Leveraging ESG Data from Multiple Providers in Equity and Credit Markets

Investors’ interest in incorporating environmental, social, and governance (ESG) considerations resulted in a large number of commercial providers offering firm-level ESG scores, which often differ, given the lack of a uniform and widely accepted definition of ESG. As a result, many investors try to identify the best provider, or develop their in-house scores. The authors look at how to efficiently leverage ESG data from multiple providers. They first discuss why it is important to standardize ESG scores across providers before taking an average, and they describe an algorithm to do so. Second, they show that the dispersion of ESG scores is useful beyond the average ESG levels. The authors find that ESG dispersions among providers can predict future returns in both stocks and corporate bonds even after controlling for the average ESG level and other systematic risk drivers. Their results suggest that investors would benefit from incorporating ESG rating dispersion in addition to the level of ESG rankings into their investment process.