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

Abstract

Environmental, social, and governance (ESG) scores measure companies' activities concerning sustainability and societal impact and are organized on three pillars: Environmental (E-), Social (S-), and Governance (G-). Different approaches have been proposed to compute ESG scores for companies, which typically rely on the aggregation of many and different sources of information. These complementary non-financial ESG scores should provide information about the ESG performance and risks of different companies. However, the extent of missing information makes the reliability of ESG scores questionable. To account for the missing information in the underlying ESG pillars, we introduce a new pillar, the so-called Missing (M-) pillar, and propose an optimization approach to compute new ESG (ESGM) scores, which should also be related to the company riskiness. As a result, the ESGM scores allow for incorporating the extent of missing information and establishing some meaningful relationship with respect to the riskiness of the companies under consideration. Interesting insights into the current limitations of ESG scoring methodology are discussed.