The Rise of Environmental, Social, and Governance Rating Agencies and Stock Price Crash Risk

ABSTRACT Research Question/Issue This study examines how the initiation of coverage by environmental, social, and governance (ESG) rating agencies and the intensity of such coverage impact firms' stock price crash risk, particularly in the context of varying levels of information opacity. Research Findings/Insights Exploiting the staggered coverage of US firms by multiple third‐party ESG rating agencies, we discover a significant negative association between the initiation and intensity of coverage by ESG rating agencies and firms' stock price crash risk. Utilizing the expansion of firm coverage by Refinitiv Asset4 in 2017 as an exogenous shock, this study provides evidence consistent with a causal relationship between ESG rating agency coverage and the reduction of stock price crash risk. This effect is more pronounced for firms with lower levels of analyst coverage, diminished voluntary disclosure, and poorer earning quality. Additionally, we find that the presence of commercial ties between ESG rating agencies and the firms they rate attenuates the effectiveness of ESG coverage in reducing stock price crash risk. Theoretical Implications This study contributes to the literature on information asymmetry by demonstrating that independent ESG rating agencies serve as critical informational intermediaries. It highlights how enhanced ESG information can help mitigate risks associated with information opacity, thereby influencing financial market outcomes. Practitioner Implications The findings suggest that investors should consider the coverage and credibility of ESG rating agencies when evaluating firms, particularly those with less transparency. Moreover, the results underline the importance for rating agencies of maintaining independence from the firms they rate to preserve their informational role and effectiveness in the market.