What ESG Actually Measures, and What It Misses

Environmental, social, and governance investing has grown from a niche approach to a mainstream fixture of global capital allocation. ESG-labelled assets under management are estimated at over 35 trillion dollars globally. The underlying assumption is that companies which perform well on ESG metrics are better managed, less exposed to long-term risk, and more likely to create durable value.

The assumption is not unreasonable. But the infrastructure built to operationalise it has significant weaknesses that investors, procurement teams, and sustainability professionals need to understand.

The Rating Problem

A 2019 study published in the Review of Finance found that ESG ratings from different providers for the same company diverged dramatically. The correlation between ratings from major providers was approximately 0.6, roughly comparable to the correlation between different analysts’ views on a company’s credit quality, but in a domain where the underlying data is far less standardised.

The divergence is not primarily due to errors. It reflects genuine methodological differences. Some providers weight environmental performance most heavily. Others prioritise governance. Some use absolute metrics; others assess performance relative to industry peers. Some rely primarily on company disclosures; others use third-party data, satellite imagery, or news analysis.

What ESG Captures Well

ESG frameworks are reasonably effective at capturing formal governance structures: board composition, executive pay policies, audit quality, and shareholder rights. These are measurable, comparable, and often correlated with financial performance.

On the environmental side, Scope 1 and 2 emissions, energy intensity, and water usage are increasingly well-reported among large listed companies, particularly those subject to mandatory disclosure requirements in major markets.

What It Consistently Misses

Scope 3 emissions, which account for the majority of most companies’ climate impact, remain inconsistently reported and difficult to verify. Supply chain social conditions, including labour practices and human rights, are even harder to assess through the kind of standardised data that rating agencies prefer.

Small and medium-sized companies, which collectively employ the majority of workers and generate a substantial share of economic output, are largely absent from ESG frameworks designed for large listed corporations.

Using ESG Data Intelligently

The appropriate response to ESG’s limitations is not to dismiss it. It is to use it as one input among many rather than as a definitive verdict. Understanding what a particular rating measures, what it weights, and what it excludes is more valuable than knowing the score itself.

For companies seeking to improve their ESG standing, the most productive approach is to focus on reducing actual impacts rather than optimising for disclosure frameworks. The two are related, but they are not the same thing, and the distinction matters.