This article has been reviewed according to Science X's editorial process and policies. Editors have highlighted the following attributes while ensuring the content's credibility: A new study from Murdoch University has found that Environmental, Social and Governance (ESG) downgrades trigger significantly larger share price losses when they come as a surprise to optimistic investors. The findings are published in the journal International Review of Economics & Finance.
Globally, ESG investing has grown significantly, with investors increasingly considering firms' sustainability performance when allocating capital. As a result, ESG scores have become an important measure for investors assessing risk. Previous research has shown that declines in ESG ratings are often associated with falls in company share prices.
"However, this market reaction is not uniform," said lead author Dr. Phu Ngoc Tran, lecturer at the Murdoch Business School. "We wanted to investigate whether investor sentiment toward a firm influenced how the market reacted to ESG rating changes," he said.
The research team analyzed ESG rating changes across S&P 500 companies between 2010 and 2024, examining more than 6,700 ESG rating events and their impact on share prices. They then measured investor sentiment using company-specific news and social media data and separated sentiment into five categories: positive, negative, risk, volatility and management-related sentiment. The study's main finding was that investors react more strongly to ESG downgrades when they were previously optimistic about a firm's prospects.
"What surprised us was that positive sentiment had a much greater influence than other forms of investor sentiment, such as fear, risk or concerns about a firm's management," said co-author Dr. Ariful Hoque of the Murdoch Business School. "Investors appear to punish ESG downgrades most severely when they contradict an otherwise positive view of the firm." The effect was strongest among larger firms and those with strong ESG track records.
"Large companies and those with strong ESG reputations appear to have the most to lose from an ESG downgrade, as these firms attract greater investor attention and higher expectations," Hoque said. Tran said the study has implications for both companies and investors. "For companies, the findings highlight the importance of protecting both ESG performance and the trust investors place in their sustainability credentials," he said.
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