ESG rating agencies and shareholder activism: the initiation of ESG rating coverage

Leveraging firms’ first-time coverage by an environmental, social, and governance (ESG) rating agency after the agency expanded its firm coverage as a shock, we find that the initiation of coverage by an ESG rating agency is positively associated with the probability and frequency of covered firms being targeted by shareholder activist interventions. We also observe that coverage by an ESG rating agency increases the likelihood that a firm responds favourably to shareholders’ demands for improvement in the firm’s ESG policies and practices. Additional tests reveal that these effects are particularly pronounced for firms with relatively opaque ESG information environments, lending support to the information supply hypothesis. Further analyses indicate that the impact of ESG rating agency coverage on shareholder activism is stronger for firms with poor ESG practices or targeted by less professional or non-hedge fund activist shareholders. Taken together, our results support the conjecture that investors’ increased access to ESG information via ESG rating agencies reduces shareholders’ ESG information costs, thereby increasing their incentive to intervene in managerial decisions related to ESG.