Introduction
Many organizations are starting to recognize the need for including their environmental, social, and governance (ESG) goals to achieve sustainability. Financial profitability is no longer the only measure of a company’s performance. As a result, investors and industry regulators are increasingly assessing the internal and external factors before making a significant decision. Specifically, venturers are focusing on the non-monetary and ethical impacts of an enterprise (Esguevillas, 2020). The objective of this paper is to synthesize the information that two articles written by McMahon and the other by Escrig-Olmedo et al. provide regarding ESG.
Similarities of the Sources
First, the articles agree that investors are increasingly relying on ESG to make their entrepreneurial decisions. According to McMahon (2020), when he, the author, started a firm, which specialized in producing reports, there were only 300 Canadian companies in need of their services in 2008. Currently, Sustainalytics produces data for tens of thousands of organizations in Australia, North America, Asia, and Europe. The author adds that the most significant change has been in how ratings are produced, in which there has been a heightened increase in the ESG ratings. Similarly, Escrig-Olmedo et al. (2019) note that about ten years ago, only the small firms were interested in such information. Many large organizations are now seeking service after recognizing that ESG is a better indicator of sustainability, reputation, and forecast.
Secondly, both articles recognize that ratings are essential for internal benchmarking, decision-making, sustainability, and performance enhancement. MacMahon (2020) explains that the Sustainalytics company classifies each firm into the existing 138 industries with their respective risks. The implication is that the information can be used to rate the level that an individual company is at based on the threats and the performance of rivals. For instance, in the mining industry, the issue of carbon emission is bound to surfaces. The company will also assess the specifics of the company to understand the degree of risk exposure. Given the thoroughness of the process, the financial departments can make informed choices. The other significance is that once the company’s weaknesses have been identified, the organization can make positive adjustments.
Likewise, the paper written by Escrig-Olmedo et al. (2019) recognizes that research agencies provide benchmarks to their clients. The firms have integrated various criteria to enhance robustness and accuracy (Escrig-Olmedo et al., 2019). All the efforts that are being made make it easy to make the right investment decisions. One of the key principles to observe when using ESG is to balance between the long-term and the short-term effects in what Escrig-Olmedo et al. (2019) refer to as the intergenerational perspective. Companies are also competing to improve their performances, thus achieving good ratings.
Thirdly, the articles agree that one of the most significant aspects of the ESG concerns hazards. MacMahon (2020) states that Sustainalytics company always assesses “what risks the businesses are exposed to and how well they’re managing them” (p.53). Similarly, Escrig-Olmedo et al. (2019) agree that market research agencies always integrate the intergenerational risk assessment and other strategies to handle such risks. The rationale for such scrutiny, as inferred from both articles, is responsible for investments to increase the probability of long-term sustainability.
In addition, the authors agree that compared to financial indices, the ESG is more challenging to assess. Escrig-Olmedo et al. (2019) list five problems with the ESG, including lack of transparency, commensurability, stakeholder preferences, trade-offs in the criteria, and not having an overall score. The issue is also addressed by MacMahon (2020), who writes that most of the social and environmental aspects are difficult to measure. Besides, the lack of uniformity in analysis and reporting may make quantification and benchmark complicated.
Different Aspects of ESG Highlighted by the Articles
Having a specific criterion for ESG evaluation is relevant in curbing the aforementioned challenges. One of the issues that major companies are having is “survey fatigue,” which MacMahon (2020) describes as “hearing from too many rating firms that request too much information” (p. 54). There is a need to decide on specific methods that can be followed to determine a firm’s ESG so that only relevant data will be collected. Notably, some scam agencies may use extra details from the firm for scandalous reasons.
There has been a significant increase in market concertation for sustainability rating over the past decade. According to Escrig-Olmedo et al. (2019), many agencies that provide ESG data have sprouted up to meet the “demands of socially responsible investors” (p.3). From 2008, when there was a financial crisis, to 2018, financial stakeholders have shown more interest in getting information about the environmental, social, and ethical nature of a firm. The indices of ESG have significantly increased when the data in 2008 is compared to that in 2018, as illustrated by Escrig-Olmedo et al. The result is that rating enterprises have shifted their focus from being a financial niche to a more diverse business.
