Can ESG ratings remain independent when the rating agency’s parent company is also being paid for credit ratings by the same firms?
Xuanbo Li, Yun Lou, and Liandong Zhang test whether Moody’s and S&P’s acquisitions of ESG rating agencies created conflicts of interest that spilled over into ratings in « Do Commercial Ties Influence ESG Ratings? Evidence from Moody’s and S&P ».
They use a stacked difference-in-differences design to compare ratings for CRA clients versus non-clients, benchmarking Vigeo Eiris’ (Moody’s) and RobecoSAM’s (S&P) scores against a consensus of Refinitiv, MSCI, and Sustainalytics.
Their main conclusions include:
- After the acquisitions, firms already paying for credit ratings receive higher sustainability ratings from the affiliated ESG rater compared to non-clients.
- The estimated effect is 0.134, about 17.16% of the relative-rating standard deviation, and holds even after benchmarking against consensus ESG ratings.
- Dynamic estimates show no meaningful pre-acquisition divergence between treated firms and controls while ESG rating inflation appears between 2019 and 2021, which supports the claim that the acquisitions triggered the rating shift.
- The effect is larger for treated firms with more intensive credit rating relationships: the estimated post-acquisition increase is 0.214 for the top tercile of relationship intensity versus 0.108 for the bottom tercile, with a statistically significant gap.
- The incremental inflation is significantly reduced for firms with stronger ESG disclosure transparency or higher long-term institutional ownership, as it limits the scope for inflated assessments.
- Larger increases in ESG ratings are associated with greater post-acquisition green bond issuance, and higher post-acquisition ESG ratings are linked to a higher likelihood that new bonds are rated by the same CRA.
- For treated firms, the relation between sustainability ratings and news weakens post-acquisition, and higher ESG ratings predict higher future greenhouse gas emissions.
This research shows a ratings signal entangled with credit rating revenues can embed commercial considerations, show reduced informativeness and strong biases towards CRA clients.
Inflated ESG ratings also help firms issue more green bonds, which suggests some issuance growth may reflect improved perceived credentials rather than improved underlying ESG performance.
The study faces three key limitations raised by the authors: they cannot provide direct evidence of CRA’s internal mechanisms, fully rule out alternative explanations, or benchmark ratings against an unbiased and interdependent benchmark.