Building reputational capital has become synonymous with business growth. From recruiting efforts to customer acquisition, business growth relies on how others perceive a brand. Rating systems have become a valuable source for these efforts. Consider popular companies like Airbnb and Uber who use rating systems to provide a qualitative scale for customers to view. Similarly, Glassdoor established their rating system to facilitate the hiring process for employers and prospective employees. Ratings demonstrate high and low points for a brand – where an organization excels and where the organization needs to improve. This becomes crucial when companies are subject to ESG evaluations. With more than 80 research and ratings organizations worldwide, the landscape has become saturated with metrics and reporting. So why have ESG ratings become fundamental to reputational capital? The answer is multifaceted.
ESG ratings develop company benchmark on several issues. According to MSCI, ESG rating is “designed to measure a company’s resilience to long-term, industry material environmental, social and governance (ESG) risks.” Based on risks and opportunities, the rating system identifies key issues that are the most material to an industry or sector. The MSCI framework provides 35 ESG key issues that are categorized in pillars: environmental, social, and governance. These publicly disclosed ratings demonstrate a company’s acumen, financial spending, and most importantly, their risk management level. Companies that perform well typically find themselves in a growth trajectory.
Companies who are subject to ESG performance evaluations will find their organization under a lens. ESG ratings provide a proxy for financial accounting and reporting. This information can become crucial to current and future stakeholders. Scores also reveal leadership acumen, action, and resiliency on common ESG factors including environmental impact, human capital management, and corporate governance. ESG-based investing relies on this transparent information to find industry opportunities. According to the Global Sustainable Investment Review 2020 total assets under management are comprised of 35.9% sustainable investment assets. This sparks an increase in trends up from 33.4% in 2018. With investment decision-making as a factor, companies are determined to perform well to strengthen relationships with investors.
There’s varying opinion on whether these ESG rating systems truly demonstrate value. The landscape is saturated with rating agencies. Others include Sustainalytics, Institutional Shareholder Services (ISS), Glass Lewis, and IRIS+. Anywhere Sikochi, George Serafeim, and Dane Christensen researched the topic and have found mixed results. There’s a parallel between scores and performance: divergent scores negatively impact performance. Based on research from 69 countries from 2004-2016, the authors found that score discrepancies are growing over time among rating agencies. This, in turn, continues to shift the markets’ volatility. Some countries have mandated disclosures causing a rise in disclosure popularity. However, this causes a great discrepancy in scores among agencies bringing a larger debate who to trust and which brings the largest impact on reputational capital.
Quality assurance will be required with an influx in ESG rating agencies. Independent, impartial assessments are required to ensure the validity of ESG ratings. With scores bringing a substantial impact to a company’s future performance, public education and awareness is required. Which ratings do you trust? Based on the scores reported, how are you impacted as an investor, management member, or employee? According to a 2020 study by Marsh & McClennan, companies with a highly-satisfied workforce typically reported higher ESG scores by a margin of 14%+. Investors are also relying on the data. 515 investors with $106 trillion in assets asked for companies to report environmental metrics through CDP.
Today’s cultural shift focuses on critical ESG themes. Decision-making for internal and external stakeholders is becoming more reliant on reputational capital. ESG ratings have become interchangeable with a company’s performance based on these themes. However, there is a careful balance between disclosures, ratings, and actionable initiatives. Marketing ESG to build reputational capital requires authenticity at its core. Although ratings are important, they are only a factor in how stakeholders evaluate and perceive an organization. Developing a narrative that is compelling, cohesive, and focused requires ESG disclosures, programs, initiatives, and proof points. This comprehensive lens is what we believe brings transparency and accountability to sustainability. Looking ahead we are monitoring the shifts in rating systems. With a lack of consistency in comparable standards around the world, agencies may face growing pressures to update their rating processes and emerge with uniform disclosure initiatives.
