How Does ESG Rating Agencies Shape ESG Disclosure and ESG Outcome? Evidence from Refinitiv's ESG Rating Methodology Update

Description

The majority of ESG rating agencies have relied on company-provided materials such as corporate disclosures when they evaluate ESG performance of the company. For instance, Refinitv, one of the leading ESG rating providers, mentions “company disclosure is at the core of our methodology” in their ASSET4 ESG score methodology guide. Therefore, given that there are various benefits of having high ESG rating, such as better access to capital, firms may try to align their corporate disclosure to rating agencies’ rating schemes in an attempt to boost ESG rating. In this proposed study, I focus on the recent ESG rating methodology update by Refinitv, and examine whether the firms followed by Refinitiv improved ESG disclosure and practices after the methodology update.In early 2020, Refinitv, one of the well-known ESG rating providers, announced updates to its ASSET4 ESG score rating methodology. Notably, Refinitv changed the way they treat firms that didn’t disclose ESG metrics. Before the methodology update, they allocated a score of 0.5 to companies which didn’t report on metrics, essentially giving them the ‘benefit of the doubt.’ However, given that this may disincentivize companies to report their ESG matters, updated methodology now assigns a score of zero to companies who don’t report on metrics relevant to the industry (Refinitv, 2020). In this paper, I examine whether firms respond to this exogenous rating methodology change by increasing their ESG disclosure and improving their ESG practices.This study has several contributions. The existing literature on ESG disclosure examine how various stakeholders such as institutional investors, policymakers and NGOs affect ESG reporting (Dhaliwal et al., 2011; Reid and Toffel, 2009; Cho and Patten, 2007). This paper extends this literature by focusing on the role of ESG rating agency – which is another important but less studied party – in shaping firms’ ESG disclosure. This study also contributes to the literature on the real effects of ESG disclosure as it examines how exogenous change in ESG disclosure affects firm’s ESG practices and outcomes. Finally, my study should be of interest to ESG rating agencies as it examines the impact of ESG rating methodology on ESG disclosures and practices.