ESG ratings: an industry in need of a major overhaul

Abstract

The impetus for adopting ESG-sensitive investment policies has increased steadily since 2006, when the United Nations outlined its Principles of Responsible Investment (PRI). Recently, a new industry aimed at helping investors to make sound ESG-driven decisions has flourished: ESG rating agencies. We investigated the ratings provided by four leading rating agencies (ISS, MSCI, S&P, and Sustainalytics) to the companies in the S&P500 index. Using measurement theory techniques, we concluded that ESG ratings currently exhibit an abysmally low level of reliability (18.3%) and agreement (5.4%). This situation differs sharply not only with the levels of reliability and agreement found in credit ratings but also with the reliability and agreement found in areas where subjectivity plays an important role, for example, wine ratings. These findings challenge the claim that ESG ratings can be helpful to make investment decisions, as they suggest that the ESG ratings industry as a whole is in much disarray.