Environmental, Social, and Governance scores (ESG scores) have become crucial for investors, regulators, and stakeholders in assessing a company’s sustainability and ethical impact.
These scores measure a company’s performance in three key areas: (1) environmental responsibility; (2) social impact; and (3) governance practices. However, the methodology behind ESG scores varies among rating agencies, leading to discrepancies in ratings for the same company.
In this latest post of the Grey Data blog we seek to explore the methodologies used to calculate ESG scores and highlights major rating agencies operating in the sector.
ESG score calculation methodology
The calculation of ESG scores involves a multi-step approach that includes data collection, assessment of materiality, application of scoring models, and weighting of factors. Here’s a breakdown of the general methodology used:
1. Data collection
ESG rating agencies gather data from multiple sources, including:
- Company disclosures (annual reports, sustainability reports, SEC filings, et cetera)
- Regulatory filings
- Media reports and controversies
- NGO and third-party research
- Stakeholder feedback
Data collection can be manual, automated, or a combination of both, using AI and machine learning to analyse vast amounts of structured and unstructured data.
2. Materiality assessment
Not all ESG factors hold the same importance for every company. Rating agencies use materiality frameworks, such as the Sustainability Accounting Standards Board Materiality Map, to identify industry-specific ESG issues that significantly impact financial performance and risk.
For example:
A financial services firm may be assessed more on governance factors (for example, board structure, transparency, and ethical business practices).
An oil and gas company may have a higher weighting on environmental factors (for example, carbon emissions, water usage, and spill management).
3. Scoring models and factor weighting
Each agency applies its proprietary scoring model, assigning weights to various ESG factors. Although models differ, they generally consider the following key dimensions:
- Environmental factors: Greenhouse gas emissions, energy efficiency, waste management, water usage, climate risk mitigation.
- Social factors: Employee relations, diversity and inclusion, community engagement, human rights policies, supply chain ethics.
- Governance factors: Board independence, executive compensation, shareholder rights, anti-corruption policies, data privacy and security.
The weighting of these factors varies by industry and rating agency methodology. Some agencies provide transparency on weightings, while others maintain proprietary calculations.
4. Quantitative and qualitative analysis
- Quantitative measures: Objective numerical data such as carbon intensity, gender diversity ratios, or executive pay ratios.
- Qualitative assessments: Subjective evaluations like policy effectiveness, controversy analysis, and corporate culture, often based on expert opinions.
5. Score normalisation and benchmarking
Once scores are assigned, they are often normalised to ensure consistency and comparability across industries and geographies. Some agencies use peer benchmarking, ranking companies relative to industry averages.
6. Final ESG score computation
The final ESG score is calculated using an aggregated weighted approach. Scores typically range from 0-100 or use categorical ratings (example, AAA to CCC). A higher score indicates stronger ESG performance.
Major ESG ratings agencies and their methodologies
Several organisations specialise in ESG assessments, each applying its own methodology. Below is an overview of the key ESG ratings agencies and how they operate:
MSCI ESG Ratings
Website: www.msci.com
Methodology:
- Uses a rules-based model, assessing companies on industry-specific ESG risks and management strategies.
- Companies are rated on a scale from AAA (leader) to CCC (laggard).
- Data is sourced from government databases, company filings, and third-party research.
- Weighted factors are based on industry relevance and financial impact.
Sustainalytics
Website: www.sustainalytics.com
Methodology:
- Uses a risk-based scoring system, assessing a company’s exposure to ESG risks and management effectiveness.
- Scores range from negligible risk (0-10) to severe risk (40+).
- Analyses company disclosures, controversies, and external sources.
- Assigns more weight to unmanaged risks that could negatively impact financial performance.
S&P Global ESG Scores
Website: www.spglobal.com/esg/
Methodology:
- Scores companies based on publicly available data and direct engagement.
- Uses a numeric scoring system (0-100) based on sector-specific criteria.
- Incorporates the Dow Jones Sustainability Index methodology.
Moody’s ESG Solutions
Website: www.moodys.com
Methodology:
- Integrates ESG risk analysis with credit ratings.
- Uses sector-specific methodologies to assess ESG exposure and risk mitigation.
- Provides transparency scores reflecting the quality of a company’s ESG disclosures.
LSEG Data & Analytics ESG Scores
Website: www.lseg.com/en
Methodology:
- Scores companies on a scale from 0-100 based on over 450 ESG data points.
- Uses 10 category scores, weighted differently based on industry relevance.
- Evaluates corporate commitments, policies, and performance metrics.
ISS ESG (aka Institutional Shareholder Services)
Website: www.issgovernance.com/esg/
Methodology:
- Provides ESG corporate ratings based on sector-specific KPIs.
- Rates companies from Prime (best-in-class) to Non-Prime (lagging ESG practices).
- Uses independent ESG research and controversy monitoring.
CDP (aka Carbon Disclosure Project)
Website: www.cdp.net/en/data/scores
Methodology:
- Specialises in climate-related disclosures and carbon emissions.
- Scores range from A (leadership) to D- (disclosure only, no action taken).
- Focuses heavily on climate risk, water security, and deforestation.
Challenges and criticisms of ESG scoring
Despite the growing importance of ESG scores, several challenges exist:
- Lack of standardisation: Different agencies use different methodologies, leading to inconsistencies in scores for the same company.
- Data reliability: ESG reporting is often voluntary, and companies may selectively disclose favorable information.
- Greenwashing risks: Some companies may exaggerate their ESG performance without substantive action.
- Subjectivity in qualitative analysis: Evaluations of governance and social factors often rely on expert opinions, which can introduce biases.
As an alternative to the methodologies explained above, our company analysis team can produce corporate ESG analysis reports for any business. The product is available as an add-on to our company SWOT analysis reports.
Efforts are underway to improve ESG scoring transparency and standardisation, with organisations like the International Sustainability Standards Board working toward unified reporting standards.
ESG scores provide a valuable framework for assessing corporate sustainability and ethical impact, influencing investment decisions and corporate strategies. However, variations in methodologies among rating agencies mean that investors and stakeholders must carefully consider multiple sources when analysing ESG performance.
As ESG standards continue to evolve, greater transparency and standardisation will be critical in ensuring that ESG scores provide an accurate and meaningful representation of corporate sustainability practices.
