.65031
ENV_AVERAGE 24342 51.59491 21.40592 35.46564 52.46667 68.73383
SOC_AVERAGE 24342 54.44293 19.03062 40.59427 54.61197 69.40008
GOV_AVERAGE 24342 54.40338 19.97798 39.6046 55.16152 70.24426
ESG_DISAGREEMENT 24342 16.40814 9.03276 9.610312 15.5561 22.03649
SOC_DISAGREEMENT 24080 21.78089 10.58806 13.81115 21.98392 29.67825
ENV_DISAGREEMENT 24342 18.71449 10.10287 10.98934 17.93645 25.24089
GOV_DISAGREEMENT 24342 18.6211 9.493976 11.75656 17.74624 24.81556
ESG_NUM 24342 2.716909 0.653472 2 3 3
ENV_NUM 24342 3.119834 0.762916 3 3 4
SOC_NUM 24342 3.056363 0.799035 2 3 4
GOV_NUM 24342 3.119834 0.762916 3 3 4
BETA 22684 0.984455 0.4444536 0.6877637 0.9504887 1.232885
SIZE 23127 22.85811 1.829296 21.63656 22.72677 24.01513
LEVERAGE 23056 1.092197 6.247692 0.347327 0.699688 1.291122
BTM 23512 −13.0513 659.5266 0.284698 0.592012 1.075406
ANALYSTCOVERAGE 22329 13.78185 7.56783 7 13 20
FORECASTDISPERSION 22329 0.288269 1.099444 0.03431 0.098627 0.26243
EPS 22329 1.863664 4.259714 0.31208 0.966782 2.3909
LONGTERMGROWTH 13574 7.571259 17.45166 1.4 6.008875 10.8885
Notes: Table 3 presents the descriptive statistics of the variables used in the main analyses. The full sample consists of 23,201 firm-month observations during the period between
January 2019 and March 2021.
Accounting in Europe 11
12
C. Mio et al.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18) (19) (20) (21)
(1) AVE_COE 0.01 0.02 0.00 0.00 −0.03 −0.02 0.00 −0.01 −0.01 −0.01 −0.01 −0.01 −0.01 0.01 0.00 0.01 −0.01 −0.01 0.03 0.03
(2) ESG_AVERAGE 0.17 0.88 0.89 0.84 −0.29 0.15 0.17 −0.25 0.31 0.37 0.35 0.37 0.1 0.52 0.14 0.14 0.5 0.12 0.11 −0.08
(3) ENV_AVERAGE 0.16 0.9 0.82 0.69 −0.21 0.02 0.01 −0.22 0.39 0.29 0.27 0.29 0.09 0.54 0.16 0.2 0.48 0.11 0.1 −0.11
(4) SOC_AVERAGE 0.19 0.9 0.84 0.71 −0.22 −0.05 0.07 −0.25 0.34 0.22 0.22 0.22 0.08 0.51 0.17 0.22 0.42 0.13 0.07 −0.09
(5) GOV_AVERAGE 0.08 0.86 0.69 0.71 −0.22 0.07 0.12 −0.26 0.34 0.32 0.31 0.32 0.12 0.44 0.11 0.13 0.43 0.02 0.04 −0.13
(6) ESG_DISAGREEMENT −0.03 −0.24 −0.2 −0.19 −0.19 0.34 0.31 0.43 0.14 0.05 0.03 0.05 −0.03 −0.11 0.01 −0.02 −0.1 −0.08 −0.07 0.01
(7) SOC_DISAGREEMENT −0.01 0.09 −0.01 −0.02 0.02 0.47 0.35 0.1 0.07 0.32 0.29 0.32 −0.02 0 −0.04 −0.18 0.1 0.02 0.1 0.07
(8) ENV_DISAGREEMENT 0.02 0.2 0.12 0.1 0.11 0.35 0.37 0.05 0.18 0.37 0.34 0.37 −0.02 0.05 −0.02 −0.04 0.08 0.04 0.02 0.02
(9) GOV_DISAGREEMENT −0.03 −0.18 −0.2 −0.19 −0.07 0.47 0.11 0.04 −0.05 0 −0.02 0 0.02 −0.15 0.02 −0.06 −0.1 −0.05 −0.06 0.01
(10) ESG_NUM 0.05 0.39 0.41 0.35 0.41 0.02 0.08 0.19 −0.02 0.71 0.67 0.71 0.02 0.38 0.06 0.11 0.39 0.04 0.09 −0.1
