September 22, 2021

ESG Ratings: “Therefore Is The Name Of It Called Babel. . .”

While BlackRock & T. Rowe ramp up the heat, companies that dutifully churn out the kind of detailed ESG disclosure investors say they want may find themselves in for an unpleasant surprise from the ESG ratings industry, at least according to a new study discussed in this HBS newsletter:

Receiving more information can clarify the complex, but not when it comes to environmental, social, and governance (ESG) scores. A recent study shows that the more information a company discloses about its ESG practices, the more rating agencies disagree on how well that company is performing along these dimensions. According to the research, a 10 percent increase in corporate disclosure is associated with a 1.3 to 2 percent increase in ESG score variation among major ratings providers, which all interpret and process disclosures differently.

With more than $30 trillion in sustainable investment capital on the line, the stakes are high for companies and investors. Institutions, such as asset managers, pension funds, and endowments, often rely on ESG ratings to make investment decisions. Divergent scores hurt firms, investors, and markets, the research findings suggest, and these effects appear to be worsening over time.

“People are being sold on money being invested responsibly by using these ratings that nobody really understands,” says Harvard Business School Assistant Professor Anywhere “Siko” Sikochi, who co-authored the paper Why Is Corporate Virtue in the Eye of the Beholder? The Case of ESG Ratings with HBS professor George Serafeim and Dane Christensen of the University of Oregon. “That’s where the danger is in having all these different ratings not being aligned in some way.”

You know, there’s something about this problem that’s strangely familiar – where have I heard something like it before? Oh yeah, that’s right – in the Book of Genesis:

And the Lord said, Behold, the people is one, and they have all one language; and this they begin to do: and now nothing will be restrained from them, which they have imagined to do. Go to, let us go down, and there confound their language, that they may not understand one another’s speech. So the Lord scattered them abroad from thence upon the face of all the earth: and they left off to build the city. Therefore is the name of it called Babel; because the Lord did there confound the language of all the earth: and from thence did the Lord scatter them abroad upon the face of all the earth.

John Jenkins