Sense and Nonsense in ESG Ratings

Concerns about the future of the natural environment, prevailing social conditions, and governance of private and public institutions inspire today’s ESG movement. This paper proposes a heuristic that can be useful in examining the ESG-scoring issue. We begin with a social control diagnostic covering business activities – one that addresses the interests and actions of various stakeholders in the system. We examine its dynamics in the context of economic, social, and political pressures, including various initiatives to set standards against which business conduct may be calibrated. We evaluate efforts to create metrics that reflect normative improvements in ESG outcomes and performance scoring against them. We assess the industrial organization of the ESG ratings industry and review key empirical studies of ESG-driven investing. We conclude with policy recommendations intended to alleviate existing shortcomings in ESG ratings and improve their role in capital allocation and corporate governance.