(11) ENV_NUM 0.03 0.44 0.33 0.27 0.44 −0.03 0.24 0.32 −0.01 0.77 0.95 1 −0.01 0.24 0 −0.1 0.41 0.11 0.15 0
(12) SOC_NUM 0.01 0.4 0.29 0.24 0.4 −0.02 0.24 0.31 0 0.72 0.95 0.95 −0.01 0.24 0.02 −0.07 0.38 0.14 0.17 −0.01
(13) GOV_NUM 0.03 0.44 0.33 0.27 0.44 −0.03 0.24 0.32 −0.01 0.77 1 0.95 −0.01 0.24 0 −0.1 0.41 0.11 0.15 0
(14) BETA 0.54 0.12 0.09 0.09 0.15 −0.04 −0.04 0.01 −0.03 0.02 0.00 −0.01 0.00 0.15 0.04 0.12 0.08 0.09 −0.06 −0.04
(15) SIZE 0.29 0.5 0.5 0.47 0.44 −0.07 0 0.13 −0.08 0.4 0.34 0.33 0.34 0.16 0.29 0.46 0.55 0.18 0.15 −0.12
(16) LEVERAGE 0.12 0 0.02 0.01 −0.03 0.03 −0.02 0.04 −0.03 −0.03 −0.04 −0.03 −0.04 0.02 0.04 0.11 0.11 −0.01 −0.14 −0.08
(17) BTM 0.41 0.02 0.03 0.04 0.02 0 −0.03 −0.04 0 −0.03 −0.06 −0.05 −0.06 0.24 0.05 0.01 0 0.1 −0.12 −0.25
(18) ANALYSTCOVERAGE 0.08 0.57 0.51 0.46 0.55 −0.12 0.11 0.12 −0.11 0.48 0.55 0.54 0.55 0.11 0.56 0 0 0.17 0.15 −0.04
(19) FORECASTDISPERSION 0.27 0.04 0.04 0.03 0 −0.02 0.01 0.02 −0.03 0.02 0.06 0.07 0.06 0.15 0.08 0.01 0.09 0.06 0.57 0
(20) EPS 0.22 0.08 0.08 0.06 0.04 −0.05 0.04 0.06 −0.04 0.07 0.11 0.12 0.11 −0.08 0.16 −0.03 −0.02 0.13 0.41 0.13
(21) LONGTERMGROWTH −0.02 −0.11 −0.12 −0.11 −0.13 0 0 −0.01 0 −0.08 −0.04 −0.04 −0.04 −0.1 −0.1 −0.08 −0.07 −0.06 0.05 0.1
Notes: Table 4 presents the correlation matrix for the variables used in the main analyses. Correlations with significance levels < 0.05 are in bold.
Accounting in Europe 13
using two different specifications: with firm fixed effects2 (column 1) and with firm and month
fixed effects (column 2).
Consistent with our hypothesis, we find that the estimated coefficient on ESG_AVERAGE is
indeed negative and statistically significant across all the models (p < 0.001 in both column
(1) and column (2)). These findings suggest that when a firm is rated by multiple ESG agency
providers, the average ESG score reduces the cost of equity capital. In other words, investors
monitor the ESG ratings provided by different agencies and use the average score to determine
the riskiness of a firm. They perceived firms to be less risky, and thus assign a lower rate of
return, when the average ESG score is higher.
In terms of the magnitude of this effect, the estimated coefficients of ESG_AVERAGE suggest
that a one-unit increase in the ESG_AVERAGE is associated with 0.0524–0.0541 percentage
points decrease in AVE_COE, depending on the model specification. Thus, a firm would
lower its cost of equity by 1.75–1.80 percentage points or (based on a mean cost of equity of
6.46%) by 27.04% to 27.92% if a firm increases its average ESG score from the 25th to the
75th percentile. This appears to be an economically significant effect.
