Environmental, Social, Governance scores and the Missing pillar -- Why does missing information matter?

TL;DR

This paper introduces a new 'Missing' pillar to ESG scores to account for unpublished information, enhancing the reliability of ESG assessments and their connection to company risk, which benefits investors and practitioners.

Contribution

The paper proposes the ESGM scoring system, incorporating missing information as a new pillar, and develops an optimization method linking scores to company risk, improving ESG score reliability.

Findings

ESGM scores better capture company risk relationships.

Inclusion of missing information reduces bias in ESG assessments.

ESGM scores can improve investment decision strategies.

Abstract

Environmental, Social, and Governance (ESG) scores measure companies' performance concerning sustainability and societal impact and are organized on three pillars: Environmental (E), Social (S), and Governance (G). These complementary non-financial ESG scores should provide information about the ESG performance and risks of different companies. However, the extent of not yet published ESG information makes the reliability of ESG scores questionable. To explicitly denote the not yet published information on ESG category scores, a new pillar, the so-called Missing (M) pillar, is formulated. Environmental, Social, Governance, and Missing (ESGM) scores are introduced to consider the potential release of new information in the future. Furthermore, an optimization scheme is proposed to compute ESGM scores, linking them to the companies' riskiness. By relying on the data provided by Refinitiv, we show that the ESGM scores strengthen the companies' risk relationship. These new scores could benefit investors and practitioners as ESG exclusion strategies using only ESG scores might exclude assets with a low score solely because of their missing information and not necessarily because of a low ESG merit.