Downgrades of environmental, social, and governance (ESG) rating are associated with sharper share price declines when investors are already optimistic about a company, according to new research that suggests market expectations can amplify the financial impact of worsening sustainability scores.
Researchers at Australia’s Murdoch University analysed more than 6,700 changes in ESG ratings among S&P 500 companies between 2010 and 2024, comparing the changes with subsequent stock market performance.
They found that ESG downgrades were followed by economically meaningful negative cumulative abnormal returns, while rating upgrades produced much weaker and shorter-lived market responses.
The effect of a downgrade was particularly pronounced when the surrounding information environment was positive, suggesting companies enjoying strong investor confidence could face a greater valuation hit when their ESG performance unexpectedly deteriorates.
“We wanted to investigate whether investor sentiment towards a firm influenced how the market reacted to ESG rating changes,” said Phu Ngoc Tran, a lecturer at Murdoch Business School and the study’s lead author.
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What surprised us was that positive sentiment had a much greater influence than other forms of investor sentiment, such as fear, risk, or concerns about a firm’s management.
Ariful Hoque, Senior Lecturer in Finance, College of Business, Murdoch University
ESG ratings, produced by specialist providers to assess companies on issues ranging from carbon emissions and governance to labour practices, have become widely used by investors as sustainability considerations play a greater role in capital allocation.
The sustainable investment market remains substantial despite recent political and investor pushback against ESG. Global sustainable funds held an estimated US$3.7 trillion in assets at the end of the second quarter of 2026, according to Morningstar, with assets reaching a record even as investor demand varied sharply between regions. US sustainable funds recorded nearly US$3 billion of net inflows during the quarter, their first positive quarter after 14 consecutive quarters of withdrawals.
But ESG scores are not standardised, and different rating providers can reach markedly different conclusions about the same company. A study comparing six major rating agencies found correlations between their ESG assessments ranging from 0.38 to 0.71, with differences in how providers measured sustainability factors accounting for more than half of the divergence.
Previous research has linked ESG rating downgrades with falling share prices, but the Murdoch study sought to determine whether different forms of investor sentiment affected the strength of that relationship.
The researchers used company-specific news and social media data to divide sentiment into five categories: positive tone, negative tone, risk, volatility and sentiment related to management.
Positive sentiment emerged as the strongest factor influencing how markets responded to an ESG downgrade.
“What surprised us was that positive sentiment had a much greater influence than other forms of investor sentiment, such as fear, risk, or concerns about a firm’s management,” said co-author Ariful Hoque, Senior Lecturer at Murdoch Business School.
The findings suggest investors react more strongly when negative ESG information conflicts with previously favourable expectations about a company.
By contrast, measures related to negative sentiment, risk, volatility and management perceptions played comparatively limited roles in determining the stock price response, according to the study.
The effect was strongest among large companies and businesses with strong ESG records before their ratings were downgraded.
“Large companies and those with strong ESG reputations appear to have the most to lose from an ESG downgrade, as these firms attract greater investor attention and higher expectations,” Hoque said.
The researchers said such companies were also more likely to be widely held by institutional investors and investment funds with ESG mandates, potentially increasing the market response when their sustainability performance weakened.
The findings could have implications for companies that have invested heavily in establishing strong sustainability reputations, Tran said.
“Firms that have built a strong ESG reputation should not assume they are insulated from market risk,” he said. “In fact, our research suggests they may face a stronger market backlash if their ESG performance deteriorates.”
For investors, the results suggest ESG rating changes should be considered alongside prevailing expectations about a company rather than viewed in isolation.
“Our findings show that the same ESG downgrade can have very different market impacts depending on investor expectations at the time,” Tran said.