In terms of other factors that help explain the cost of equity, the results for the control variables
corroborate prior studies. The estimated coefficient on BETA is positive and statistically signifi
cant (p < 0.001) across all specifications. In line with prior literature (Sharpe, 1964; Lintner,
1965), these findings suggest that a firm’s sensitivity to market volatility is positively associated
with cost of equity. Conversely, we find that the estimated coefficient on ANALYSTCOVERAGE
is negative and statistically significant (p < 0.001) across all specifications. This is consistent
with findings from prior literature (Bowen et al., 2008; Gebhardt et al., 2001), as analyst cover
age enhances transparency, reduces information asymmetry and thus cost of equity. Most of the
other characteristics in the model do not yield significant results. Finally, the SIZE is negatively
associated with the cost of equity (p < 0.05 in the model with firm and month fixed effects)
suggesting that larger firms benefit from economies of scale and perceived stability, thus redu
cing the risk premium investors require.
14 C. Mio et al.
value-relevance of the ESG scores for investors. Thus, the beneficial effect of the average ESG
score on the cost of equity is weaker in the presence of high ESG rating disagreement.
In terms of the magnitude of this effect, the estimated coefficients for ESG_INTERACTION
indicate that a one-unit increase in ESG_DISAGREEMENT leads to a reduction in the negative
impact of ESG_AVERAGE on AVE_COE by 0.000904–0.000966 percentage points, depending
on the model specification. Increasing ESG_DISAGREEMENT from the 25th to the 75th percen
tile attenuates by 0.011–0.012 percentage points the reduction in the cost of equity associated
with a one-unit increase in the average ESG score. Thus, increasing ESG_DISAGREEMENT
from the 25th to the 75th percentile is associated with a 16–19 percent reduction in the
impact of a one-unit increase in the average ESG score on the cost of equity, depending on
the model specification. This appears to be an economically meaningful moderating effect.
In terms of other characteristics in the model, we find that the cost of equity has a positive and
statistical significance with BETA and a negative and statistical significance with
ANALYSTCOVERAGE.
Taken together, the results from Table 6 suggest that the average ESG score is associated with a
reduction in the cost of equity capital and such association is weakened by ESG rating
disagreement.
6. Additional Analyses
6.1. Disentangling the Individual ESG Pillars
Previous literature shows that not all the ESG dimensions have the same impact on the cost of
equity (El Ghoul et al., 2011). To advance our understanding of whether our main findings hold
in each ESG pillar, we conduct an additional test to investigate whether the average score and
disagreement on environmental, social, and governance can influence the cost of equity.
Then, we re-estimate Equations (1) and (2) using the average environmental (ENV_AVERAGE),
social (SOC_AVERAGE), and governance (GOV_AVERAGE) scores. We calculate the rating dis
agreement separately for the environmental (ENV_DISAGREEMENT), social (SOC_DISAGREE
MENT), and governance (GOV_DISAGREEMENT) pillars. The interaction term for each model
(SOC_INTERACTION, ENV_INTERACTION, and GOV_INTERACTION) is obtained by multi
plying the average score for each pillar with the corresponding standard deviation.
Specifically, we run the following regressions:
The empirical results are available in Online Appendix C (Equations (3) and (4)), Online
Appendix D (Equations (5) and (6)), and Online Appendix E (Equations (7) and (8)). The coeffi
cients of average ratings (ENV_AVERAGE, SOC_AVERAGE, and GOV_AVERAGE) are all
negative and significant (p < 0.001). Therefore, H1 is confirmed also when the ESG pillars are
separately examined. The results also suggest that the social score has a larger impact on decreas
ing the cost of equity than the environment and governance scores.
Finally, the interactions terms are not significant for any of the individual pillars. Therefore,
H2 is not supported when the ESG score is disentangled into its components. This suggests that
investors interpret the divergence in the score of individual ESG dimensions differently com
pared with the divergence at the level of the overall ESG score. While overall ESG rating dis
agreement is negatively perceived by investors, the lack of convergence may not affect
investors’ perceptions of firms’ riskiness in case of individual pillars.
These results suggest that ESG rating disagreement amplifies the increase in the cost of equity
due to the uncertainty in forecasting EPS. Thus, firms with high levels of analyst earnings fore
cast dispersion suffer from a larger increase in the cost of equity in the presence of higher levels
of ESG rating divergence.
7. Robustness Checks
In this section, we report the results of some sensitivity analyses to test the robustness of our main
results on the moderating role of the ESG rating disagreement.
