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The Market for ESG Ratings

Author

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  • Azarmsa, Ehsan
  • Shapiro, Joel

Abstract

The boom in Environmental, Social, and Governance (ESG) investing has created a demand for ESG ratings. ESG ratings, unlike credit ratings, measure multiple unrelated categories. We provide a model of ESG ratings competition where raters provide information about these categories and set fees. Raters specializing in different categories maximizes the amount of information transmitted and total surplus, and is the competitive outcome when investors are less concerned about ESG performance. When investor concerns about ESG performance are large enough, the competitive outcome is for them to generalize – splitting their effort among the categories, resulting in less informative ESG ratings. In this case, generalizing increases the stand-alone value of the ratings, and, hence, the raters’ pricing power. The possibility of greenwashing by firms can make generalization the unique equilibrium. We also demonstrate that specialization maximizes ratings disagreement and, thus, empirical measures of disagreement may be poor measures of surplus.

Suggested Citation

  • Azarmsa, Ehsan & Shapiro, Joel, 2024. "The Market for ESG Ratings," CEPR Discussion Papers 19290, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:19290
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    More about this item

    Keywords

    ESG ratings; Information transmission; Market structure;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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