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Take it with a pinch of salt—ESG rating of stocks and stock indices

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  • Erhart, Szilárd

Abstract

This paper investigates the environmental, social, and governance (ESG) ratings of 20 leading stock exchange indices by analyzing and aggregating ratings of underlying stocks. ESG ratings are increasingly important inputs to sustainable investments in the European Union and United States with the phasing-in disclosure regulations. We find that ratings from two different rating providers (Sustainalytics and Refinitiv) for the same listed stocks are only weakly correlated, even if the scaling differences of the ratings are adjusted. Monte Carlo simulations are conducted to estimate how the choice of major ESG rating inputs (i) aggregation formula, (ii) weighting scheme and (iii) data provider influence the uncertainty of ratings and thus indirectly the sustainable investment process. The simulations reveal that the uncertainty is primarily related to choice of the ESG rating provider. We found that the popular best-in-class portfolio selection could be built on ESG scores. In lower segments of the ESG asset universe, investment selection becomes more challenging due to the increasing uncertainty of ratings. Finally, the paper shows that exchanges in the European Union provide relatively good ESG investment opportunities in international comparison.

Suggested Citation

  • Erhart, Szilárd, 2022. "Take it with a pinch of salt—ESG rating of stocks and stock indices," International Review of Financial Analysis, Elsevier, vol. 83(C).
    • Handle: RePEc:eee:finana:v:83:y:2022:i:c:s1057521922002629
    DOI: 10.1016/j.irfa.2022.102308
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    References listed on IDEAS

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    1. Rajna Gibson Brandon & Philipp Krueger & Peter Steffen Schmidt, 2021. "ESG Rating Disagreement and Stock Returns," Financial Analysts Journal, Taylor & Francis Journals, vol. 77(4), pages 104-127, October.
    2. Samuel Drempetic & Christian Klein & Bernhard Zwergel, 2020. "The Influence of Firm Size on the ESG Score: Corporate Sustainability Ratings Under Review," Journal of Business Ethics, Springer, vol. 167(2), pages 333-360, November.
    3. M. Saisana & A. Saltelli & S. Tarantola, 2005. "Uncertainty and sensitivity analysis techniques as tools for the quality assessment of composite indicators," Journal of the Royal Statistical Society Series A, Royal Statistical Society, vol. 168(2), pages 307-323, March.
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    Cited by:

    1. Kanno, Masayasu, 2023. "Does ESG performance improve firm creditworthiness?," Finance Research Letters, Elsevier, vol. 55(PA).

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    More about this item

    Keywords

    Sustainable finance; ESG rating; Stock index;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • M14 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Corporate Culture; Diversity; Social Responsibility

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