We model how a profit-maximizing agency decides whether to sell ESG ratings to issuers or investors. For firms in sufficiently green sectors or when the proportion of socially responsible investors is large enough, ESG ratings increase expected stock prices and the “issuer pays” business model is more profitable than “investors pay”. When all investors are socially responsible, the model coincides with a model of credit ratings, explaining why credit ratings are sold to issuers while most ESG ratings are sold to investors.Ratings boost equilibrium investment in ESG but their impact on welfare is ambiguous, even for socially responsible investors.

We survey 509 equity portfolio managers from both traditional and sustainable funds on whether, why, and how they incorporate firms’ environmental and social (“ES”) performance into investment decisions. ES performance influences stock selection, engagement, and voting for over three quarters of investors, including nearly two thirds of traditional investors. The primary motivation is financial, even among funds marketed as sustainable. Few are willing to sacrifice financial returns for ES performance, largely due to fiduciary duty concerns. A second driver is constraints, such as fund mandates, firmwide policies, and client wishes, which led 72% to make stock selection, voting, or engagement decisions they otherwise would not have. Achieving ES impact is seen as much less important, even among sustainable funds.

We study manufacturing firms' production responses to an emission capping regulation. Firms lower emissions by improving energy efficiency, substituting towards cleaner fuels, and moving from producing electricity to purchasing it from the grid. They move away from coal-intensive products and increase their abatement expenditures. These changes improve firm productivity, supporting theories that regulation prompts technology adoption. In the aggregate, we document lower product variety and an altered firm-size distribution, driven by a reduced likelihood of business formation. Our findings highlight the mechanisms behind how mandated pollution reduction can be effective and the costs it imposes, suggesting a loss of agglomeration externalities.