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August 26, 2024
New To Corporate Sustainability? Start Here
September 18, 2024
ESG—you’ve likely heard of it. It refers to the environmental, social, and governance aspects of a company’s operations and practices. And, it’s becoming increasingly important.
Over the past five years, products with ESG-related claims experienced an average cumulative growth of 28%, compared to 20% for products without these types of claims.
Moreover, ESG performance improves employee productivity, leads to cost savings, and results in fewer regulatory interventions. It’s a win for consumers, businesses, and the planet. But, how do stakeholders, investors, and consumers gauge the quality and impact of a company’s ESG initiatives? One answer is ESG scores.
An ESG score is an objective measure of how well a company is performing across three areas:
Environmental
Social
Governance
A high ESG score means a company is making a positive impact. Their efforts are legitimate and meaningful. A low ESG score, on the other hand, indicates a company can do more to fulfill their responsibilities
What kinds of things does an ESG score measure? Let’s examine the three focus areas in more detail.
There are many different facets to this question, and an ESG score attempts to capture them all. It looks at things like energy sources, waste management, water usage, and carbon emissions
Companies that adopt strategies like switching to renewable energy sources or implementing robust recycling programs might earn higher scores.
Social
How does the company treat people?
Every business is a people business. There are workers and customers, stakeholders and investors, and those living in the communities where the company operates. The social aspect of the score evaluates labor practices, diversity and inclusion, and community engagement.
This area examines the company’s structure and leadership. How are top management and board members held accountable? It looks at ethics and stakeholder rights. Things like fair compensation, diverse leadership, and transparency help a company score well.
How To Calculate Your ESG Score
ESG scores are not something you calculate yourself. Third-party ESG rating agencies – including MSCI ESG Research, Sustainalytics, and Moody’s – oversee the ESG scoring process. Each agency uses its own complex algorithms and methodologies to evaluate companies, making the process more objective and less susceptible to bias.
What kinds of things does an ESG score measure? Let’s examine the three focus areas in more detail.
Step 1: Identify Key ESG Issues
MSCI flags the most material ESG risks and opportunities for a given industry sector. Drawing on over 13 years of live tracking, they select the most relevant and impactful ESG factors, which they term "Key Issues". There are 33 possible issues that will be assessed.
Step 2: Collect and Assess Data
MSCI then gathers thousands of data points relevant to the Key Issues. They leverage publicly available information, proprietary research, and company disclosures to collect the information needed to make a holistic and fair assessment
Step 3: Weight the Key Issues
Each Key Issue is weighted according to its potential impact on the company, its value, and the time horizon over which this impact might come to be. Immediately relevant issues might carry more weight than long-term or less critical ones.
Step 4: Score the Company
Based on the weighted Key Issues and the data collected, MSCI assigns a rating to the company. Ratings range from CCC to AAA, where:
CCC (Laggard). The company is lagging in managing ESG risks relative to its industry peers.
B, BB, BBB (Average). The company has a mixed or unexceptional record in balancing ESG risks and opportunities.
A, AA, AAA (Leader). The company has a strong ability to manage the most impactful ESG risks and opportunities.
Lifting your score can help you attract more investors, retain employees, and grow your customer base.
The first step is identifying areas that need the most improvement. You might score highly when it comes to governance but below your industry benchmark for environmental practices, for example. Then, set goals. Decide on realistic initiatives you could introduce to strengthen your performance in lacking areas.
Implementing energy-efficient practices and transitioning to renewable energy sources
Developing an effective recycling program and introducing production techniques, where relevant, that minimize waste
Sourcing materials from suppliers that share your sustainability values and have committed to reducing their environmental impact
Making strides toward fair wages and compensation, as well as safe working conditions for employees across the entire supply chain
Celebrating diversity in hiring by cultivating an inclusive corporate culture and work environment
Supporting local communities by donating time or resources
Introducing policies that make your business practices more transparent
Hiring a diverse board of directors with various skills and backgrounds
Ensuring executive compensation is proportionate and aligns with company performance
Truly impactful ESG is not about making big, disruptive changes. It’s about consistency. It’s about introducing small, manageable improvements that, over time, add up. Always review your progress and strive for more.
Business can be a force for good. If you’d like a partner to guide your ESG journey, please don’t hesitate to contact us.
