Do changes in ESG ratings really produce short-term stock market effects?
Thomas Cauthorn, Maurice Dumrose , Julia Eckert, Christian Klein, and Bernhard Zwergel investigate this question by replicating prior research on ESG rating changes in « Rating Changes Revisited: New Evidence on Short-Term ESG Momentum ».
They uncover several methodological flaws in the original analysis and report no evidence of short-term « ESG momentum » in stock performance, contradicting earlier findings:
- The replication finds no significant abnormal stock returns in the month after an ESG rating upgrade or downgrade, which contradicts Shanaev and Ghimire (2022), who reported stock underperformance after ESG downgrades and outperformance after upgrades.
- The prior study assumed investors would monitor MSCI ESG ratings and rebalance portfolios on a monthly basis immediately after rating changes, which the authors argue is an unrealistic assumption.
- The original dataset did not actually cover all MSCI-rated U.S. companies as claimed, which may have biased the 2022 study’s results.
- The replication computes continuously compounded portfolio returns instead of the discrete returns used in the original.
- The original analysis found a significant -1.2% monthly alpha following ESG downgrades and +0.6% after upgrades. After correcting methodological errors, these alphas are no longer statistically different from zero.
- The initial study relied on one source (MSCI), while in the replication the authors added a second rating dataset from Vigeo Eiris (Moody’s ESG) and still found no short-term performance effect.
- Even when varying what counts as a “rating change,” the results hold and the authors find no significant abnormal returns post-change.
This study suggests immediate trading on ESG rating upgrades or downgrades is unlikely to yield excess returns, as such rating changes do not trigger any reliable short-term market reaction.
Sustainability factors may be financially relevant, but their effects on stock value unfold gradually as more investors integrate them, not via quick momentum pops in the month after a rating change.
The analysis focuses on the 2010-2021 period with two rating sources (MSCI and V.E.), so the findings may not generalise to current market behaviours or other ESG rating methodologies or contexts.