Furthermore, integration of the ESG principles is important to achieve standardization of the procedure. The first principle is recognizing that sustainability is multidimensional and comprises of three concepts, namely economic, environmental, and social. Next, there is recognition of the intergenerational perspective, which ensures the evaluation of past performance and forecasting while making preparations for the future. Thirdly is the principle of stakeholder approach in which needs and expectations of relevant individuals presently are addressed in consideration of the projected time. Last but not least is life cycle thinking in which the impacts of upstream and downstream activities are managed (Escrig-Olmedo et al., 2019). When there are regulations governing procedures of obtaining ESG, it will be easy to normalize the applications.
Big data and internet connectivity have played a significant role in the development and use of ESG.
In their article, Escrig-Olmedo et al. (2019) exemplify Morgan Stanley Capital International (MSCI) as a research agency that utilizes this technology. The company took advantage of the big data to expand its scope as an ESG provider. The firm has also developed indices from the massive flow of information that they receive on ratings in the construction industry. Making use of information technology is, thus, a good way for an organization to be more competitive.
Relevance, Issues, and Use of the ESG
The ESG analysis has increased accountability and corporate social responsibility in different industries. For example, the Paris 2016 Agreement on Climate Change made companies conscious of the harm that they possibly cause to the environment (Escrig-Olmedo et al., 2019). However, the expectations of the ESG scores have largely been criticized as being unrealistic. According to MacMahon (2020), ESG controversies and other issues such as the inability to quantify results may result in application challenges. Problems concerning the security and privacy of data have also been raised since some agencies ask for more sensitive information (MacMahon, 2020). Therefore, the need for international standardization cannot be overemphasized so that ESG’s application will be more relevant.
The articles also state that increase in the number of large agency firms that assess ESG is a significant issue with both positive and negative consequences. MacMahon (2020) recalls that when Sustainalytics started, there were only 20 people, but currently, the firm has more than 650 people. The fact that ESG agencies are now “bigger, more professionalized and finance industry-connected” implies they can produce more accurate findings to act as drivers for transforming the firm (Escrig-Olmedo et al. 2019, p. 13). There has been a substantial increase in the analytical rigor and scrutiny of ESG to provide good ratings. However, the rise in the number of researchers without standard ratings makes it difficult to verify the accuracy of the information.
Assessment of the environment, social and corporate governance may offer valid information for internal advocates to promote change. The identification of the risks that a firm is going through is a significant step in transforming a company (MacMahon, 2020). Knowing the problems motivates the managers and auditors to seek solutions. The result is continuous improvement of the organization, and sustainability can be achieved. Since the focus is given to the community and the ecosystem, the overall improvement initiates a web of positive change to all the related stakeholders.
Conclusion
Financial ratings have ceased being the only indices to assess the sustainability level of a firm. Many, large and small, companies are now seeking the services of companies that provide information on other non-financial aspects. The ESG is relevant for benchmarking, risk assessment and management, and promoting informed decision-making. Several criteria and principles are often used for standardization, but there are still challenges since most of the elements that are analyzed cannot be quantified. Increased mergers and acquisitions leading to bigger and more professional agencies and utilization of new information technology such as big data are a positive trend. More research and improvements in ESG are needed to enhance the accuracy of ESG.
References
Escrig-Olmedo, E., Fernández-Izquierdo, M., Ferrero-Ferrero, I., Rivera-Lirio, J., & Muñoz-Torres, M. (2019). Rating the raters: Evaluating how ESG rating agencies integrate sustainability principles. Sustainability, 11(3), 1-16. Web.
Esguevillas, C. (2020). Why ESG ratings matter and how companies use them. Simply Sustainable. Web.
MacMahon, S. (2020). The challenge of rating ESG performance. Harvard Business Review, 52-55. Web.