In a recent article, we seek to shed light on several important aspects of measuring and providing data about companies’ performance on environmental, social, and governance (ESG) issues. The article is intended to provide a useful guide for the rapidly rising number of people entering fields involving such issues. We focus on the following:
- The sheer variety, and inconsistency, of the data and measurements and how companies report them. Listing more than 20 different ways companies report their employee health and safety data, we show how such inconsistencies lead to significantly different results when looking at the same group of companies.
- “Benchmarking,” or how data providers define companies’ peer groups, can be crucial in determining the performance ranking of a company. The lack of transparency among data providers about peer group components and observed ranges for ESG metrics creates market‐wide inconsistencies and undermines their reliability.
- The differences in how ESG researchers and analysts deal with vast data gaps that span ranges of companies and time periods can cause large disagreements among the providers, with different gap‐filling approaches leading to big discrepancies. We provide the example of estimating employee turnover for a leading airline and show how different models produce different data.
- The disagreements among ESG data providers are not only large but increase with the quantity of publicly available information. We interpret this finding as evidence of the need for a clearer understanding of what different ESG metrics might tell us and how they might best become standards for assessing corporate performance.
What can be done to address these problems with ESG data?
Companies should take control of the ESG data narrative by shaping disclosure instead of being overwhelmed by survey requests. To that end, companies should customize their metrics to some extent, while at the same time seeking to self‐regulate by reaching agreement with industry peers on a reasonable baseline of standardized ESG metrics that allow various companies’ performances to be compared. We understand that companies may want to convey the uniqueness of their business models by customizing their reporting practices. At the same time, we believe that most companies should be able to accept and work with a reasonable baseline for reporting standards. Organizations like the Sustainability Accounting Standards Board (SASB) have made significant progress in providing such a baseline. Taking control of the ESG data narrative can also help with one of the major frustrations of sustainability departments, “survey fatigue.” Many companies have identified the need to come together as industries and take control of the narrative that gets communicated to their investors. An example of such efforts has occurred in the U.S. electric utilities industry. The Edison Electric Institute, the association that represents all U.S. investor-owned electric companies, assembled a working group of companies and investors to develop industry-focused and investor-driven ESG reporting practices. The outcome of the working group was a simple reporting template that includes an excel-based tool for utilities to use when reporting qualitative as well as quantitative information. Taking a similar approach, a project run by KKS Advisors and sponsored by the Rockefeller Foundation is creating Industry ESG working groups that aim to bring together leading companies within an industry and their major long-term investors to agree on certain ESG issues and metrics. The goal is to promote collaboration among companies to solve common sustainability issues by developing industry standards, generating data, and creating industry knowledge. To achieve this goal requires effective communication with investors.
For investors, our message is to push for meaningful disclosure of metrics by narrowing the demand for ESG data. In the past, investors have made vague and, in many ways, unfocused requests for data. As a recent study found, the most important barrier for the use of ESG data in investment decisions is the lack of comparability of metrics across companies and across time. Investors should agree on a baseline of indicators and metrics that would be informative on a core set of ESG issues that are of prime importance, such as climate change, labor conditions, and diversity.
Stock exchanges should give serious consideration to issuing guidelines for and even mandating ESG disclosure. The exchanges can be the coordinating mechanism, working with companies, investors, and regulators to design smart disclosure guidelines. The Sustainable Stock Exchanges initiative is an effort taking us in that direction, exploring how exchanges together with investors, regulators, and companies can enhance corporate transparency.
Data providers need to agree on best practices and become as transparent as possible about their methodologies and the reliability of their data. In discussing the methods they use to assess a company’s performance, data providers should include not only a list of material issues and a description of their scoring methodology, but more detail on the peer groups used, and clearly distinguish between actual data and data that they infer from other factors. Data providers could also establish some best practices for assessing performance that could be followed by the whole industry—which could be especially helpful in the case of diversified businesses.
This post comes from Sakis Kotsantonis, managing partner of KKS Advisors, and George Serafeim, the Charles M. Williams Professor of Business Administration at Harvard Business School. It is based on their paper, “Four Things No One Will Tell You About ESG Data,” available here.