Higher corporate social responsibility ratings limit short selling. Among firms with high expected values of short interest, those with higher ESG scores and higher environmental scores have less shorting. We find evidence consistent with higher ESG scores creating additional costs and risks for short sellers through two channels: 1) some long-side investors are reluctant to sell high ESG stocks, even if valuations warrant it; and 2) short squeeze risk—high ESG stocks experience positive sentiment-driven price jumps when public attention to ESG spikes. The lack of shorting impacts asset prices. Stocks with high ESG scores are less responsive to negative earnings announcements. High ESG stocks that are avoided by short sellers have low future stock returns.

We propose a new measure of ESG-specific skill based on fund manager trades and ESG rating changes. We differentiate between proactive ESG managers, whose trades predict future changes in ESG ratings, reactive ESG managers, who change their portfolio allocation after a change in ESG ratings occurs, and non-ESG managers. The predictive ability of proactive managers is persistent in out-of-sample tests, consistent with manager skill. For identification, we rely on an exogenous methodology change of one ESG rating provider that redefined ESG ratings levels without releasing new information. Reactive managers significantly change their holdings in firms whose ESG ratings exogenously change, consistent with a lack of ESG skill. Proactive managers do not trade in the direction of the change, consistent with their trading no new ESG information. This ESG skill has economic implications: Investors in mutual funds with an explicit sustainability mandate reward proactive managers with 58bps higher average quarterly flows.