The origins of ESG demand: Evidence from retail and institutional investor responses to environmental rankings

Abstract This paper examines the origin of the demand for corporate environmental responsibility in capital markets by comparing the responses of retail and institutional investors to environmental information releases. Employing public green rankings for S&P 500 firms, we show that retail investors respond positively to increases in public rankings by paying a green premium and increasing their holdings during the period when environmental, social and governance (ESG) investment was becoming increasingly popular. Conversely, increases in private green scores do not result in significant market reactions, indicating that institutional investors did not emphasize environmental protection in their investment decisions. A quasi‐natural experiment and robustness tests with institutional holdings provide additional support for this finding. This effect has disappeared in recent years, as demand from retail investors has been met by institutional options. Overall, this study provides evidence that retail investors are the primary drivers of early demand for environmental responsibility, providing important policy implications to incentivize institutional investors.