From monopolistic behaviors and accounting frauds to workplace harassment and environmental incidents, these scandals could have significant adverse effects on companies, ranging from consumer boycotts to legal penalties. Not to mention, the scandals would damage the reputation of both the companies themselves and their shareholders.
ESG-related controversies have cost investors a lot. According to research by Bank of America Merrill Lynch, major ESG-related controversies during 2014 to 2019 wiped USD534bn off the value of the large US companies among the S&P 500. The picture below shows the average peak-to-trough performance of ESG controversy stocks relative to the S&P 500.
The impact of controversies on share prices
(Source: Bank of America Merrill Lynch)
Another research from Société Générale found that 75% of companies hit by a major controversy saw their shares lower than the MSCI World Index by an average of 12% in the subsequent two years. Also, the stocks typically lagged their regional benchmarks by 4%. Furthermore, a paper conducted by Monash University in Australia, highlighted market reactions were much more obvious for bad than good news. This is because investors tend to overweight the possibility that controversy may happen again, or the impact of controversy could be prolonged.
Currently, major ESG data providers also have assessment services on corporate controversies. For example, Refinitiv and ISS have ESG Controversies Scores while Sustainalytics provides controversies rating in each controversies research report. MSCI has both scores and reports. It is necessary to note that both controversy scores and ratings reflect the corporate negative issues that have already hit the newswires. So, compared to what the score and rating of ESG controversies are, how to assess the ESG controversies is more important. Understanding how ESG controversies impact a company may give an explanation of ESG score dropping, as well as an inspiration for improvement.
MSCI: Exclude companies with controversies score of 0 from indexes
MSCI’s ESG Controversies Score uses a 0-10 score and color-coded alerts. For each individual controversy case, it is scored based on a combination of severity, type, and status. Severity is determined both by the nature and scale of impact. Type could be divided into structural and non-structural. Structural type means there is evidence of an underlying problem at the company, poor culture, or lack of adequate governance and oversight. Non-structural type indicates the controversy comes about because of isolated bad actors or random misfortune rather than poor culture or governance failures. Status is updated on the basis of new developments and regular research and review. Ongoing means the case is active, with the last known development occurring within the last two years. Concluded means the case has been resolved/closed/withdrawn. Historical concern means the case concluded more than three years ago but is high profile and forms an important part of the company’s ESG history.
After assigning scores and flags to the individual controversy case, MSCI calculates KPI scores, and then aggerates them to sub-pillar levels, pillar levels, and overall company levels. Pillar level contains three dimensions, sub-pillar level contains five categories, and beneath it there are 28 indicators. At each level, the score is determined by the lowest-scored component. Each company receives an overall score and flag.
In addition, every company will be received MSCI’s Global Norms Screening. The screening is designed to judge whether a company or fixed income issuer is misaligned with or violates global norms and conventions. The global norms and conventions include the United Nations Global Compact Principles (UNGC), the International Labour Organization’s (ILO) conventions, and so on. Based solely on content covered by that norm’s framework, MSCI’s Global Norm Screening provides an overall signal of three types: Pass, Fail, or Watchlist.
By April 2021, out of 6,969 companies in MSCI’s dataset, only 28 companies had a score of 0. A further 138 companies had a score of 1, which put them on the watchlist. Companies with a score of 0 are excluded from the MSCI ESG Focus Indexes. Another example of negative screening is MSCI Select ESG Screened Indexes, which immediately excludes companies that fail to comply with the global norms, particularly the UNGC. Also, MSCI designed several more indexes to reflect the performances of companies that have above-average ESG ratings relative to their sector peers. For example, MSCI Emerging Markets (EM) Select ESG ex Controversies Index, a sub-index of MSCI Emerging Market Index, requires companies eligible for inclusion to have an MSCI ESG Controversies Score of 3 or above.
For part 2, there will be a scoring methodology introduction of Refinitiv, another ESG controversy score provider. Also, for a company’s future growth, there are some properties of controversies that a company should not ignore.
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