What do companies do once they’ve been evaluated on their environmental, social and governance (known as ESG) performance?
It’s a good question when you think about Rio Tinto following its out-of-the-league act of global vandalism in destroying a 46,000 year old sacred site of major significance in human history just to get to the ore with which to make steel girders and the like.
Its ESG ratings had up to then hovered around average. S&P’s ESG Risk Atlas (published May 13, 2019) saw no problem with Rio Tinto. “Rio Tinto is a large employer and its social practices in relation to local communities are at least in line with industry standards”. Similarly was its governance. CSRHub gave it a 68 er cent rating compared with more than 20,000 thousand other companies.
Its own sustainability report (“Driving Human Progress [sic]: 2019 Sustainability Highlights“) judged that it “engaged communities in ways that are inclusive, respecting dignity, rights, culture and way of life”.
So is there any value in such “sustainability ratings”? Or should we take them with a pinch of (Himalayan, sustainably mined) rock salt?
They’re certainly on the rise. More and more companies are getting independent agencies to report on how well they are meeting their environmental and social responsibilities. Or being rated whether they like it or not.
Agencies such as the Dow Jones Sustainability Index, the FTSE4Good Index, and the MSCI ESG Indices score firms on a range of specific issues to do with everything from pollutant emissions, human rights, child labour to responsible management (responsible to whom?).
Many agencies also publish lists of companies and how well they meet certain ESG thresholds.
Most of the public, and shareholders, think this is a Good Thing because they believe it has a positive influence on companies’ sustainability performance. But this is only true if companies follow through on the rating agencies’ recommendations.
Up to now, little has been known about how many do and to what extent. Recent research, however, shows that firms can react very differently to being rated.
It turns out, according to Ester Clementino and Richard Perkins in an article in the Journal of Business Ethics that, unsurprisingly, it hinges upon managers’ beliefs regarding the benefits they will get from conforming to ESG requirements and whether or not doing so would be in line with their corporate strategy.
Rating agencies use publicly available information, third-party research, firms’ sustainability/integrated reports and information on corporate websites to score companies. Some also send questionnaires and some let companies review and send feedback on their profiles before releasing them.
Investors use these profiles to assess their exposure to ESG-related risk. But they’ve been criticised for unreliability, inconsistency, the quality of data, and the limitations of using a common framework for the measurement of social and environmental responsibility.
But what if companies don’t care or don’t want to engage with the reports? What if they even resent being judged? What if they become hostile or dismissive, or try to influence the ratings process?
All of these responses are possible and have happened.
It turns out that only those companies that were already actively conforming to rating agencies criteria, define and action new policies in response to being rated, the researchers of this paper concluded. Admittedly their survey is confined mostly to utilities in Italy, but they estimate that the results are fairly typical of global companies.
They found that although many companies do react to being rated, this does not mean that they alter their behaviour in any meaningful way. The most common response is to make more information available on those attributes on which they had been evaluated in a format that’s better suited to the way that the agencies assessed them.
This, the researchers say, could mean that they are trying to game the system – that is, to make themselves look better than they actually are. A form of greenwashing if you like.
Fewer companies actually changed their policies, practices or performances.
Many passively conform. This can mean that they grudgingly acquiesce on just some of the requirements, or that they find a compromise between what they actually want to do – their corporate objectives – and what they feel they would like to be seen to be doing.
Their overall conclusion is that the reactions to being rated largely depend upon “managers’ perceptions of the business value of internalising and adjusting to ESG ratings”, which is to say, “the reputational, financial and strategic value”.
If your ESG rating is not exactly aligned with your business objectives, what are you going to do? is the question the authors are implicitly asking.
Well, we know what Rio Tinto did: said one thing and did something completely different – spectacularly.
So next time you read an ESG report, and a company’s reaction to it, just remember Juukan Gorge – the proof is in what companies do not what they say.
David Thorpe is author of the books Solar Technology and the new One Planet Cities. He also runs on line courses such as Post-Graduate Certificate in One Planet Governance. He is based in the UK.