Relative to whom? The impact of peer groups on ESG ratings and financial performance

This paper investigates how peer groups affect the financial informativeness of ESG ratings. Many ESG rating agencies evaluate firms relative to their industry or sector peers, but the consequences of this methodological choice remain largely anecdotal and have received little systematic empirical attention. Using the Refinitiv ESG framework (which applies a best-in-industry approach) we construct an alternative best-in-sector rating and assess their respective abilities to reflect sustainability-related financial risks. Our findings show that firms with low ESG ratings consistently earn higher abnormal returns than those with high ratings, consistent with the existence of a sustainability risk premium. While this pattern holds across both methodologies, the return spread is significantly larger under the best-in-sector approach. This suggests that broader peer groups are more effective in distinguishing firms with financially material sustainability risks.