The Determinants of ESG Ratings: Rater Ownership Matters

Does the ownership structure of rating agencies influence sustainability ratings?

Dragon Yongjun Tang, Jiali Yan, and Chelsea Yaqiong Yao study whether firms connected to ESG rating agencies through common institutional ownership receive systematically different ratings in « The Determinants of ESG Ratings: Rater Ownership Matters ».

They use ownership data, rating data, and quasi-natural experiments to detect meaningful changes in treatment between firms and and work out their causes. Their main conclusions include:

• Firms sharing large institutional shareholders with an ESG rating agency (sister firms), receive significantly higher ratings than non-connected firms, even after controlling for firm size, profitability, and other characteristics.
• The rating premium for sister firms increases with the size of the institutional owner’s stake in the rating agency, which suggests ownership power strengthens rating inflation.
• A natural experiment based on the acquisition of an ESG rater shows that firms only receive higher ratings after becoming ownership-connected.
• Rating inflation is concentrated in sustainability dimensions classified as financially immaterial under SASB standards, while material ESG concerns are not similarly inflated.
• Benchmarking against another major rater shows no convergence over time, indicating that inflated ratings are not corrected by market learning or peer raters.
• Despite receiving higher initial sustainability ratings, sister firms experience worse future outcomes, including more negative sustainability-related news events.
• These patterns persist across alternative definitions of ownership connections, matched-sample analyses, and continuous measures of ownership intensity.

The findings imply that sustainability ratings embed conflicts of interest arising from rater ownership, even in investor-pay business models , by strategic manipulation of low-materiality indicators.

ESG analysts and asset managers should incorporate rater governance and ownership structures into their due diligence processes, especially considering inflated ratings fail to predict real sustainability performance.

The study’s limitations stem from its focus on one major ESG data provider and a specific post-acquisition period: while the identification strategy is strong, the authors do not assess how widespread such ownership structures are across the entire ESG rating industry.