Can you trust ESG scores? Why investors should be cautious

An ESG score is a numerical measure (from 0-100) of a company’s performance on various ESG (Environmental, Social, and Governance) topics. 

Investors use ESG scores to assess companies’ ethical practices and long-term sustainability; however, with each passing day, evidence emerges showing that ESG scores are untrustworthy and cannot be used to drive investing decisions. 

This article discusses why ESG scores are untrustworthy and explains why investors should be wary of these scores.

Can You Trust ESG Scores?

As an investor, can you trust ESG scores? Well, we hate to be the bearers of bad news, but No, you cannot. Here’s why:

1: ESG Scores Are Inconsistent

For starters, ESG scores vary from agency to agency. 

There are no universally accepted regulations or standards for collecting and reporting ESG data. Without much regulation or standardization, different rating agencies may use different methodologies and criteria to calculate their scores, making it challenging to compare scores across companies and resulting in inconsistent ratings. 

Secondly, there is no guidance on which issues should be dealt with first. 

There is no guidance on which issues should take the front seat and which ones should be put on hold. Many well-established rating agencies give precedence to financial materiality, while niche rating agencies often focus on a specific issue or uphold corporate goodness. 

Third, there are many rating systems. 

Because there are many rating systems, investors find it challenging to choose a system that can help them make a positive impact. It would be better for investors if there were one accurate rating system. 

2: ESG Scores Can Elevate Companies that Have Negative Effects

ESG scores promote bad companies.

A company may score well even if it does not fit a rating agency’s vision of “sustainable.” It is common knowledge that dumping tons of greenhouse gases into the atmosphere, emptying hazardous water into water bodies, or discrimination harms people. 

However, a company may score well due to its impact in other areas. This is because there is a lack of consensus on which issues should be dealt with more harshly than others. 

3: ESG Scores Can Mislead Investors

Rating agencies can market ESG scores to mislead investors. A company can engage in greenwashing, presenting itself as ethics-driven when it is really business risk-driven. 

This can involve practices like making insignificant changes to their operations to make it seem as though they are sustainable or blatantly lying about their operations. 

Investors who use ESG scores to make investment decisions can be misled by greenwashing and can invest in companies that are neither ethical nor sustainable. 

4: ESG Scores Can Be Influenced

There is a potential for bias when giving ESG scores. Rating agencies can give higher scores to popular or well-known companies or to companies they have professional or personal connections with. 

Use Discretion When Tracking ESG Scores 

Even though ESG scores are a valuable measure of a company’s sustainability and ethicality, they are not always trustworthy. ESG scores can be inconsistent, promote companies with bad practices, mislead investors, and be influenced. 

As an investor, you should supplement ESG scores with other tools like news articles about a company. This will give you a better idea of a company’s ethical and sustainability practices and help you make more informed investing decisions.