ESG rating divergence, investor heterogeneity and cost of equity capital

The rapid development of environmental, social, and governance (ESG) rating services has turned the spotlight on ESG rating divergence. This study empirically investigates the association between ESG rating divergence and cost of equity capital (COE) in the Chinese capital market. We find a positive association between ESG rating divergence and COE, which is driven by higher information asymmetry and hidden ESG risks. Additional cross-sectional tests show that this positive association exists only for firms with low levels of investor sophistication, investor sentiment, and investor attention. Finally, we find that for firms with higher ESG rating divergence, a higher COE is associated with lower firm value and a lower level of external financing.