A new study from Murdoch University has found that an environmental, social and governance downgrade can inflict an especially severe blow on a company’s share price when it collides with investors’ previously optimistic expectations. The research suggests that markets do not respond to ESG news in isolation. Instead, the reaction depends heavily on the emotional and informational climate surrounding a company before its sustainability rating changes. When investors have developed a strongly positive view of a firm, an unexpected deterioration in its ESG score can appear not merely as a negative data point, but as a contradiction of the company’s broader reputation and future prospects. That mismatch may intensify selling pressure, producing a sharper market response than the same downgrade would generate for a company already viewed with suspicion.
ESG investing has expanded rapidly over the past decade, making sustainability assessments increasingly influential in financial decision-making. Environmental scores may reflect issues such as emissions, resource use and climate exposure; social measures can include labour practices, product safety and community relations; and governance assessments often examine board structures, executive accountability, shareholder rights and corporate transparency. Investors use these indicators to estimate risks that may not be immediately visible in traditional financial statements. A falling ESG rating can therefore be interpreted as a warning about regulatory penalties, reputational damage, operational disruption or future costs. Previous research has linked ESG deterioration with declining share prices, but the Murdoch study addresses an important question: why does the market punish some downgrades far more aggressively than others?
Led by Dr Phu Ngoc Tran, a Lecturer at the Murdoch Business School, the research team examined ESG rating changes among companies in the S&P 500 between 2010 and 2024. The dataset contained more than 6,700 ESG rating events, allowing the researchers to compare market reactions across a large group of major publicly traded companies and over a substantial period of changing investor attitudes. Rather than treating every rating adjustment as equivalent, the study connected each event with information about how investors had been discussing and evaluating the company beforehand. This approach enabled the researchers to investigate whether the market’s reaction to a downgrade was shaped by expectations that had already been formed through news coverage, public commentary and social media activity.
To measure those expectations, the researchers used company-specific news and social media data to construct a multidimensional picture of investor sentiment. Instead of reducing sentiment to a single positive-or-negative score, they separated it into five categories: positive sentiment, negative sentiment, risk-related sentiment, volatility-related sentiment and management-related sentiment. This distinction is technically important because different forms of sentiment may influence trading in different ways. Positive sentiment can represent confidence in a company’s growth, strategy or reputation, while risk sentiment may reflect concern about uncertainty or potential losses. Management sentiment can focus on executive decisions and leadership quality, whereas volatility sentiment may signal expectations of unstable price movements. By examining these dimensions separately, the researchers could test which type of investor outlook most strongly altered the consequences of an ESG downgrade.
The central finding was that positive investor sentiment had the strongest influence on the market’s response. ESG downgrades were associated with substantially larger share-price losses when they followed a period in which investors had expressed unusually optimistic views about the company. In this setting, the downgrade represented a negative surprise. Investors who had expected a firm to maintain strong performance, responsible conduct or sustainability leadership suddenly had to revise their assumptions. That process, known in financial economics as expectation revision, can lead to rapid repricing as market participants reassess the company’s future cash flows, risk exposure and reputation. The study indicates that optimism can therefore create a form of vulnerability: the more confidence investors place in a company’s overall story, the more damaging a contradictory ESG signal may become.
The result was more pronounced than the influence of fear, risk concerns, volatility or negative views about management, according to co-author Dr Ariful Hoque of the Murdoch Business School. This does not mean that investors ignore those other forms of sentiment. Rather, the findings suggest that a downgrade has a distinctive psychological and financial effect when it breaks through an established positive narrative. A firm that is already viewed negatively may have less reputational value left to lose, and a new ESG concern may confirm what investors already suspect. By contrast, a company surrounded by positive expectations may experience a sharper shock because the downgrade forces investors to question the reliability of earlier signals. The market reaction may consequently reflect not only the rating change itself, but also the collapse of confidence that had accumulated beforehand.
The researchers also found that the effect was strongest among larger companies and firms with strong ESG track records. Large corporations generally attract more analyst coverage, media attention, institutional investment and social media discussion, creating conditions in which new information can spread quickly and influence many traders at once. Their size can also increase the financial consequences of ESG controversies because these companies operate across more markets, employ larger workforces and face greater scrutiny from regulators, consumers and investors. A strong ESG reputation raises expectations further. Companies that have consistently presented themselves as sustainability leaders may be judged against a higher standard, so even a single downgrade can appear especially inconsistent with their public identity. In financial markets, reputational capital can function as an asset, but the study suggests that it can also increase the potential cost of disappointment.
For corporate leaders, the findings offer a warning against treating ESG performance as a communications exercise separate from financial risk management. A strong sustainability reputation may support investor confidence, but it also creates an expectation that the company will continue to meet demanding environmental, social and governance standards. If performance weakens, delayed disclosure, unclear explanations or a perceived gap between public commitments and actual practices could magnify the reaction. Companies may therefore need to monitor ESG indicators continuously, improve the quality of sustainability reporting and communicate promptly when material problems emerge. Protecting investor trust requires more than publishing ambitious targets; it depends on demonstrating that those targets are supported by measurable progress, credible oversight and consistent operational decisions.
The results also have implications for investors, who may benefit from considering ESG rating changes alongside the sentiment conditions surrounding a company. A downgrade should not automatically be interpreted as having the same significance in every case. Its impact may depend on the firm’s previous reputation, the strength of investor optimism, the amount of attention focused on the company and the extent to which the new information contradicts market expectations. The study does not suggest that positive sentiment is inherently irrational or that ESG ratings alone determine future returns. Instead, it shows that market reactions are conditional and can be amplified when new information conflicts with an established narrative. The paper, titled “Which investor sentiment drives the ESG–return link? A multi-dimensional sentiment perspective on ESG changes,” was co-authored by Dr Thi Le and published in the International Review of Economics & Finance. Its broader message is that sustainability information becomes most financially powerful when it changes what investors thought they already knew.
Subject of Research: People; investors and publicly traded companies
Article Title: Which investor sentiment drives the ESG–return link? A multi-dimensional sentiment perspective on ESG changes
Web References: https://www.sciencedirect.com/science/article/pii/S105905602600643X?via%3Dihub
References: Tran, Phu Ngoc, Ariful Hoque, and Thi Le, “Which investor sentiment drives the ESG–return link? A multi-dimensional sentiment perspective on ESG changes,” International Review of Economics & Finance, DOI: 10.1016/j.iref.2026.105530
Keywords: ESG investing, environmental social and governance ratings, investor sentiment, stock markets, share prices, corporate reputation, financial economics, sustainability, S&P 500, market risk
