Environmental ratings and stock returns: The dominant role of climate change

We analyze the effect of MSCI's environmental rating changes on stock returns for U.S.-listed firms. We consider the aggregate environmental rating, its four underlying theme ratings, and thirteen environmental key issue ratings from which both the aggregate and theme ratings are constructed. We find that the positive effect of aggregate environmental rating changes on subsequent stock returns is driven by changes in the underlying climate change rating with no significant impact of any of the other underlying theme ratings. Specifically, a one point increase in climate change rating, measured on a ten-point scale, is associated with stock returns increasing by about one percentage point over a subsequent period of six months. Changes in the underlying carbon emissions rating are the most important driver of the impact of climate change rating changes on stock returns. Further analyses highlight the forward-looking nature of carbon emissions ratings in capturing emissions-related risks. Specifically, they show carbon emissions rating changes predict changes in future carbon emissions and carbon emission intensity.