In light of the heightened focus on environmental, social, and governance (ESG) performance in the corporate landscape, poor performance and negative news will have a significant impact on corporate development.
Therefore, assessing the development potential of a company should not rely solely on financial metrics but should also consider ESG performance. Over the past ten years, factors such as climate change and sustainability risks have increasingly emerged as key factors for investors in their asset allocation decisions. The market believes that strong ESG performance can facilitate consistent profit growth, sustain competitive advantage, and enable long-term sustainable development. Moreover, it allows organizations to proactively identify and manage risks through forward-looking strategies, mitigating investment losses attributable to inadequate ESG performance or negative news. As a practical tool for investors, ESG ratings offer a convenient and accessible means to gauge a target company’s ESG performance. By referring to these ratings, investors can rapidly and directly comprehend a firm’s ESG maturity and discern its significant risk exposures.
ESG ratings are crucial in evaluating a company’s sustainability performance, but their effectiveness is compromised by several data quality and methodology issues. The effectiveness of ESG ratings is hampered by limitations in data sources and the lack of standardized evaluation methods, leading to varying institutional judgments and interpretations that can cause fundamental problems. Firstly, current ESG ratings suffer from a lack of unified standards, with different rating agencies like MSCI ESG, DJSI, Hang Seng Sustainable Development Enterprise Index, and Sustainalytics establishing their research and analysis frameworks. This results in inconsistencies in rating indicators and increases sustainable investment risks. Additionally, most ratings consider the performance of the three ESG pillars and use their average value or predetermined weight to aggregate them into an overall score. This approach may offset positive and negative impacts, dilute rating information, and failing to analyze a company’s performance in different aspects. In some cases, strong social and governance performance may overshadow severe environmental risks, providing little assistance to investors seeking to mitigate potential ESG risks. Furthermore, The effectiveness of ESG ratings hinges on the reliability of external information collected. Nevertheless, internal corporate information such as ESG reports and company documents may contain misleading claims, resulting in biased rating results.