Had it not been for the rise of the pandemic’s second wave or the post-election mayhem, Phillip Morris’ addition to a club of companies that are supposed to be doing well on environmental, social, and governance (ESG) factors might have gotten a bit more attention. After all, the company sells 700 billion cigarettes a year. How could it have joined the Dow Jones Sustainability Index (DJSI) North America, one of hundreds of recently created market indexes that track firms purporting to rate well on product safety, greenhouse gas emissions, board diversity, and other ESG factors?

The reason is simple. The bar for what constitutes a good corporate citizen is abysmally low and may have made ESG investing, arguably the hottest trend in investing today, a greater force for destabilizing society and the planet than if it didn’t exist at all.

At the core of the problem is how ESG ratings, offered by ratings firms such as MSCI and Sustainalytics, are computed. Contrary to what many investors think, most ratings don't have anything to do with actual corporate responsibility as it relates to ESG factors. Instead, what they measure is the degree to which a company’s economic value is at risk due to ESG factors. For example, a company could be a significant source of emissions but still get a decent ESG score, if the ratings firm sees the pollutive behavior as being managed well or as non-threatening to the company’s financial value. This could explain why Exxon and BP, which pose existential threats to the planet, get an average (“BBB”) aggregate score from MSCI, one of the leading rating companies. It could also be why Phillip Morris made it onto the DJSI. The company recently committed itself to a “smoke-free” future, which ratings agencies might perceive as reducing regulatory risk even though its next generation of products remain addictive and harmful.

Read the full article about ESG ratings by Hans Taparia at Stanford Social Innovation Review.