Environmental Social and Governance (ESG) Ratings

For the rational, self-interested investor who seeks to maximize returns reliable information about the risks and value generating opportunities of an investment is essential of any investing strategy. Reliable data for evaluating corporate performance along Environmental Social and Governance (ESG) dimensions could be useful to limit market distortions due to the inability of investors to evaluate ESG externalities, that are costs (benefits) not disclosed in conventional financial statements (Park and Ravenel 2013). ESG data can offer to mainstream financial analysis a unique tool to assess future company and investment performance. Given the significance of ESG data for financial markets transparency, there is a general consensus about its legitimacy in the financial sector. Despite these trends, the proliferation of ESG ratings and some systemic weaknesses prevent the comprehensive ESG integration into mainstream investing. ESG ratings provided by specialized rating institutions play an important role in the enhancement of socially responsible investing (SRI) although an effective comparison among several ESG ratings model is not possible to reach (Dorfleitner et al. 2015). Nevertheless, ESG ratings are highly relevant to managers and investors including ESG issues into their decision-making process. Therefore, it is important to analyze the main features of ESG ratings, factors and methodology criteria to provide an in depth overview about the different models proposed by the well-known ESG ratings providers. The remainder of this entry is structured as follows. After a brief review of the ESG ratings definitions, second section “Environmental Social and Governance Factors and Criteria: Background” summarizes background on ESG factors and criteria, and then the third section “ESG Ratings Providers’ Methodologies and Criteria: An Overview” provides insights about methodologies adopted to develop ESG ratings models, especially focusing on two ESG ratings providers, i.e., MSCI ESG Research and Thomson Reuters ESG Research Data. The fourth section “ESG Ratings and Climate-Related Indicators” highlights the inclusion of climate-related indicators into ESG ratings model. Finally, the last section “Future Perspectives and Conclusion” explains the future perspectives of ESG ratings and some concluding remarks.