Cost of ESG evaluation
Individuals, governments and societies want corporations to behave in more ethical and sustainable ways. The rise in popularity of sustainable investing products shows that many investors feel the same way. Assessing how corporations stack up in terms of their environmental, social and governance impact is difficult, subjective, expensive and time consuming. Some data that would be useful to evaluate corporations are not publicly available. Assessing how well a company treats its employees involves subjectively measuring how employees feel in addition to looking at hard data like employee pay. Speaking with management, employees and suppliers is useful but access is difficult.
Consequently, there are a number of ESG ratings agencies, which include KLD (MSCI Stats), Sustainalytics (Morningstar), Vigeo Eiris (Moody’s), RobecoSAM (S&P Global), Asset 4 (Refinitiv), MSCI, Bloomberg, Dow Jones and Fitch. It’s important to keep in mind that ratings agencies measure the financial impact of a company’s ESG behavior. As a member of society, you might care more about a company’s impact on the actual underlying environmental, social and governance factors than the financial consequences of that impact.
There isn’t a standard set of data sources ESG ratings agencies use to evaluate companies. Every agency uses their own unique set of data. Data sources include company reported data, third party data and company characteristics data. Company reported data include financial statements, footnotes, ESG and governance specific disclosures, company websites and product recall information. Third party data comes from governments and regulators, academia, non-governmental organizations, media, external websites, product reviews, macro and event risk analyses and other sources. Company characteristic data includes product specifics and location. Products, like oil and gas, have higher ESG risks than others. From an ESG perspective, doing business in the European Union is riskier than doing business in many developing countries because of laws and regulations.
Each ratings agency uses its own proprietary ratings methodology. There are many underlying ESG indicators and sources for this data. Each agency will select their own combination of data to evaluate and score companies. Even with the same data, agencies might have different assessments. Some agencies compare companies across all industries, while others only compare companies within industries. Agencies use different methods to improve the reliability of the data, such as human analyses, artificial intelligence, company and peer reviews, and industry and regional bias removal. Agencies may or may not incorporate forward looking views along with current data. Have a least a basic understanding of the methodology and its strengths and weaknesses for any rating you use.
Not every company has an ESG score. Sufficient data is not available for some companies. Large companies have the human and financial resources to provide necessary data. Regardless of size, companies in the European Union are more likely to provide ESG data. Demand for ESG scores is lower for smaller, less recognized companies, so agencies won’t spend the time and resources to evaluate them. In general, ESG ratings are available for large companies by market capitalization and for companies within regions that promote more ESG transparency.