McDonald’s, for instance, was given an upgrade of its E.S.G. rating last year by MSCI, which cited reduced risks to the company’s bottom line as a result of changes that the company made concerning packaging material and waste. But greenhouse gas emissions from the operations and supply chain of McDonald’s, which is one of the world’s largest buyers of beef, grew by 16 percent from 2015 to 2020. Those emissions are a direct cause of climate change, but because MSCI didn’t see them as posing a financial risk for McDonald’s, they didn’t negatively affect the rating.
This is hardly an isolated case. According to a recent Bloomberg analysis of 155 rating upgrades, only one cited a cut in emissions as a factor.
Given this lenient rating system, it’s not difficult for a company to be deemed environmentally or socially responsible. Indeed, 90 percent of stocks in the S&P 500 can be found in an E.S.G. fund built with MSCI ratings.
Most technology stocks, including Alphabet and Meta, are part of E.S.G. funds, despite concerns about their role in facilitating the spread of misinformation and hate speech. Coca-Cola and Pepsi have gotten very high E.S.G. scores and find themselves in most big E.S.G. funds, despite manufacturing products that are a major cause of diabetes, obesity and early mortality and despite being the world’s largest contributors to plastic pollution. Perhaps most egregiously, BP and Exxon get respectable ratings from MSCI.
This system works well for Wall Street. It keeps the raters in business because it ensures that their customers, the investment firms, have lots of stocks with which to construct portfolios. It enables financial institutions to present themselves as contributing to the well-being of society and the planet. And it allows them to charge higher fees to investors, because E.S.G. funds are seen as different from conventional index funds, in part because they tap into investors’ consciences.
But this system isn’t good for the world. Instead of measuring the risks that environmental and social developments pose to companies, raters and investors should measure the risks to humanity posed by companies.
The best approach would be for rating agencies to measure the costs to society and the environment that are not directly borne by companies — what economists call negative externalities. This would include the health care costs to society of smoking or excessive soda consumption or the acceleration of climate change as a result of greenhouse gas emissions.