ESG ratings firms provide information to market participants (investors, analysts, and corporate managers) about the relation between corporations and non-investor stakeholders interests. They do so by sifting masses of data to extract insights into various elements of environmental, social, and governance performance and risk. Investors rely on this information to make investment decisions, while corporations use ratings to gain third-party feedback on the quality of their sustainability initiatives. Recently, ESG ratings providers have come under scrutiny over concerns of the reliability of their assessments. In this Closer Look, we examine these concerns. We review the demand for ESG information, the stated objectives of ESG ratings providers, how ratings are determined, the evidence of what they achieve, and structural aspects of the industry that potentially influence ratings. Our purpose is to help companies, investors, and regulators better understand the use of ESG ratings and to highlight areas where they can improve. We find that while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.
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