From: Issue 47

CSR ratings

22 January, 2014

Does more information add more value?

Written by Dror Etzion, Contributor, Magali Delmas, Contributor and Nicholas Nairn-Birch, Contributor

The ascendance of socially responsible investing as a viable financial strategy has been accompanied by a similar proliferation of ratings schemes for assessing corporate social responsibility. Simply, if investors want to allocate their funds with SRI principles in mind, they need data that will allow them to make informed decisions. Indeed, over 50 rating methodologies for assessing environmental and social performance have been developed, more than a third of them since 2005. At some point, this may have become too much of a good thing.

“We’re awash in metrics,” said Allen White, co-founder of the Global Reporting Initiative at a recent conference.

Indeed, as more ratings systems emerge, it becomes less likely for each new methodology to provide unique or supplemental information. True, different ratings use different criteria, different methodologies, different weighting schemes and, perhaps most importantly, data from different sources. More information can yield more richness and greater analytical precision, but too much information can also be distracting and confusing.

So, does more information add more value? We decided to examine the extent to which dimensions of CSR behaviour used by various rating organizations are in fact complementary or redundant. Rather than examining a specific rating scheme in isolation, we selected ratings data drawn from multiple sources – in essence, mimicking the approach of a savvy investor with a range of information sources at her disposal.

Specifically, we looked at the ratings produced by three organizations: KLD, Trucost and Sustainable Asset Management (SAM). All three are highly visible not only to investment managers and executives but also to general audiences more broadly. For example, the Newsweek Green Rankings lean on data from KLD and Trucost, while the Dow Jones Sustainability Indexes draw on data from SAM.

More importantly for our purposes, each is designed differently. KLD ratings are based on publicly available information from media providers and do not rely on data provided by the companies themselves. SAM’s methodology relies primarily upon company responses to sustainability questionnaires. Trucost, meanwhile, imputes a score for each firm based on government census and survey data, industry data and statistics, and national economic accounts, and then quantifies the environmental impacts and damage costs associated with these extractions.

In our study, we used a statistical technique called principal components analysis. It is commonly used in the social sciences to distill a large set of variables to a small set that retains most of the information. These small sets of variables, called principal components, are uncorrelated to each other, meaning that each captures a distinct aspect of the original data. Our analysis revealed that integration of the KLD, SAM and Trucost rating schemes generates two distinct components of CSR performance:

• The process dimension captures the management practices and systems that firms put into place to improve their CSR performance.

• The outcome dimension captures the impact of these practices and systems on people and the planet

The fact that there are two distinct and independent dimensions implies that processes and outcomes are much less linked than we would perhaps expect. Companies may excel at reporting, governance and the utilization of environmental management systems, yet still emit substantial amounts of pollution. Or, more cynically, they may put in place such processes “just for show” rather than actively pursuing meaningful outcomes. Moreover, process measures can be easily communicated by companies (e.g., “all our facilities are ISO 14000 certified”), and perhaps more easily fed into rating schemes.

As a second step, we examined to what degree the two dimensions were associated with market value. We found, of the two, the process dimension is more aligned with market value. Perplexing at first glance, yes, but it actually makes a lot of sense. If process measures are more abundant and can more easily be fed into ratings methodologies, they will influence market valuation.

Share |

Featured Content from Issue 47 See all content

Report

Launched in 2005, the Global 100 annual clean capitalism ranking is announced each year during the World Economic Forum in Davos. Scroll down below to see the 2014 list and gain insight with related editorial; visit global100.org to learn more about what and who is behind the annual ranking.