A first potential concern about the robustness of our results is that firms with high levels of
ESG rating disagreement may be systematically different from those with a low level of ESG
rating disagreement, which could result in a potential endogeneity problem. To circumvent
this bias, we perform propensity score matching (PSM). We match a group of control firms
(those with low levels of disagreement, i.e. ESG_DISAGREEMENT < 30) to a treated group
(those with high levels of disagreement, i.e. ESG_DISAGREEMENT > 30) with similar charac
teristics. We use k-nearest neighbor matching with a maximum of fifteen control firms for each
treated firm and set a caliper width of 0.05 for the propensity score to ensure close matches. The
observations are matched in a random sequence to prevent deterministic patterns based on the
initial order. The firms were matched based on industry, book-to-market ratio, leverage, long
term growth, size, beta, and year.
The matching results are available in Online Appendix H. The t-test shows that the difference
in means between the treated and control group is non-significant, thus indicating a good match.
18 C. Mio et al.
We then used the matched sample to estimate the effect of having high/low ESG rating dis
agreement on the cost of equity capital using a treatment variable equal to 1 if the firm is part
of the treatment group and 0 if it is part of the control group.
The empirical results of Equation (10) are available in Online Appendix I. We find that for
firms with low level of ESG disagreement, the coefficient for average ESG score remains nega
tive and significant, whilst for firms with high ESG disagreement the effect of the average ESG
score remains significant but diminishes in magnitude. This corroborates our results showing that
the relationship between ESG score and a cost of equity capital is conditional on the level of ESG
rating disagreement.
Second, to further corroborate our results, we split our data by the level of ESG rating dis
agreement, to examine the effect of the average ESG score on the cost of equity in the presence
of low and high levels of ESG rating disagreement. Since in our sample, the variable ESG_DI
SAGREEMENT ranges from 0 to 61, we created two groups of firms: firms with ‘Low disagree
ment’, with ESG_DISAGREEMENT ranging from 0 to 29, and firms with ‘High Disagreement’,
with ESG_DISAGREEMENT ranging from 30 to 61. Our model thus becomes:
The empirical results of Equation (11) are available in Online Appendix J. We find that for
firms with low levels of ESG disagreement, the coefficient of ESG_AVERAGE remains signifi
cantly negative, while for firms with high ESG disagreement, the coefficient of ESG_AVERAGE
becomes non-significant. This corroborates our results showing that the relationship between
ESG score and cost of equity capital is conditional on the level of ESG rating disagreement.
8. Conclusion
This paper examines the consequences of ESG rating disagreements on the cost of equity. We
used a sample of 23,201 firm-month observations from January 2019 to March 2021, and con
trolled for firm-specific determinants as well as firm and month-fixed effects; our empirical
analysis reveals interesting findings that are consistent with our hypotheses.
First, we find that firms with higher average ESG scores benefit from a lower cost of equity
capital. Second, we document that the level of ESG rating disagreement positively moderates
the negative relationship between average ESG score and cost of equity. This finding suggests
that the beneficial effect of ESG ratings for the cost of equity is weaker for firms with a high
level of ESG disagreement.
To refine our main findings, we conducted three additional analyses. First, we find that the
relationship between the average score and cost of equity capital is negative and significant
for each individual ESG dimension, but that the level of ESG rating disagreement is not a sig
nificant moderator for any pillar. Second, we split our sample into firms that operate in industries
covered by the EU taxonomy on sustainable activities and those that do not operate in industries
covered by the EU taxonomy, to find that while a high average ESG score reduces the cost of
equity in all industries, the ESG rating disagreement is a significant moderator only for firms
in industries covered by the EU taxonomy. Third, to corroborate our evidence that the ESG
rating disagreement is perceived by investors as a source of uncertainty, we find that the level
Accounting in Europe 19
of ESG rating divergence is a positive moderator of the relationship between analyst earnings
forecast dispersion and cost of equity capital. This means that firms with high levels of
analyst earnings forecast dispersion suffer from a larger increase in the cost of equity in the pres
ence of higher levels of ESG rating divergence.
We validate our main results by using propensity score-matching (PSM) to control for differ
ences in firm characteristics between treatment and control groups, and reach similar conclusions
after matching each firm having a high level of ESG disagreement with its nearest neighbor.
Overall, our study makes timely contributions to different streams of literature.
