This paper provides the first rigorous assessment of the financial sectors’ resilience to biodiversity transition risk. We provide “bottom-up” stress tests using comprehensive

euro-area credit registry data and a market-based “top-down” stress test based on

banks’ stock return sensitivities to biodiversity risk. Industries exposed to biodiver-

sity transition risk account for approximately 15% of total bank credit to non-financial

firms, compared to about 25% for climate-exposed industries. Stress test scenarios

indicate that even under severe conditions, additional losses in biodiversity-exposed

industries would constitute only 0.3 to 0.5% of the financial system’s corporate loan

portfolio. A top-down market-based approach yields similar results with capital short-

falls following a biodiversity shock peaking at 0.5% of banks’ market capitalization.

These results suggest that biodiversity transition risks currently pose only a moderate

threat to financial stability

We study how holdings by investors who consider environmental, social, and governance (ESG) issues when formulating investment decisions affect market efficiency. We find that a higher level of socially responsible institutional ownership (SRIO) results in a lower level of stock price informativeness, measured by the future earnings response coefficient. Using an exogenous shock to SRIO, we show that this relationship is causal. Due to their ESG preferences, socially responsible institutions (SRIs) place less weight on earnings information and thus hinder the incorporation of future earnings information into stock prices. In contrast, they place more weight on ESG information. Correspondingly, the market reaction to earnings news weakens as SRI holdings increase, and vice versa for ESG news. We rule out various alternative explanations such as 1) SRIs are less skilled than their counterpart institutions in processing financial information, 2) firms provide less financial information in response to increased SRIO, or 3) firms’ general information environment is changed due to change in ownership composition. Overall, our findings suggest that ESG information increases investors’ information processing costs and hampers stock market efficiency in incorporating future earnings information.

Environmental, social, and governance (ESG) rating ambiguity, defined as the divergence of ESG ratings across different agencies, is often considered a problem for ESG investors, because extant research assumes that investors use ratings for evaluation purposes and rating ambiguity makes stocks hard to evaluate. We extend this literature by theorizing how ESG investors can take advantage of ESG rating ambiguity to rationalize controversial investment decisions so that these decisions can appear simultaneously congruent with incompatible institutional demands from the financial logic and the social logic inherent in ESG investing. We analyze a panel dataset comprising 7,248 firms across 67 countries between 2006 and 2021, focusing on green stocks and sin stocks that exemplify incompatible institutional demands. We find that ESG rating ambiguity increases ESG ownership in sin stocks and decreases ESG ownership in green stocks. Our findings remain, using a difference-in-differences analysis based on a regulatory shock, addressing the alternative explanation (i.e., investors use financial returns as a non-ambiguous criterion) and using different measures and rating coverage.