ESG Honestly
Posted 22 November 2023
Do firms with diverse boards achieve higher ESG ratings? A new study may have the answer.
In the new trading environment of encroaching sustainability regulation, it is quickly becoming essential for corporates to demonstrate the strength of their board diversity and ESG ratings to investors, insurers and regulators.
As firms face a plethora of incoming rules mandating disclosures on their net-zero transition plans, diversity policies and the outcomes of both, ESG ratings are also becoming a catalyst for business enablement, growth and performance.
The investment management community has arguably led the field in embedding ESG ratings into decision making, but ESG data is increasingly being deployed to inform underwriting decisions among insurers too, on a global basis.
A question has however lingered around the wider topic, specifically on the link between D&I and ESG scores. Put simply, do firms with diverse boards achieve higher ESG ratings?
A new study of corporates has provided the closest thing yet to a definitive answer.
Published in the Harvard Business Review, the research involved analysis of 15 years of data from companies on the S&P 1500 to determine if the diversity of a firm’s board of directors influenced its environmental rating from MSCI, an ESG data provider based in the US.
The conclusion drawn by the author Ethan Moon, an associate consultant at management consultancy Bain & Company, was clear.
“A 10-percentage point increase in the proportion of females on a board — roughly equivalent to one additional female director — is correlated to a 17.5% increase in a firm’s environmental rating.”
His analysis also discovered that a similar rise in the proportion of black directors was associated with an 18.4% boost in MSCI’s environmental scores.
Global correlations
This relationship between board diversity and ESG has been studied previously, but Moon’s research marked the first time the link had been assessed using a large data set and a more prolonged period.
It is notable that earlier reports, which also established a positive correlation between diversity, ESG and the broader financial performance of companies, applied in global territories with a variety of corporate cultures.
A study of 494 non-financial firms listed on the Chinese stock exchange from 2018 to 2022, undertaken by independent Chinese researchers, found that the impact of gender diversity was “positive and significant” for firms in relation to both ESG and financial performance.
The authors, whose work was published in 2023 in The International Review of Economics and Finance, noted that “a stable and less divisive corporate governance environment” helps the execution of ESG practices.
They also suggested that the best approach involves efforts to promote board diversity that aligns sufficiently with sustainability goals.
Back in 2018, another report from researchers at ISS Corporate Solutions concluded that the relationship between ESG and board diversity is “mutually beneficial”, and that the firms they studied with more gender-diverse boards outperformed their peers on ESG metrics.
This may sound familiar to executives responsible for leading either D&I initiatives or ESG policies. But, importantly, these reports are cumulatively amassing a body of empirical evidence that strongly supports the assertion that boardroom diversity fuels ESG performance.
It is also possible that regulators have noted such findings, as they formulate policies to bring diversity into their respective rulebooks.
Regulatory trends
In the UK, the financial watchdogs are working on plans to bring both ESG ratings companies and diversity into the regulatory regime. Rules for ratings firms are expected to be introduced next year while, on diversity, policymakers continue to formulate their thinking with industry discussion papers.
In the US, ESG is a searingly divisive topic. Some states are introducing legislation to ensure ESG is not used punitively in investment decisions while others have moved to bring ESG reporting onto their statute books.
In Europe, as part of a package of sustainable finance measures, the European Commission is also looking to bring ESG data providers under regulation.
Despite the culture wars on this topic raging throughout the US, the ultimate direction of travel for D&I and ESG (at a federal level at least) in Western economies is heading only one way. Corporates can expect more disclosure requirements imposed on them, with significant breadth and depth.
New responsibilities
Heightened attention on ESG ratings will come not only from the watchdogs. Investors, banks, insurers and corporates will also be asking more searching questions about D&I and ESG of firms throughout their stakeholder chains.
One could almost call it a new age of corporate transparency, with companies becoming accustomed to gathering swathes of data on their partners’ status across the three components of ESG, while providing it to them about their own progress.
As this period of openness is ushered in over the coming years, and the data on firms becomes readily available to extract and analyse, the link between board diversity and ESG performance may become even more explicit.