Investors are increasingly incorporating assessments of companies’ performance on environmental, social, and governance (ESG) issues in their portfolio decisions. The global assets under management of the signatories to the United Nations Principles for Responsible Investment (PRI) have grown from about $20 trillion in 2010 to about $121 trillion in 2021.
Figure 1 Assets under Management of PRI Signatories from 2010 to 2021
Just as traditional investors rely on sell-side analysts and credit rating agencies, socially responsible investors rely on ESG rating agencies as information intermediaries that gather and summarize information about a firm’s ESG performance. Prominent ESG rating agencies include MSCI (KLD), Refinitiv, Sustainalytics, RepRisk, S&P Global, Bloomberg, FTSE Russell, and ISS Global. The number and influence of those agencies have grown significantly in recent years, reflecting the rise of socially responsible investment. However, there is widespread disagreement in ESG ratings because of differences in methodology and standards. Investors cite inconsistency among ESG ratings as one of the top barriers for making ESG investment decisions. In addition, in a new study, we find that ESG disagreement is positively associated with disagreement and uncertainty in the capital market. Thus, managers have strong incentives to reduce ESG disagreement.
Just as management forecasts and conference calls provide greater transparency about a firm’s fundamentals, voluntary ESG reports potentially provide greater transparency about a firm’s ESG performance. The number of ESG reports issued by U.S. public companies increased from less than 500 in 2010 to more than 2,100 in 2021, according to Corporate Register. Investors cite these reports as the top source of ESG information. Our study examines whether the effectiveness of voluntary disclosure in resolving disagreement among capital market information intermediaries extends to the ESG context.
Figure 2 Number of ESG Reports in the U.S. from 2010 to 2021
Consistent with this possibility, we provide the first evidence that management–provided ESG disclosure is associated with lower disagreement among ESG raters in the U.S., where ESG reporting is voluntary. We find that disagreement among ESG rating agencies is lower for firms that voluntarily issue ESG reports. Our evidence demonstrates the beneficial role of these voluntary disclosures for the intended audience of these reports – those that care about and monitor firms’ ESG performance. Using textual analysis, we find that longer reports are associated with less disagreement among ESG raters while more positive reports or those with more sticky words are associated with heightened disagreement. These findings highlight the importance of managers’ word choices in reducing disagreement among ESG raters, thereby answering the general call for research that uses textual analysis to measure the information content of ESG reports (Ballou, Casey, Genier, and Heitger, 2012) and contributing to the literature on the qualitative and textual features of firm disclosures (e.g., Dyer, Lang, and Stice-Lawrence, 2017).
Moreover, the association between ESG disclosure and ESG disagreement is more pronounced when firms obtain third-party attestations on their ESG reports, especially from accounting firms. This finding resolves the mixed evidence from prior research on the value of external assurance in the ESG context (e.g., Michelon, Pilonato, and Ricceri, 2015) and answers the calls for research on the benefits of obtaining assurance from accounting firms in the ESG context (Ballou et al., 2012; Pflugrath, Roebuck, and Simnett, 2011). Taken collectively, our in-depth content analysis of ESG reports provides actionable insights and practical implications to managers about how their ESG disclosure choices can reduce ESG disagreement among rating agencies.
In addition, we find that the adoption of advanced levels of Global Reporting Initiative (GRI) reporting standards promotes greater consensus among ESG raters, which should be of interest to standard setters who wish to promote best practices in ESG reporting in the U.S. Specifically, the finding both highlights the benefit of reporting that organizes and contextualizes ESG information and contributes to the debate on whether the U.S. should adopt mandatory rules for ESG reporting (Christensen, Hail, and Leuz, 2021).
Furthermore, we document that the negative association between ESG disclosure and disagreement is more pronounced for firms in environmentally sensitive industries, demonstrating the role of external pressure in eliciting high quality ESG disclosures and answering Rupley, Brown, and Marshall (2012)’s call for papers that investigate environmental matters. Moreover, utilizing textual analysis, we further document that disclosures about environmental and social issues help reduce disagreement about a company’s performance on those issues. However, disclosures about corporate governance in an ESG report do not reduce disagreement about a company’s governance performance, likely because the SEC requires U.S. companies to disclose extensive governance information in their filings (e.g., proxy statements), which substitutes for governance disclosures in voluntary ESG reports.
Finally, we show the economic importance of reducing ESG disagreement. Specifically, our finding that ESG disagreement is associated with uncertainty in the capital markets provides new evidence on the long-debated question of whether ESG affects a company’s value. Combined with our finding that ESG disclosure is negatively associated with ESG disagreement, we also highlight a specific channel for Dhaliwal, Li, Tsang, and Yang (2011)’s evidence of a negative association between ESG disclosures and cost of capital.
 Ballou B., Casey R. J., Grenier J. H., and Heitger, D. L. (2012). Exploring the strategic integration of sustainability initiatives: opportunities for accounting research. Accounting Horizons, 26(2), 265–288.
 Dyer, T., Lang, M., and Stice-Lawrence, L. (2017). The evolution of 10-K textual disclosure: Evidence from Latent Dirichlet Allocation. Journal of Accounting and Economics, 64(2-3), 221–245.
 Michelon, G., Pilonato, S., and Ricceri, F. (2015). CSR reporting practices and the quality of disclosure: An empirical analysis. Critical Perspectives on Accounting, 33, 59–78.
 Pflugrath, G., Roebuck, P., and Simnett, R. (2011). Impact of assurance and assurer’s professional affiliation on financial analysts’ assessment of credibility of corporate social responsibility information. Auditing: A Journal of Practice & Theory, 30(3), 239–254.
 Christensen, H. B., Hail, L., and Leuz, C. (2021). Mandatory CSR and sustainability reporting: economic analysis and literature review. Review of Accounting Studies, 26(3), 1176-1248.
 Rupley, K. H., Brown, D., and Marshall, R. S. (2012). Governance, media and the quality of environmental disclosure. Journal of Accounting and Public Policy, 31(6), 610–640.
 Dhaliwal, D. S., Li, O. Z., Tsang, A., and Yang, Y. G. (2011). Voluntary nonfinancial disclosure and the cost of equity capital: The initiation of corporate social responsibility reporting. The Accounting Review, 86(1), 59–100
This post comes to us from professors Michael D. Kimbrough at the University of Maryland’s Robert H. Smith School of Business, Xu (Frank) Wang at Saint Louis University’s Chaifetz School of Business, Sijing Wei at Creighton University’s Heider College of Business, and Jiarui (Iris) Zhang at SUNY Brockport. It is based on their recent paper, “Does Voluntary ESG Reporting Resolve Disagreement Among ESG Rating Agencies?” available here.