People have become progressively more interested in Environmental, Social and Governance (ESG) scores over the past several years. An ESG score calculation can help investors and other concerned stakeholders evaluate how companies are doing in areas like sustainability and social responsibility. Investors could then use that information to decide which companies are worth paying attention to, while non-investors could rely on those details to narrow down which businesses most align with their ideals.
However, calculating an ESG score is not as straightforward as it may seem. Here are some key things to know about the process.
ESG Scores Measure Two Main Things
The first thing to know is that the specialists who calculate ESG scores have variations in their specific processes. Even so, they’re looking for two main things:
- How well the company performs in ESG
- The amount of exposure it has to ESG risks
Decision-makers often use ESG scores to see where a company is performing well versus where and how it has work to do. Moreover, because a total ESG score encompasses numerous aspects, it could reveal surprising things about how a company does business. Maybe it’s a leader in sustainable construction practices but falls short in fair labor practices.
Can an ESG Score Calculation Happen Through Self Assessment?
People at some companies perform audits to assess how well the business functions in certain areas. The results of those examinations are often valuable. However, if company leaders want a true ESG score or rating, they’ll need to rely on one of the third-party providers that specialize in offering them.
The scoring methodology differs slightly across such ESG raters, too. Here’s a closer look at the process used at MSCI. That organization scores approximately 8,500 companies. Thus, it’s one of the most-referenced options.
MSCI groups companies into laggards, average performers or leaders, and there are several possible ratings within each group. The scores, listed from worst to best, are:
So, a company performing outstandingly well would likely receive an AAA rating and get ranked as a Leader. However, the businesses with the most shortcomings would probably get a CCC rating, categorizing it as a Laggard.
Many ESG rating firms do not disclose ESG score calculation specifics. Representatives from those organizations consider it proprietary information. However, in some cases, they offer particular details, such as to show how they use thorough processes.
S&P Global is one company that offers ESG-scoring services. The company performs its Corporate Sustainability Assessment to help clients see where they stand on ESG matters. It includes 730 question-level scores that influence how a company does on the 125 criteria scores related to the environment, social and governance spheres.
More specifically, S&P Global’s strategy for calculating environment scores includes aspects like a company’s biodiversity commitments and how it disposes of hazardous and non-hazardous waste. Then, the social-related scores relate to things like safety policies and human rights pledges. Finally, the governance arm delves into what the company does to combat crime, corruption and bribery, how executives get paid and whether the company adequately manages its supply chain.
Other ESG raters use numerical scales. Then, a rating of one could mean there’s insufficient data or that a company is a particularly weak performer. On the other hand, achieving a rating of five would indicate a business follows best practices in a particular area. In such cases, a company might have separate ratings reflecting its ESG score and overall risk exposure.
ESG Scores Can Reflect Thoughtful Actions
Most decision-makers know the importance of understanding how the things they do now could impact what happens years from now. Many such choices occur when constructing new buildings or remodeling old ones. For example, a building will not meet fire codes unless it has exterior curtain wall assemblies offering a 1-2 hour rating. It reflects how long people have to evacuate a building before flames come through the assembly.
Decision-makers have lots of opportunities to raise their ESG scores by ensuring all construction-related actions keep the environment in mind. That might mean using recycled materials in construction and reducing waste whenever possible. It could also involve looking at ways to make the building use fewer resources in its daily operations.
A company could also raise its social and governance scores by being transparent about things like labor practices and where its money comes from and goes within an organization. A useful thing to remember is that an ESG score calculation does not only encompass the decisions made at a business. It also involves how that organization does compared to its peers.
Maybe a business leader wants to be a green-building trendsetter in their respective industry. In that case, they might specifically find partners that will work with them to achieve that aim.
Where Does ESG Score Calculation Data Come From?
A company that provides ESG ratings does not merely examine a company’s internal practices to reach a scoring decision. Instead, the information that goes into creating an ESG score gets pulled from various public, quasi-public and private sources. Those might include:
- Public: The company’s sustainability reports, press releases and information from media coverage
- Quasi-Public: Data from government and regulatory agencies and relevant nonprofits
- Private: Information taken from questionnaires given to clients to complete during ESG-rating processes
However, since how the ESG raters handle that information differs, some people criticize the validity of ESG ratings. That’s understandable since one company could get a different rating depending on which firm assigns it. Thus, people have begun advocating for standardization in ESG score calculation methods.
If all companies used the same framework, interested members of the public would know how to interpret particular ratings. However, more than 600 companies currently offer ESG scores. That means standardization may not happen anytime soon.
Getting an ESG Score
The first step to receiving an ESG score is researching which companies offer that service and how much they charge. From there, people can engage directly with those providers to find out what their process is, how long it takes and other specifics.
It’s easy to find media coverage of companies having their ESG scores upgraded or downgraded based on certain events. However, business leaders should remember that an ESG rating is only one factor that people increasingly rely on when assessing companies. There’s no problem with paying attention to and trying to improve an ESG score. However, leaders should try not to become too fixated on it while letting other aspects of operating the business slip.