Episode 9 Anywhere Sikochi The Limitations of ESG Ratings
Anywhere (Siko) Sikochi is an Assistant Professor at Harvard Business School (HBS) where he teaches the Financial Reporting and Control course to MBA students. He is a faculty affiliate to the Gender Initiative at HBS and the Center for African Studies at Harvard University. Siko recently co-authored an article titled “Why is Corporate Virtue in the Eye of The Beholder? The Case of ESG Ratings” which explores the link between disclosures and ratings.
In this episode, Siko shares his insights on the limitations of ESG ratings, how ESG trends are viewed by leaders in Africa, the kernels of wisdom he aims to share with his business students and much more.
More information results in more disagreement:
Counter to common belief, Siko and his colleagues have found in their research that more ESG disclosure results in greater disagreement between ESG ratings. This is because ESG rating companies have different views on what to measure or how to measure it. In this context, when you give ESG evaluators more information, you’re giving them more things to disagree on.
It’s easier to agree on ESG ‘inputs’ than ‘outcomes’:
It’s easier for raters to agree on ESG ‘inputs’ than on ‘outcomes’. ‘Inputs’ include plans or policies to ensure strong ESG performance (e.g., a diversity policy). Outcomes focus on actual ESG performance (e.g., the % of female executives in a company). When you look at what the ESG rating companies are reviewing, it’s much easier for them to tick boxes on ‘inputs’ but these assessments miss the very reason why we’re talking about ESG - what we care about is ‘outcomes’. The challenge is agreeing on what a good outcome looks like. For example, is a 1% injury rate at a company good if the industry average is 4%? It’s much easier to agree on whether that company has a health and safety policy.
Rating transparency, regulation and proactive company disclosure needed:
Improving ESG outcomes is ultimately the goal. We want to see healthy/included employees, environmental protection and remove corruption from business dealings.
In order to achieve this we need 1) ESG ratings to be more transparent about their methodologies, 2) regulators to solidify performance standards and 3) companies to drive their own narrative with disclosures rather than trying to score points with ESG rating companies.