Over the past two decades, investor demand for firms’ non-financial information, particularly Environmental, Social, and Governance (ESG) data, has surged. This has led to the emergence of numerous ESG rating agencies, which assimilate and transform complex, non-financial disclosures into more accessible metrics (ESG scores) that help investors identify material ESG risks otherwise overlooked by traditional financial analysis. These scores are now central to how many investors assess corporate sustainability and integrate it into their financial decision-making.

While considerable attention has been paid to ESG scores themselves – their divergence across rating agencies, their correlation with stock performance, and their influence on capital allocation – the role played by the rating agencies that produce these scores has received far less scrutiny. In particular, how ESG raters shape investor decisions remains an underexplored area. In a recent paper, we focus not on the ESG scores themselves, but on how changes in methodologies used to calculate those scores can influence investor behavior and thus give ESG raters meaningful influence over financial markets.

Any attempt to isolate the role of ESG raters must begin with a key observation: ESG scores are composite measures, blending inputs that deserve separate consideration. One consists of the companies’ own disclosures of their ESG data, information that’s available to both raters and investors alike. The second, more distinctive component, derives from each ESG rater’s own methodological choices: how it interprets, weighs, and processes that data.

Our study exploits a unique event involving ESG in 2010, when MSCI, after acquiring RiskMetrics, altered the methodology of its MSCI-KLD ESG Stats ratings (including both collection and interpretation of  data). The change led to significant shifts in firms’ ESG ratings – not due to any actual change in the companies’ ESG performance, but because of the new methodology. Some firms saw their ESG scores rise or fall solely because of the new data collection criteria. This event provided the ideal quasi-experimental setting to test an important question: Do investors respond to changes in ESG ratings that are purely the result of rating agency methodology, rather than any real change in company performance?

The answer is yes, but not all investors respond the same way.

Retail vs. Institutional Investors

Our study finds that retail investors reacted strongly to the changes in ESG scores. Companies that received an upgrade due to the new methodology experienced a significant increase – about 26 percent – in the number of individual shareholders. In contrast, institutional investors remained largely indifferent, showing no significant change in their holdings or their numbers. This difference highlights the informational advantage of professional investors, who are more likely to conduct their own ESG assessment rather than rely on third-party ratings. In contrast, individual investors tend to depend more heavily on the scores provided by major ESG data providers, lacking the time or resources to independently evaluate firms’ sustainability performance.

Visibility Matters

Is this documented effect uniform across all companies? Not quite. The study reveals that the impact of ESG-rating changes is far from homogenous and is significantly influenced by a firm’s visibility or investors’ familiarity with the company.  The increase in individual ownership following the methodological change was concentrated among large-cap companies, those with high trading volumes, and those with more extensive analyst coverage. These three characteristics serve as common proxies for a firm’s visibility. In essence, ESG rating changes had the largest effect when they involved firms that investors already recognized or followed.  For lesser-known companies – those with limited analyst coverage, smaller market caps, or lower trading activity – the same changes in ESG scores did not generate a comparable response. This suggests that visibility acts as a critical amplifier: When a firm is already on the radar of individual investors, a positive ESG rating shift is more likely to trigger an increase in its investor base, particularly among retail investors. This finding underscores the importance of visibility not only in shaping investor attention, but also in magnifying the market impact of ESG ratings – particularly among individual investors who often rely on recognizable names and accessible information when making investment decisions.

Asymmetry in Investor Reaction

Another key finding is that investor response was asymmetric. Retail investors were more likely to buy stocks that received rating upgrades but did not correspondingly sell those that were downgraded. This pattern is consistent with behavioral biases like regret aversion, where investors are reluctant to sell losers even in the face of negative signals.

Broader Implications for Investors, Firms, and Regulators

The study highlights the critical influence ESG rating agencies can have – not through changes in firm performance, but through their own methodological decisions. This is particularly relevant now, as regulators, especially in the EU, are pushing for greater transparency and standardization in ESG ratings. A 2024 EU regulation now requires ESG rating providers to disclose their methodologies, which could further shape how investors interpret ESG information.

ESG ratings strongly influence investor perceptions and provide new insights into the mechanisms through which ESG information is processed in financial markets. In our paper, we show that individual investors respond strongly to positive ESG rating shocks, particularly for firms with high visibility, while institutional investors appear indifferent to such mechanical changes.

For companies, the implications are clear: Improving ESG visibility – even through rating upgrades driven by methodology – can broaden their investor base, particularly among retail investors. For investors and regulators, the findings reinforce the need for greater scrutiny of rating agency practices, given their ability to sway market behavior.

This post comes to us from professors Ariadna Dumitrescu at Esade Business School, Albane Tarnaud at IESEG School of Management, and Mohammed Zakriya at IESEG School of Management. It is based on their recent paper, “Does the ESG Rating Methodology Matter to Investors? Insights from Breadth of Ownership,” available here.