Strategic Management Journal Strat. Mgmt. J. (2010) Published online EarlyView in Wiley InterScience (www.interscience.wiley.com) DOI: 10.1002/smj.840 Received 12 November 2008; Final revision received 19 December 2009 HOW FIRMS RESPOND TO BEING RATED AARON K. CHATTERJI 1 and MICHAEL W. TOFFEL 2 * 1 Fuqua School of Business, Duke University, Durham, North Carolina, U.S.A. 2 Harvard Business School, Boston, Massachusetts, U.S.A. While many rating systems seek to help buyers overcome information asymmetries when making purchasing decisions, we investigate how these ratings also influence the companies being rated. We hypothesize that ratings are particularly likely to spur responses from firms that receive poor ratings, and especially those that face lower-cost opportunities to improve or that anticipate greater benefits from doing do. We test our hypotheses in the context of corporate environmental ratings that guide investors to select ‘socially responsible,’ and avoid ‘socially irresponsible,’ companies. We examine how several hundred firms responded to corporate environmental ratings issued by a prominent independent social rating agency, and take advantage of an exogenous shock that occurred when the agency expanded the scope of its ratings. Our study is among the first to theorize about the impact of ratings on subsequent performance, and we introduce important contingencies that influence firm response. These theoretical advances inform stakeholder theory, institutional theory, and economic theory. Copyright  2010 John Wiley & Sons, Ltd. INTRODUCTION Information asymmetry has long been understood to complicate market transactions (Akerlof, 1970). Incomplete information prevents buyers from knowing when to believe suppliers’ claims about product attributes that are not directly observable prior to purchase. Independent agencies that rate and rank products and companies can help con- sumers overcome information asymmetries. Such agencies operate in a wide variety of contexts, rating consumer products (Consumer Reports), ser- vices (Michelin’s guidebooks), and corporate debt Keywords: information disclosure; environmental per- formance; corporate social responsibility; industry self- regulation; ratings ∗ Correspondence to: Michael W. Toffel, Harvard Business School, Soldiers Field, Boston, MA 02163, U.S.A. E-mail: mtoffel@hbs.edu (Moody’s). 1 These rating schemes are institutions designed to achieve a common objective: to pro- vide credible information to help company stake- holders such as potential buyers, employees, and investors overcome an information disadvantage. Better informed stakeholders can make better deci- sions about which products to purchase, in which stocks or bonds to invest, and with which compa- nies to seek employment. Prior scholarship has found evidence that inde- pendent company ratings can affect the behavior of consumers and investors. However, scholars have 1 Companies are subjected to an increasing number of ratings and rankings, from ‘Best Places to Work’ (Fortune, 2008; HRC, 2008) to assessments of environmental and social responsibility (Chatterji and Levine, 2006). In fact, a recent survey counted more than 183 public lists across 38 countries of companies rated or ranked on the basis of their reputation for corporate citizenship, employee relations, leadership, innovation, and other characteristics (Fombrun, 2007). Copyright  2010 John Wiley & Sons, Ltd.