Confusion surrounding three letters

Sustainability ratings are increasingly affecting capital flows on financial markets and influencing corporate conduct. Less publicized, though, is the fact that ESG ratings from different providers diverge from each other substantially sometimes, making the fundament for investor or managerial decisions and the basis of many academic studies confusing and vague. The sustainability industry is still in its infancy with regard to its information base.


(ESG) ratings move billions…

The rating agencies Standard & Poor’s, Moody’s, and Fitch rank among the most influential institutions in the global financial market (alongside central banks). They rate the creditworthiness of governments and corporations and thus have a big influence on their financing costs. They also decide whether the credit standing of a bond issuer is sound enough for a coveted investment-grade seal or needs to be classified in the more speculative high-yield (or junk) bond segment. The important role that credit ratings play in the world of finance owes in large part to their standardization and comprehensibility, which is reflected in a very high correlation (99%) between the ratings from the different providers.

Providers of ESG ratings have also gained increasing influence in recent years. In the Principles for Responsible Investment community, 3,826 institutional investors (as of end-2021) with over USD 100 trillion in combined assets have pledged to integrate ESG information into their investment decisions. Sustainability investing continues to enjoy growing popularity, particularly in Europe, thanks in part to a regulatory tailwind and despite greenwashing scandals and a decline in performance in recent quarters. This means that more and more investors are thus relying directly or indirectly on outside opinions from specialized ESG rating providers like Sustainalytics and Refinitiv. Moreover, a growing number of academic studies use ESG ratings as a basis for their empirical analyses. ESG ratings are thus increasingly influencing decision-makers and could potentially have far-reaching effects on securities prices and corporate policies.


…but are very divergent

So far, so good – and no problem? Not necessarily! Because as analysts1 already illuminated several years ago, ESG ratings from different providers disagree with each other, substantially sometimes. A more recent study published last year by F. Berg, J.F. Kölbel, and R. Rigobon (MIT Sloan, University of Zurich)2 reconfirmed this discrepancy. It found that although correlations between ESG ratings from six prominent providers (KLD, Sustainalytics, Moody’s ESG, S&P Global, Refinitiv, and MSCI) are not completely inexistent, they are nonetheless low, with coefficients ranging from 0.38 to 0.71. The authors of the study probed deeper into these rating divergences and mapped the different rating methodologies onto a common taxonomy of categories. This way they were able to detect three main causes of the divergences between ESG ratings:

  • Weight divergence (6%): ESG ratings diverge from each other because rating providers weight the three main categories – environmental, social, and corporate governance – as well as their subcategories differently. For example, the working conditions at a company may have a higher or lower weight than the company’s exhaust gas emissions, depending on the rating agency.
  • Scope divergence (38%): ESG ratings differ from each other because they focus in part on different (ESG) attributes. Some rating agencies, for instance, include companies’ lobbying activities in their evaluation of the G (governance) aspect of ESG while others do not.
  • Measurement divergence (56%): ESG ratings diverge from each other because different rating providers measure the same attribute using different indicators or different information bases. This third factor is the largest cause of ESG rating discrepancies, accounting for 56% of overall rating divergence. According to the authors of the study, measurement divergence is driven in part by a “rater effect” (which is also known as the “halo effect”): when a company receives a high score in one ESG category, it often receives high scores in all of the other categories from that same ESG analyst (the rater). In contrast to conventional credit ratings, in which each individual analyst usually appraises only one partial aspect of overall creditworthiness, ESG ratings for a company are usually formulated entirely by a single analyst. The analyst’s subjective perception of the company thus has a substantial impact on the final rating.

Motley rating mosaic | Aggregate confusion raises a lot of doubts

Correlation between ESG ratings

SA – Sustainalytics, SP – S&P Global, MO – Moody’s ESG, RE – Refinitiv, KL – KLD, MS – MSCI

Sources: F. Berg et. al (2022), Kaiser Partner Privatbank


Aggregate confusion is problematic

The divergence between ESG ratings highlighted once more by this latest study has a number of (important) implications. First, it impedes the main purpose of sustainability ratings, which is to judge the ESG performance of companies or mutual funds and portfolios. Second, the rating divergences reduce the incentive for companies to strive to improve their E, S, and G performance because they send them vague signals about necessary remediation actions and about how favorably they would be received by the financial market. Consequently, it’s likely that many an effort or investment to improve ESG scores doesn’t get undertaken by companies in the first place. Third, given the rating confusion, it seems very questionable to make CEO compensation contingent on achieving specific ESG ratings. If managers align their companies’ operations to optimally meet the ESG criteria set by rating provider X, they may end up receiving much lower scores from rating providers Y and Z. This dilemma could cause companies to fall short of the actual ultimate goal of comprehensively improving their sustainability.

Divergent sustainability ratings also at a minimum challenge one of the basic premises put forth by ESG advocates, who postulate that corporate sustainability efforts are fundamentally relevant to enterprise value and influence investor preferences and stock prices. Rating divergences, however, at the least are likely to dilute this influence. And, finally, divergent ESG ratings also present a challenge for academia – the choice of a specific ESG rating provider can greatly affect the findings of a study and the resulting conclusions drawn from them. To come straight to the point, due to the divergences, any decisions based on today’s ESG ratings contain an extra element of uncertainty.


No simple solution

Unfortunately, there is no simple solution at hand for doing away with the aggregate rating confusion involved in sustainability investing. Although the various ESG rating agencies could agree to use the same ESG categories and attributes as well as identical weights, the biggest contributor to the confusion – measurement divergence – cannot be eliminated so easily. Comprehensive, universal, and binding regulatory guidance on collecting and measuring ESG-relevant data that arguably would be needed to end measurement divergence is not in sight anytime soon. It’s up to regulators to harmonize existing ESG disclosure requirements and to establish and promote a common taxonomy of ESG categories. Efforts undertaken to this end in Europe are the most advanced thus far, but even the EU taxonomy is still far from fully developed. The investment experts at Kaiser Partner Privatbank are well aware of the glaring ESG ratings jungle. ESG ratings accordingly form only one part of a much more comprehensive sustainability analysis in our sustainability strategies.


1) A.K. Chatterji, R. Durand, D.I. Levine, S. Touboul (2016): “Do ratings of firms converge? Implications for managers, investors and strategy researchers”

2) F. Berg, J.F. Kölbel, R. Rigobon (2023): “Aggregate Confusion: The Divergence of ESG Ratings”

Oliver Hackel, CFA Senior Investment Strategist

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