Recent studies suggest that institutional investors rely on third-party ESG ratings in addition to their own ESG evaluations when making financial decisions. In this paper, I examine the effects of the firms’ MSCI ESG labels on their ownership by ESG-focused institutional investors and as a result, on their perceived cost of capital. To identify this effect, I use the unique institutional setting that MSCI ESG rating methodology provides. I employ a regression discontinuity design around the two cutoffs where the MSCI continuous ESG scores are converted into three distinct ESG labels. I find that everything else being equal, high-ESG firms with the best ESG labels attract higher ownership by ESG institutional investors and have lower perceived cost of capital compared to similar firms with average ESG labels. Surprisingly, low-ESG firms with the worst ESG labels also have higher ownership by ESG institutional investors and lower perceived cost of capital compared to similar firms with average ESG labels. I provide evidence that these opposite effects are driven by different investment strategies that institutional investors pursue based on the firms’ MSCI ESG labels.
