The truth and consequences on ESG ratings

Overview

Environmental, Social, and Governance (ESG) ratings have become instrumental to financial markets and the real economy. Investors want to make their portfolio greener without losing too much of a return.

As a result, these green firms outperformed more polluting (brown firms) over a decade. In other words, investors require a higher expected return for these brown firms. This means that they will have to pay more to attract external funding. This makes the transition toward a green economy much more difficult.

This relationship becomes even more complicated when we insert rating agencies, who give ESG ratings. There is only a 50% overlap across the major rating agencies for the same firms. Firms with a higher disagreement have to pay higher expected returns.

Similarly for brown firms, this increases their cost of capital. This, again, makes a transition toward a green economy more difficult. As the subject of this event has a significant impact on future funding streams for large organizations and the projects they instigate and administer, a better understanding of it by the civil engineering community is of crucial importance.