As environmental, social and governance (ESG) issues ascend on the priority lists of boards and stakeholders, third-party rating and reporting organizations have developed ways of measuring companies' efforts. Is a company failing to meet compliance obligations for environmental impact? Are diversity, equity or other governance issues putting the company at legal or reputational risk? The ESG reports and ratings developed answer these questions ' often including a numeric or other "ESG score' ' to provide clarity on ESG actions and for investment decisions.
For stakeholders and investors, ESG reports and ratings take some of the complexity out of evaluating a company's ESG activities. As standard ESG benchmarks continue to evolve, independent ESG scores provided by third parties serve as important reference points for comparison.
Just as corporate boards should stay abreast of evolving ESG standards and frameworks, they should also be aware of what goes into an ESG score and why they're important to investors and stakeholders. These scores can be a significant factor in attracting capital and maintaining transparent stakeholder communications on ESG. Here's a brief overview of what boards need to know.
What is an ESG Score?
A credit score communicates a consumer's ability to pay back debt. A bond rating provides context for an issuer's ability to meet financial commitments and avoid default. Similarly, an ESG risk score gauges a company's performance on ESG issues and exposure to ESG-related risks. They are calculated against a set of ESG metrics and may be expressed on a number scale or through a letter ranking system.
ESG reports and ratings are important comparison tools for value-minded investors, asset managers, financial managers, and other stakeholders measuring a company's ESG performance over time and against their market and industry peers.
The scores themselves and surrounding context fill in the picture of a company's performance on environmental, social and governance issues. According to the Harvard Law School Forum on Corporate Governance, such reports 'often form the basis of informal and shareholder proposal-related investor engagement with companies on ESG matters.'
Who are the ESG Rating Agencies?Several third-party providers ' including agencies and research and analysis firms ' evaluate companies on ESG performance and determine independent ESG scores for investment decisions and comparison against peers. Examples include:
- Bloomberg ESG Data Services, which offers ESG data for more than 11,700 companies in 102 countries
- Corporate Knights Global 100, an annual global ranking of corporate sustainability performance by Toronto-based magazine Corporate Knights
- Sustainalytics ESG Risk Ratings, designed to help investors identify financially material ESG risks for more than 12,000 companies
- Dow Jones Sustainability Index Family, headlined by DJSI World, which represents the top 10% most sustainable companies among the largest 2,500 in the S&P Global BMI
- Thomson Reuters ESG Scores, which measures ESG performance across 10 themes for more than 6,000 companies globally
- RepRisk, which uses artificial intelligence and machine learning to compile coverage of ESG risk assessment for more than 160,000 public and private companies
What is a Good ESG Risk Score?Methodology, scope, and coverage vary significantly among each agency. Bloomberg and Corporate Knights rate companies on a 100-point scale, for example. Thomson Reuters assigns a score between 0 (worst) and 1 (best) with a corresponding letter grade. RepRisk measures companies on the RepRisk Index (0 to 100) and provides a RepRisk rating (AAA to D).
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ESG Scoring and Ratings ExplainedProviders differ in almost every approach to ESG scoring, from the formulas they use for determining ESG ratings to how they weight individual factors to how they publish their results.
Collecting ESG Data
Some agencies do not rely on companies to provide data for their scores. Corporate Knights, for example, only utilizes publicly available data. RepRisk goes so far as to intentionally exclude company self-disclosures, analyzing information from public sources and stakeholders.
Other agencies involve companies from the outset. Companies that Dow Jones invites for possible inclusion in its Dow Jones Sustainability Index (DSJI) World listing must fill out a questionnaire. Bloomberg sources data through CSR reports, public sources, and direct company contact ' penalizing companies that are missing data with a lower rating.
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ESG Scores Criteria
Most ESG reports and ratings consider all three ESG categories: environment, social and governance.
Environmental scoring factors range from a company's greenhouse gas emissions to its treatment of animals. Common evaluation criteria include metrics on:
- Climate change
- Soil and water contamination
- Renewable energy
- Environmental policy
- Are workers in factories abroad treated ethically?
- Do employees earn a living wage?
- Are facilities regularly inspected and safe to work?
- Can employees take leave when they are sick or for other personal reasons?
Social scores may also reflect charitable contributions, customer interactions, community impact and policy influence.
Finally, governance scoring criteria evaluates legal and compliance issues and board operations:
- Does the company abide by all local, state and federal laws?
- Does board composition represent diverse backgrounds and perspectives?
- How does executive and non-executive compensation compare to the company's peers?
Many ESG scores take industry context into account. Corporate Knights, for instance, only scores companies based on performance indicators that are relevant to their industry.
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Who Can See a Company's ESG Risk Score?
Some ESG ratings and reports are publicly available. The DJSI, for example, releases world and regional indices on top-performing companies annually.
Other ratings and reports, such as those by Bloomberg and RepRisk, are created for investors about companies they want to invest in.
Some organizations allow companies to verify data before sending ESG scores to investors, and ' in the case of RepRisk and Dow Jones ' provide companies feedback on how they can improve their scores and ESG performance.
Why ESG Scores and Ratings Matter
A company's performance on ESG issues ' which span everything from cybersecurity to climate change to diversity, equity, and inclusion ' is becoming an increasingly important factor for stakeholders and in investment decisions.
Organizations with a good ESG score are thought to be better equipped to anticipate future risks and opportunities, more inclined to longer-term strategic thinking and to prioritize long-term value creation over short-term gains. As such, the consequences of a substandard score can be momentous.
Research increasingly shows that companies that adhere to ESG principles are lower-risk investments and more resilient over time. For that reason, forward-thinking boards stay knowledgeable about their company's ESG issues and activities, the various third-party organizations evaluating their efforts, and their ESG scores. Ready for your board to start operationalizing its ESG efforts? Download an ESG roadmap from Diligent today.
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