As I alluded to earlier, the category itself is frankly incoherent. It would make sense to rate companies purely on their carbon emissions (or, as we’ll discuss later, a company’s exposure to climate change–related risk). Instead, because of the intermingling of unrelated “responsibility” factors in the grade, the rating algorithms might aggregate an environmental score with one based on, for example, how many members of a company’s board are women, and then spit out an arbitrary grade.
A 2019 paper from MIT Sloan School of Management on ESG rating divergences studied the scores given out by six rating firms and found that, while they chose widely differing things to measure, there were a few “lowest common denominator” categories that each agency included in its ratings. Those are “Biodiversity, Employee Development, Energy, Green Products, Health and Safety, Labor Practices, Product Safety, Remuneration, Supply Chain, and Water.” The limits of this approach to “sustainable capitalism” are immediately clarified: A company might be poisoning the water, but it could still get a slight boost in its ESG score if it’s very good at training its employees to poison water more effectively.
This is not just a hypothetical scenario. A recent letter to the Financial Times by Garvin Jabusch, a working asset manager, highlighted the silliness of ESG rating…
