New research from Goizueta Term Chair Associate Professor of Accounting Suhas Sridharan raises questions about the credibility of ESG ratings—and whether the agencies behind them need greater scrutiny themselves.
Eyebrows were raised back in 2022, when electric carmaker Tesla was suddenly dropped from the S&P 500 Environmental, Social, and Governance (ESG) Index. The Index—one of the world’s foremost ESG equity benchmarks—tracks the performance of companies against a set of specific environmental, social, and corporate criteria, ranking and essentially recommending those companies to investors who care about sustainability. The decision to remove Tesla, known for its pioneering work in EVs and energy storage, was met with scorn by CEO Elon Musk—not least because oil and gas behemoth Exxon Mobil remained on the S&P list. Taking to X, he complained that “ESG is a scam…SPGlobal Ratings have lost their integrity.”
Whatever the rights and wrongs of the case—with S&P citing Tesla’s codes of business conduct and a lack of disclosures—the imbroglio highlights something critical: a growing debate around the quality and credibility of ESG ratings—and those that produce them.
Weighing in here is new research by Goizueta Term Chair Associate Professor of Accounting Suhas Sridharan. Together with Assistant Professor of Accounting at CUNY Hunter Yifan Yan 26PhD, and Professor & Rebecca Cheney McGreevy Endowed Chair of Accounting Teri Yohn, and colleagues from Columbia Business School, she has looked at discrepancies and inconsistencies within ESG ratings—and between the “raters” whose summaries are critical to the composition of ESG indices and investment funds. What they find is evidence that ESG raters could be prone to conflicts of interest—and with the market set to quadruple in coming years, says Sridharan, this should be a cause for consternation among investors and regulators alike.
“ESG investing is a rapidly growing space. It has evolved from niche strategies to a core pillar of asset management today, as investors and funds look to mitigate risk and make bets on organizations best positioned to benefit from the shift to a lower-carbon economy,” says Sridharan. “What’s interesting is that a lot of sustainability disclosure remains largely outside of regulatory requirements. So the job of identifying those organizations has largely fallen to independent entities or intermediaries who collect data on ESG activities, synthesize that data, and use it to produce a score or rating that investors can purchase from them.”
As a business model, this is “theoretically unproblematic,” she adds—even though much of the data and processing methods of independent ESG rating agencies remain essentially “vague,” with raters themselves deciding which relevant metrics to include or not.
“The thing about ESG ratings is that they use a user-pay model. So even if the rater is making subjective decisions about what criteria to use, the rating itself is likely to be pretty objective because it’s the potential investor who’s paying for it—and not the company that is being rated or scored. It’s the opposite of a credit rating in that sense. The investor stumps up the cash for the rating, so the rater has little or no incentive to score a company higher or lower—if anything, the whole business model makes for a good alignment of interests.”
The problem arises when ESG rating agencies start looking to consolidate their business. And the principal way they are doing this is by becoming index providers.
A Conflict of Interest?
Indices are essentially financial tools or recipes for investment funds: a formula that tells investors which companies to hold or invest in, and in what amounts. Index providers make money by renting out or licensing this recipe for a fee; however, the revenue is typically tied to the value of client funds’ assets under management, or AUM. If the fund does well, or if it grows quickly, it becomes more attractive to other potential investors. As they invest more, the fund’s AUM grows—and so too does the licensing revenue for the index provider.
“Say a BlackRock or another big investment firm creates a fund using your ESG index with $1 billion of AUM and it starts doing well. Soon you’re going to have investors making a bet on that fund. Suddenly you have $3 billion of AUM and your licensing fee may have just tripled,” says Sridharan. “If you want to make money as an index provider, suddenly there’s a real incentive for you to include high-performing companies in your index—companies that not only have strong ESG credentials but also robust stock performance.”
The potential for a conflict of interest arises when ESG raters are also index providers—when they not only rate companies but also decide whether or not to include them in their ESG indices, with the goal of attracting investment and generating licensing fees.
“This is the issue. You have this dual business model of rating companies while simultaneously profiting from indices based on your own ratings,” says Sridharan. “So the question is: do ESG raters who are also index providers end up inflating ratings for companies with more robust stock returns? Isn’t there an incentive to score profitable companies more highly if they are also going to help drive the performance of your index?”
The Pressure to Inflate Ratings
To put this to the test, Sridharan and her colleagues compared ESG ratings from two agencies with different profiles: MSCI, a leading ESG rater whose principal business is the construction of indices, and Refinitiv, which is primarily focused on selling ratings data. Altogether, they looked at more than 7,500 ratings observations for around 1,500 U.S. firms between 2012 and 2019—including ratings that were assigned to the same companies in the same period.
Parsing the data and allowing for differences in methodologies and characteristics in the firms rated, she and her co-authors find the same pattern: companies with better stock returns consistently receive significantly higher ESG ratings from the agency with the index-licensing business. And it’s not down to quality of data or superior research methodology, says Sridharan.
“We drilled down into the data to rule out the possibility that index licensing gives providers access to better ESG insights, but there is nothing that suggests this is the case. When you look at what happens over time, the higher ESG ratings do not translate into better real-world ESG activities or outcomes among the firms included in the index. It’s not like they are using better quality predictive data to rate these companies, nor do the ratings issued by the other agency ‘catch up’ to these higher ratings. So there’s nothing to suggest that index licensing gives raters better information to construct ratings.”
The evidence clearly points to a potential conflict of interest when raters have a dual business model, says Sridharan. When agencies also profit from index construction, they may face subtle but powerful pressures to favor firms that boost index returns.
With the ESG investment market size projected to grow from $46 trillion to more than $180 trillion by 2034, as investors increasingly look to mitigate climate risk, diversify portfolios, and pinpoint companies best positioned to benefit from the transition to a lower-carbon economy, these findings have real relevance to investors and regulators.
“As an investor, if you care about ESG performance, I think it should matter enormously to you whether the companies bundled in your fund actually deliver along that dimension or not. So instead of just relying on one rating, maybe try looking at a couple, or focus on the areas in which they deviate and try to understand the reasons for those deviations.”
And as the regulatory landscape shifts, with less emphasis on obligatory ESG disclosure requirements in the United States, the market will likely be forced to rely more on intermediaries like raters to surface important information,” says Sridharan. The question for regulators and stakeholders is whether these agencies should also be allowed to profit from indices built on their own ratings—and, if so, how they go about assessing companies.
“Certainly, we would welcome more monitoring of the ESG rating system and the raters themselves. And that might involve greater scrutiny of what they do, what they’re permitted to do and how they function—a kind of rating of the raters that I think is only going to become more important.”
From sustainable investing and financial markets to emerging technologies and the future of business, Goizueta faculty research tackles complex questions with real-world implications. Explore more faculty research and insights.
