University of Cambridge

Best Paper Award Winner – 2020 Ivey ARCS Ph.D. Sustainability Academy

Seminar Information

Falling Out of Frame: When Firms Benefit from ESG Rating Deviance

Abstract

Although some research has shown that firms often benefit from being highly rated on social evaluation ratings, recent research has suggested surprising benefits of being rated in the middle or even toward the lower end of the industry. Given these discrepant findings, it is critical for scholars to examine the theoretical mechanisms and contingencies that could explain such divergence. Thus, we examine the conditions that might cause investors to overlook firms’ positively or negatively deviant environmental, social and governance (ESG) ratings, as well as the conditions under which such deviance and lack of scrutiny benefits those firms. Using a balanced panel dataset of 2,313 companies across 62 industries and 70 countries from 2013 to 2018, we explore when and under what conditions firms benefit from being rated high, in the middle, and low on ESG. Our results suggest that firms that conform to industry ESG ratings on average benefit from positive investor evaluations. However, when industries experience salient legitimacy threats related to ESG issues, conforming firms are penalized, while those firms that overperform or underperform in their ESG metrics benefit from being ignored by investors. These benefits are accentuated when the industry is highly conforming in its ESG performance, minimizing scrutiny of outliers. Finally, we find that when the social evaluation of industries is perceived as material and investors are more prone to scrutiny, only positive deviation from industry ESG norms is rewarded due to increased scrutiny by investors. Our findings contribute to longstanding research on institutional theory, while advancing the growing and important literature at the intersection of social evaluations and optimal distinctiveness.