How do ESG labels, that are assigned to firms by ESG rating agencies, affect their ownership by ESG-focused institutional investors and their perceived cost of capital? I identify this effect using 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. Everything else being equal, high-ESG firms with the best ESG labels have higher ownership by ESG institutional investors and 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.
