ESG ratings - A compass without direction - Edward Watts - ASWQ V3I2 - March 2025

In their paper, "ESG Ratings: A Compass Without Direction," the authors explore the rising demand and confusion surrounding ESG ratings. They analyze the limitations and inconsistencies within the industry, particularly how ratings often fail to align with investors' expectations. ESG ratings are primarily used to assess a company’s management of financially relevant ESG risks, rather than its broader impact on society or the environment. This leads to discrepancies between ratings, such as Tesla being rated highly by some agencies and poorly by others, based on differing methodologies. The authors highlight that ESG ratings are industry-adjusted, which can create confusion and undermine their reliability. Furthermore, the paper questions the effectiveness of these ratings in improving portfolio performance and whether they should be regulated. Despite these issues, ESG ratings remain important tools, though investors need to understand what these ratings truly measure and their limitations.