The Aggregate Confusion Project

Our first paper produced under this project looks into the differences between environmental, social, and governance (ESG) ratings provided by six popular ESG rating agencies. We identify three main factors contributing to the rating divergence: scope, measurement, and weight. Measurement was found to be the biggest contributor, accounting for 56% of the divergence, followed by scope at 38%, and weight at 6%. Our study also detected a "rater effect," where a rater's overall opinion of a company affects the rating of specific categories. The results call for greater attention to how the data underlying ESG ratings are generated.

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Florian Berg, Julian F Kölbel, Roberto Rigobon, Aggregate Confusion: The Divergence of ESG Ratings, Review of Finance, Volume 26, Issue 6, November 2022, Pages 1315–1344, https://doi.org/10.1093/rof/rfac033

Awards + Recognition:

• Lead article, Review of Finance
• Editor's Choice, Special Issue on Sustainable Finance, Review of Finance
• Best overall paper award GRASFI 2020
• Best paper award on ESG Standards GRASFI 2020
• Investments & Wealth Institute Governance Insight Award 2021
• Best paper award Liechtenstein Workshop of Sustainable Finance 2021
• Runner up best paper award Gronen Conference 2020

The explosion in ESG research has led to a strong reliance on ESG rating providers. This paper documents widespread changes to past ratings from a key rating provider, Refinitiv ESG (formerly ASSET4). Depending on whether the original or rewritten data are used, ESG-based classifications of firms into ESG quantiles and tests that relate ESG scores to returns change. 

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Berg, Florian and Fabisik, Kornelia and Sautner, Zacharias, Is History Repeating Itself? The (Un)Predictable Past of ESG Ratings (August 24, 2021). European Corporate Governance Institute – Finance Working Paper 708/2020, Available at SSRN: https://ssrn.com/abstract=3722087 or http://dx.doi.org/10.2139/ssrn.3722087

Awards + Recognition:

• John L. Weinberg/IRRCi 2022 Research Paper Award 
• Cornell ESG Research Conference 2022 Best Paper Award
• CFA Society Germany Investment Research Award Runner-up

How does ESG performance affect stock returns? Answering this question is difficult because existing measures of ESG performance — ESG ratings — are noisy and, therefore, standard regression estimates suffer from attenuation bias. To address the bias, researchers propose two noise-correction procedures, in which they instrument ESG ratings with ratings of other ESG rating agencies. The corrected estimates demonstrate that the effect of ESG performance on stock returns is stronger than previously estimated: after correcting for attenuation bias, the coefficients increase on average by a factor of 2.6, implying an average noise-to-signal ratio of 61.7%. In simulations, our noise-correction procedures outperform the standard approaches followed by practitioners such as averages or principal component analysis.

Read their research here

Berg, Florian and Kölbel, Julian and Pavlova, Anna and Rigobon, Roberto, ESG Confusion and Stock Returns: Tackling the Problem of Noise (October 12, 2021). Available at SSRN: https://ssrn.com/abstract=3941514

Awards + Recognition:

• ARCS 2022 People's Choice Award

This study examines the impact of ESG ratings on mutual fund holdings, stock returns, corporate investment, and corporate ESG practices, using panel event studies. We focus on changes in the MSCI ESG rating, which we show is the most relevant rating for the holdings of ESG mutual funds in the US. We document that rating downgrades reduce ownership by mutual funds with a dedicated ESG strategy, while upgrades increase it. We find a negative long-term response of stock returns to downgrades and a slower and weaker positive response to upgrades. Regarding firm responses, we find no significant effect of up- or downgrades on capital expenditure. We find that firms adjust their ESG practices following rating changes, but only in the governance dimension. These results suggest that ESG rating changes matter in financial markets, but so far have only a limited impact on the real economy.

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Berg, Florian and Heeb, Florian and Kölbel, Julian, The Economic Impact of ESG Ratings (September 4, 2022). Available at https://ssrn.com/abstract=4088545

In “The Signal in the Noise,” we argue that abandoning ESG now would essentially be throwing the baby out with the bath water.  ESG, however flawed, is currently the best way to measure the ethical behavior of companies and that ESG data, when deployed with greater transparency, can be an important source of information for investors.

“Given the complexity of what ESG measurement entails, we believe that the only solution to gathering, analyzing, and aggregating the data runs through commercial ESG rating agencies and ESG data providers,” write authors Florian Berg, Jason Jay, Julian Kölbel, and Roberto Rigobon.

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The Signal in the Noise. Florian Berg, Jason Jay, Julian Kölbel, Roberto Rigobon, CESifo, Munich, 2023, EconPol Forum 24 (1), 23-27

We quantify the financial performance of environmental, social, and governance (ESG) portfolios in the U.S., Europe, and Japan, based on data from six major ESG rating agencies. We document statistically significant excess returns in ESG portfolios from 2014 to 2020 in the U.S. and Japan. We propose several statistical and voting-based methods to aggregate individual ESG ratings, the latter based on the theory of social choice. We find that aggregating individual ESG ratings improves portfolio performance. In addition, we find that a portfolio based on Treynor-Black weights further improves the performance of ESG portfolios. Overall, these results suggest there is a significant signal in ESG rating scores that can be used for portfolio construction despite their noisy nature.

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Berg, Florian and Lo, Andrew W. and Rigobon, Roberto and Singh, Manish and Zhang, Ruixun, Quantifying the Returns of ESG Investing: An Empirical Analysis with Six ESG Metrics (February 27, 2023). Available at SSRN: https://ssrn.com/abstract=4367367

A first-order concern regarding sustainable finance is that it may crowd out individual support for more effective, policy-driven approaches to address societal challenges. We find that the opportunity to invest in a climate-conscious fund does not erode individuals’ support for climate regulation. While sustainable finance may resemble a placebo in the sense that individuals appear very optimistic about its societal impact, it is not a dangerous placebo that crowds out political engagement.

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Heeb, Florian and Kölbel, Julian and Ramelli, Stefano and Vasileva, Anna, Is Sustainable Finance a Dangerous Placebo? (June 19, 2023). Swiss Finance Institute Research Paper No. 23-46, Available at SSRN: https://ssrn.com/abstract=4484166

We report results from a pre-registered field experiment about the impact of index provider engagement on corporate climate policy. A randomly chosen group of 300 out of 1227 international companies received a letter from an index provider, encouraging the company to commit to setting a science-based climate target to remain included in its climate transition benchmark indices. After one year, we observed a significant effect: 21.0% of treated companies have committed, vs. 15.7% in the control group. This suggests that engagement by financial institutions can affect corporate policies when a feasible request is combined with a credible threat of exit.

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Heeb, Florian and Kölbel, Julian, The Impact of Climate Engagement: A Field Experiment (January 24, 2024). Swiss Finance Institute Research Paper No. 24-04, Available at SSRN: https://ssrn.com/abstract=4711873 or http://dx.doi.org/10.2139/ssrn.4711873

Firms that obtain assurance for their carbon accounting report on average a 9.5% higher carbon intensity than their peers. When controlling for assurance, we do not find evidence that SBTi target setters reduce their future emissions. Instead, firms that obtain assurance reduce their future carbon intensity by 3.3%. This has implications for portfolio managers and ESG raters as taking reported carbon emissions at face value would lead to penalizing firms that are more serious about their carbon reductions. It also calls for mandatory assurance when carbon reporting is mandatory and when reported emissions are generally relied upon in regulation.

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Berg, Florian and Oliver Huidobro, Jaime and Rigobon, Roberto, On the Importance of Assurance in Carbon Accounting (February 21, 2024). Available at SSRN: https://ssrn.com/abstract=4734240