First, we extend the evidence on the value-relevance of ESG performance for market partici
pants, by documenting that ESG scores affect investor risk perception and reduce the required
rate of return. Additionally, our study reveals that the presence of multiple ESG raters for the
same firm is not per se negative. Evidence on the negative relationship between the average
ESG score and cost of equity suggests that investors carefully consider the existence of multiple
ratings for the same firm, and that they monitor and use the average score to assess a firm’s level
of risk.
However, our study shows that the presence of multiple ESG ratings has adverse consequences
for users when agency providers significantly disagree in rating the same firm. Indeed, as a
second area of contribution, this study broadens our knowledge and understanding of the econ
omic consequences of ESG rating disagreement. The lack of compatibility and convergence in
ESG ratings makes it more complex to integrate sustainability information into investment
decisions. As hypothesized, we show that this state of confusion in measuring the same firm
is perceived by investors as valuable information on the uncertainty surrounding the authenticity
and value relevance of a firm’s sustainability actions, and therefore, its real capacity to success
fully manage impacts, risks, and opportunities associated with sustainability issues. We reveal
that this uncertainty weakens the beneficial effects that a good ESG score has on the perceived
riskiness of a firm, and in turn, on the required rate of return for equity investors.
Our additional analyses suggest that the ESG rating disagreement is monitored by investors
not only when they look at the ESG ratings but also when they make use of financial estimates
and projections by analysts. In both cases, the dispersion in ESG ratings is perceived by investors
as information indicating the level of uncertainty about a firm’s future economic and financial
performance.
Thus, our study corroborates prior evidence that ESG rater disagreements are associated with
uncertainty in the capital market (Christensen et al., 2022; Kimbrough et al., 2022; Serafeim &
Yoon, 2023). This study sheds light on the consequences of the disagreement on the cost of
equity; therefore, it is closely related to Gibson Brandon et al. (2021) and Avramov et al.
(2022), which among other things, address a similar question. While Gibson Brandon et al.
(2021) find that ESG rating disagreement is associated with an increase of 92 basis points in
the annual cost of equity capital, Avramov et al. (2022) show that the negative ESG-CAPM
alpha relationship only exists among stocks with low rating uncertainty. However, the theoretical
framing and the research design we use to address this question are quite different from theirs;
hence, our study contributes to advancing and refining the understanding of the impact of ESG
rating disagreement on the cost of equity in different ways. First, while Gibson Brandon et al.
(2021) and Avramov et al. (2022) use a sample of US firms, our paper builds on European
firms. Second, the empirical evidence we provide (January 2019 to March 2021) is more
recent than the empirics in Gibson Brandon et al. (2021), who use data from 2010 to 2017,
and Avramov et al. (2022), who use data from 2002 to 2019. Additionally, our contribution
lies in revealing that ESG disagreement has a negative moderating effect on the positive relation
ship between average ESG score and cost of equity capital, while Gibson Brandon et al. (2021)
and Avramov et al. (2022) investigate the marginal effects of disagreement on the cost of equity.
20 C. Mio et al.
Thus, our study more clearly shows the interplay between the average ESG rating and ESG rating
disagreement. We document that a high level of disagreement hinders the usefulness of a good
ESG rating as a proxy for a low level of firm’s riskiness, and jeopardizes the beneficial effects on
the cost of equity. Finally, while Gibson Brandon et al. (2021) and Avramov et al. (2022) only
use the overall ESG score, we replicate the analyses with the scores for each E-S-G-dimension,
finding that the rating disagreement does not work as a moderator of the relationship between the
cost of equity and average score for any individual pillar.
Finally, our study has some implications for the recent debate on the lack of convergence in
sustainability reporting (Stolowy & Paugam, 2023). While sustainability reporting is self-narra
tive disclosure from the firm, ESG rating is an external assessment of the same real sustainability
actions. Providing evidence on the disagreement among major sustainability rating agencies and
on the adverse consequences for users and rated companies, we show how the lack of a level-
playing field in the definition and measurement of sustainability issues creates complexities
for firms, investors, and other stakeholders analyzing corporate sustainability-related activities.
Given that the probability of convergence in sustainability reporting appears limited, at least in
the short term (Stolowy & Paugam, 2023), our findings can be a useful starting point to anticipate
the adverse consequences that may follow from the persistence of the state of confusion in the
sustainability reporting landscape. Additionally, they support recent regulatory initiatives
aimed at enhancing alignment and comparability in sustainability reporting, such as the Corpor
ate Sustainability Reporting Directive within the European Union and IFRS Sustainability Dis
closure Standards developed by the International Sustainability Standards Board (ISSB).
