We find that rating downgrades by ISS cause negative announcement returns of –1.14%. Thus, rating information is highly relevant for financial markets. We examine whether the information content reflects the underlying corporate governance quality of the firm. We find that announcement returns are lower for downgraded firms with higher potential agency costs. Since the cost of weaker governance is higher in such firms, this is consistent with the market revising downward its expectation of future firm performance due to the unexpected lower governance quality communicated by downgrades.

Given that proxy advice has been shown to also affect stock prices, we examine whether the rating announcements returns are driven by subsequent ISS proxy recommendations. We find that the negative returns are not caused by higher expectations of an ISS proxy recommendation against management. In particular, we show that the correlation between downgrades and subsequent proxy recommendations against management is small, and that the negative returns are not driven by downgrades that occur closer to the proxy season.

via Do Corporate Governance Ratings Change Investor Expectations? Evidence from Announcements by Institutional Shareholder Services