Inside the ESG ratings: (Dis)agreement and performance

Abstract

We analyze the ESG rating criteria used by prominent agencies and show that there is a lack of a commonality in the definition of ESG (i) characteristics, (ii) attributes and (iii) standards in defining E, S and G components. We provide evidence that heterogeneity in rating criteria can lead agencies to have opposite opinions on the same evaluated companies and that agreement across those providers is substantially low. Those alternative definitions of ESG also affect sustainable investments leading to the identification of different investment universes and consequently to the creation of different benchmarks. This implies that in the asset management industry it is extremely difficult to measure the ability of a fund manager if financial performances are strongly conditioned by the chosen ESG benchmark. Finally, we find that the disagreement in the scores provided by the rating agencies disperses the effect of preferences of ESG investors on asset prices, to the point that even when there is agreement, it has no impact on financial performances.

Quantitative ESG disclosure and divergence of ESG ratings

“…This study contributes to several streams of literature. First, it extends the literature on non-negligible divergence of ESG ratings among different rating agencies (Chatterji et al, 2016;Billio et al, 2021;Gibson Brandon et al, 2021;Jørgensen and Ellingsen, 2021). The findings of the author suggest that even quantitative ESG disclosure brings about multifarious interpretations of ESG performance and hence inconsistent ratings, which provide further empirical evidence for the presence and determinants of rating disagreement.…”

“…It has been debated critically in both academic literature and investment practices that the ESG ratings of a given firm can be extremely different across rating providers. Prior studies (Chatterji et al, 2016;Billio et al, 2021;Gibson Brandon et al, 2021;Jørgensen and Ellingsen, 2021) document a surprising lack of rating agreement between worldwide well-established information intermediaries, with an average correlation from 0.3 to 0.66. What is worse, Gibson Brandon et al ( 2021) and Avramov et al (2022) find that ESG rating disagreement seems to mislead even professional investors in their investment decisions and then discourages them from sustainable investment and active engagement in corporate ESG issues.…”

“…Regulators, including the United States SEC and the European Commission, have expressed a heightened concern on the quality and precision of ESG ratings. In general, the consistency of ESG ratings across different data providers reached an amazingly low correlation from 0.30 to 0.66 (Chatterji et al, 2016;Billio et al, 2021;Gibson Brandon et al, 2021;Jørgensen and Ellingsen, 2021). The lack of consistency calls into question the validity of ESG ratings, which could cause a whole set of adverse consequences as follows: first, the disagreement may potentially taint sustainable investment decisions, raising challenges for investors to integrate ESG dimensions into investment strategies and leading to inefficiencies in the capital market.…”

Corporate sustainability and analysts' earnings forecast accuracy: Evidence from environmental, social and governance ratings

“…ESG ratings contain information on how well firms address environmental, social and governance issues to achieve sustainable development rather than merely focusing on profit maximisation. More precisely, the first priority of ESG is the environmental dimension, such as climate change, air and water pollution and biodiversity loss, which assesses firms' involvement in carbon emissions, waste, water and resource management (Billio et al, 2021). The social dimension focuses on both internal stakeholders, such as employees, and external stakeholders, such as suppliers and customers, and includes various issues from workplace and product safety to human rights.…”

Higher expected returns for investors in the energy sector in Europe using an ESG strategy

“…ESG duties were not only seen to have little impact on financial success, but they were also seen as a potential burden on the latter, as they were linked to cost rises. (Billio et al, 2021).…”