The evidence we provide should be of interest to practitioners and policymakers.
Our findings reveal that diverse ESG ratings may have adverse consequences for the rated
companies as they may undermine the value relevance of good ESG scores. Therefore, we rec
ommend that companies be cognizant of the ESG rating landscape in which they operate, recog
nizing that rating agencies have their own methodologies that may not always converge. To
effectively leverage their sustainability efforts, firms should actively monitor and understand
the methodologies of each ESG provider, thus identifying relevant ESG factors and how they
are assessed. Firms should avoid selectively choosing favorable ESG raters, as investors tend
to scrutinize all scores assigned to the same firm. Furthermore, companies should strive to main
tain consistency in their scores across all providers since divergence among ratings is viewed
unfavorably by investors and may diminish the positive effects of a strong sustainability
performance.
Our study offers important implications for policymakers by demonstrating the economic
importance of reducing ESG disagreement. It highlights the need for policymakers to contribute
to developing a shared and unified understanding of what constitutes good ESG performance and
promoting common metrics to measure ESG attributes. Our findings show how the lack of
common rules for ESG ratings may have adverse effects on the economic system. A persisting
state of confusion and uncertainty may discourage investors from integrating environmental,
social and governance factors into their investment decisions, and this may decrease the flow
of investments on sustainable economic activities. This scenario may discourage companies
from investing and engaging in sustainability issues as the possibility of an economic return
from a good ESG profile becoming more remote. In this sense, the EU Taxonomy Regulation
for sustainable activities and the recent proposal from the European Commission (2023) for a
regulation to improve the reliability, comparability, and transparency of ESG ratings, represent
desirable efforts to enhance the quality of information about ESG ratings and enable investors to
make better-informed decisions regarding sustainable investments.
Our study is subject to some limitations. First, our analysis is based on the ESG ratings from
four rating agencies. Therefore, it could be further enriched by including data from additional
Accounting in Europe 21
ESG raters (e.g. MSCI). Second, our sample is restricted to European firms, and as a result, our
findings may have implications suitable only for this context. The EU is a unique research
setting, where investor attention and concern about the ESG performance of companies may
be exacerbated by the proliferation of regulation on ESG-related issues (e.g. mandatory sustain
ability/ESG reporting). Future research may investigate the extent to which this regulation con
tributes to reducing the ESG rating divergence and explore alternative institutional settings.
Finally, our study is limited by the proxy that we adopted to measure the cost of equity. To
further advance the debate on the economic consequences of ESG disagreement, future research
may explore the extent to which the market reactions are dependent upon the causes of the dis
agreement (i.e. measurement, scope, and weight) or the type of investors.
Contributing to understanding and solving the issues associated with the measurement and
assessment of corporate sustainability is crucial to facilitate the transition to a more sustainable
economy.
Notes
1
Similar to the case of Bollore, for other firms in our database Bloomberg provides only the scores for the individual E, S,
and G pillars, without giving the aggregate ESG score. For our analyses, we only used the ESG scores directly provided
by Bloomberg since we did not deem it appropriate to manually calculate the missing scores.
2
We employ firm fixed effects to address some of the endogeneity prevalent when using ESG ratings; however, we
acknowledge endogeneity cannot be entirely ruled out in our analysis.
Acknowledgments
The authors acknowledge the research support from the EIBURS project ESG-credit and Trans
pArEEnS project ‘Mainstreaming Transparent Assessment of Energy Efficiency in ESG
Ratings’. Aoife Fitzpatrick gratefully acknowledge research support from Prof. Loriana Pelizzon
and the Leibniz Institute for Financial Research SAFE. The usual disclaimer applies.
Disclosure statement
No potential conflict of interest was reported by the author(s).
ORCID
Chiara Mio http://orcid.org/0000-0003-0945-0334
Marco Fasan http://orcid.org/0000-0002-9426-6090
Francesco Scarpa http://orcid.org/0000-0002-6633-6127
Antonio Costantini http://orcid.org/0000-0002-9143-8125
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Appendices
Appendix A. Variable Definitions