Job market candidates

Although most research argues that firms benefit from receiving a high social evaluation rating, recent studies have found surprising benefits of being rated in the middle or even toward the lower end of an industry, suggesting other mechanisms are at play. We address this puzzle by examining when firms benefit from being rated high, low, and in the middle compared to their industry peers on environmental, social, and governance (ESG) ratings. Drawing on theory of firm classification, we argue that as new social evaluations are promoted, rating metric uncertainty encourages reliance on prototype- rather than goal-based assessments. Specifically, in the context of such uncertainty, investors tend to reward firms that are most prototypical – those that are rated in line with their industry’s average ESG rating. While firms whose ratings diverge from industry norms are penalised for falling out of line, salient industry legitimacy threats reverse the effect, such that falling out of line (high and low ratings) becomes beneficial. Moreover, we show that while ratings homogeneity within an industry amplifies these effects associated with falling out of line, lower ratings uncertainty encourages investors to shift from prototype- to goal-based evaluation and fine-grained scrutiny of firms. In such cases, investors only reward firms whose ESG ratings positively diverge from the industry average. Our findings contribute to the literature on social evaluation ratings and ongoing theoretical debates regarding prototype- versus goal-based classification of firms.