The Impact of ESG Rating Disagreement on Stock Returns: A Comparative Study of North American and European Markets

Abstract

This thesis investigates the impact of Environmental, Social, and Governance (ESG) divergence on stock returns in North American and European markets. The study illustrates the ESG rating dispersion among three well-established ESG data vendors: MSCI, Bloomberg, and Refinitiv, aiming to determine whether the degree of such dispersion within the ESG ratings can serve as an indicator of abnormal returns. Moreover, this paper explores and compares how this effect of divergence differs across two geographical markets, North America and Europe. The Fama-French three-factor model, the Carhart four-factor model, and the Fama-French five-factor are applied along the empirical analysis. The portfolios within the research consist of securities from North American and European markets, from January 2014 to December 2023. Additionally, the portfolios are sorted by the degrees of rating divergence – high, low, and mixed. The findings pinpoint the distinct differences between the two markets on how ESG dispersion affects stock returns. While risk premiums arise for portfolios with rating divergence, the European market tends to be more sensitive to such phenomena. In addition, the Environmental and Governance divergence could potentially serve as a signal for identifying investment opportunities for North America, whereas the Social and Governance pillars within ESG are the primary drivers for the dispersion for Europe. This research further extends the understanding of ESG investing by shedding light to the financial implications of ESG divergence under different market dynamics.