In an evolving world, where consumers and investors are increasingly concerned about climate change and corporate responsibility, an ESG score is one way for investors to assess companies’ efforts, thus this represents an investment potential through the eyes of professional rating agencies.
But what is an ESG score? An ESG score shows a company’s attentiveness to environmental, social, and governance issues, mostly from a risk perspective, and from the point of view and using the decision weights of the rating agencies. These are the same rating agencies that provide credit scores, thus investors are used to the ranking system and leverage these scores when buying stocks for their portfolios.
Who provides the ratings and how?
There are a few ESG rating agencies: MSCI, Sustainalytics, S&P, Fitch and ISS among others.
Researching publicly reported data, ESG rating providers use a scoring system on a scale of 0-100 or 0-40+ or A-F, employing their own methodology or weights to each ESG topic. These organizations either reach out to corporations during the scoring process to resolve any questions about specific data points or read their sustainability reports to extract their ESG information.
As mostly, agencies score public corporations based on the information contained in company reports, disclosing more detailed ESG metrics in the report could potentially increase the ESG score.
Why do ESG scores matter?
ESG scores offer consumers and investors data illustrating a company’s commitment to ESG topics and the risk from environmental, social, and governance practices. The increasing relevance of sustainability issues means it has an influence on how favorably stakeholders or future customers judge a company.
ESG scores have the dual benefit of playing a role in investment decisions and causing companies to look at ways to improve their sustainability practices. When investors consider a company’s financial performance together with their ESG score, they get a long-term outlook through the eyes of the new generation of consumers and employees.
But ESG scores aren’t perfect, as they mostly look at ESG issues from a risk perspective with apparently applying less weights for the impact effect. That can mean overlooking positive impacts like reducing greenhouse gasses, using renewable energy, implementing supply chain labor standards, supporting diversity and society.
Ramifications of a good score
A good ESG score for companies makes them more appealing to investors compared to those who score poorly.
Investors, financial institutions, and asset managers increasingly consider ESG factors in making their decisions because sustainable companies represent intelligent long-term investments and are sought by investors.
Companies with strong ESG scores may also appear on ESG indexes, creating the potential for higher trading volume, improved exposure, and a higher share price. Good ESG scores correspond with investment values because good scores lessen anticipated risk. Institutional investors, in particular, look to corporations that show lower levels of risk and could frequently find ESG ratings significant to their decision-making.
Companies are now increasingly aware of the potential benefits of a high ESG rating as well as the correlation between ESG performance and investment value. So much so that from 2011 to 2018, the number of S&P 500 companies that shared their ESG statistics increased from 20% to 86%.
Ramifications of a bad score
Receiving a bad ESG score has the opposite effect on all the benefits listed above.
Since having a comprehensive corporate ESG strategy is an expectation today, companies with poor ESG scores may cause wariness in investors who seek to minimize risk and look for more sustainable, long-term performance.
Notably, more than 60% of investors aged 70 and under hold that every investment fund should consider ESG metrics.
A recent example of the drawback of a lower ESG score was Tesla’s removal from the S&P 500 ESG index. That resulted in a debate about the transparency and accuracy of the rating methodologies.
How can a company increase its ESG score?
Here are a few considerations for companies looking to obtain a good ESG score or improve their current one.
1. ESG reporting
When companies make ESG reporting a central part of their strategy, they can optimize ESG performance by analyzing data points, forming dedicated teams, and implementing socially responsible hiring practices. Publishing a well-thought, data-driven ESG report makes it easier for rating agencies to analyze the ESG practices and can potentially increase the score.
2. Track and analyze
Tracking ESG metrics and finding ways to improve current values is essential to that strategy. By setting targets and KPIs and achieving them, corporations can measurably increase their ESG scores and enjoy the associated benefits.
3. Connect with a rating agency
For additional guidance on picking ESG topics to measure, it’s essential for corporations to understand their ESG scores. By connecting with ESG rating agencies, companies can better discern the details of their performance in each category and locate specific deficiencies.
4. Hire and empower the ESG team
Hiring a dedicated ESG team ensures a company optimizes its ESG posture in several ways. A focused ESG team enhances transparency and can improve the quality of data and metrics collection. Such a group could lead the ESG reporting and potentially increase the ESG score.
5. ESG best practices
By implementing ESG best practices, companies demonstrate to investors their commitment to sustainability goals.
A good ESG rating is essential for a company to appeal to investors, but it may seem like a daunting task to obtain one. ESGgo makes it easy to collect, monitor, optimize, and analyze your company’s ESG status. A powerful, deep technology tool for internal ESG monitoring, gap analysis, and AI-based optimization.
*Disclaimer: This summary is for general education purposes only and may be subject to change. ESGgo, Inc., and its affiliates (the “Company”, “ESGgo”, “we”, or “us”) cannot guarantee the accuracy of the statements made or conclusions reached in this summary and we expressly disclaim all representations and warranties (whether express or implied by statute or otherwise) whatsoever.