This paper examines the causal impact of ESG ratings and their divergence on retail investors’ sustainable investment decisions. Using a survey with an framed choice experiment conducted with 2,025 German retail investors, we document three key findings: (i) While about two in three investors claim they own sustainable equity funds, merely six percent actively incorporate ESG ratings into their own portfolio decisions; (ii) the use of ESG ratings is tightly linked with perceived credibility of ESG ratings and sustainable finance literacy; (iii) higher average ESG ratings increase investment in sustainable funds, but rating divergence reduces such allocations. We formally show that the results are consistent with an ESG portfolio choice model in which ESG rating divergence acts as noisy signals of sustainability and investors differ in their responsiveness based on rating credibility, sustainability preferences, and financial expectations. Although ESG rating divergence has a weaker effect on committed ESG investors, we show that it significantly deters retail investors with low exposure to green assets and those with higher financial literacy from investing sustainably.
