Understanding ESG scores and firm performance: Are high-performing firms E, S, and G-balanced?

Abstract

What is the relationship among independent third-party rating agency weighted ESG scores, balanced weighted ESG scores, and firm performance? Research studies show that the relationship between rating agency ESG scores and firm performance is mixed and likely inconclusive. This is because rating agencies have the discretion to choose from among many comparable E, S, and G measures that are not the same in scope and measurement, leading to variations in component weights that can cause material differences in reported weighted average ESG scores. To overcome this variation, we propose an extension to organisational ambidexterity theory that incorporates ESG activities and use balanced E, S, and G weights to calculate ESG scores. Using a combination of quantitative and qualitative methodologies on a sample 562 U.S. firms in the Forbes 2000 ranking, we find balanced weighted ESG scores are associated with firm performance, and the greater the positive percent difference between rating agency ESG scores and balanced ESG scores the lower the firm performance. Rating agency weighting methodologies may unknowingly be encouraging firm greenwashing.