David Brodwin is a cofounder and board member of American Sustainable Business Council. Follow him on Twitter at @davidbrodwin.
Once upon a time, "corporate performance" meant growth in sales and profit, pure and simple. However, over the past two decades, pressure from customers, investors, and activists has aimed the spotlight at nonfinancial measures like environmental and labor practices and corporate governance. More than 100 new rating firms have sprung up to track performance in these areas. Executives have begun to pay attention.
The proliferation of new (and mostly proprietary) ratings was once welcomed, but it has now become a challenge. Investors and other stakeholders struggle to understand what each rating covers, and why different rating services produce wildly different scores for the same company. Rated companies struggle to supply data to dozens of independent rating services. Ratings do not yet have the impact they should in promoting a more sustainable economy.
A Need for Clarity and Consistency
Ratings only add value if it's clear what is being rated, and if the results are consistent and honest. The proliferation of diverse rating methodologies confuses the market, and it delays the changes that more robust ratings could foster.
Some of the confusion involves what is being measured. For example, a company may receive a high rating from one service for its energy-efficient data centers while getting a poor rating from another service for labor conditions in its factories. Some of the confusion results from inconsistent ratings over time: A company may get a top rating one year and a mediocre rating the next year, even though little has changed in its operations. And conflicts of interest undermine trust, as some ratings services seek consulting contracts from the companies they rate. With all this confusion, companies have learned how to cherry-pick the ratings. They proudly display those ratings that put them in a positive light while avoiding those that yield less favorable results.
Rating the Raters
"We need rating instruments that are credible, efficient, and understandable" says Allen White, Vice President at Tellus Institute and founder of the Global Initiative for Sustainability Ratings. The Global Initiative, a joint project of Tellus and the NGO Ceres, will certify ratings against a standard of excellence to help investors and other users understand what lies behind the assessments produced by various raters.
The Global Initiative's rating certification will work at three levels: principles, issues, and indicators. A level 1 certification means that the principles underlying the rating align with basic standards put forward by the organization. A level 2 certification means that the issues (e.g. carbon emission, living wages, good governance) that the rating addresses are comprehensive give the stated purpose of the rating. And a level 3 certification means that the specific indicators are robust for the issues being rated. Any rating service can be certified at any of the three levels. The certification will include a narrative that describes what the rating covers and how well it covers it.
What a Sustainability Rating Really Means
The Global Initiative for Sustainability Rating certification will help the public understand what various ratings really mean. For example, suppose you are a wine buyer for a restaurant. You are considering a wine from a vintner that claims a 5 star rating for sustainability. With the group's certification framework, you could find out that that this particular rating service does an excellent job of assessing the carbon footprint of the winery's agricultural practices and their outbound logistics. But, you would also learn that the rating does not consider labor practices, and it is lenient in its treatment of potentially hazardous pesticides. Based on that information, an investor, consumer, or potential employee could make a more informed decision about the credibility of the winery's rating.
Fewer but Better Ratings
The Global Initiative for Sustainability Rating and its partners hope that their certification will encourage greater use of sustainability ratings by enhancing their rigor, dynamism, and transparency. They also hope that by assessing ratings they will encourage weaker rating services to improve. Ultimately the result may be fewer ratings, but the ones that survive will be more useful and more influential in the marketplace. The Global Initiative has an impressive list of partners in the United States and abroad, including AMD, USB, Siemens, PepsiCo, Bloomberg, Hermes and Oxfam.
Growing the Power of Sustainability Ratings
Sustainability ratings are attracting new respect among investors and operating companies. "Sustainability works!" says Bruno Bertocci, head of global sustainable equity investing for UBS. UBS has found that top performers on sustainability metrics build superior brand equity and often have an edge in attracting talent. In Bertocci's experience, "when sustainability factors are taken into account alongside traditional measures of valuation, superior investment results can be obtained."
AMD found that their focus on sustainability led them to build tools for making more energy-efficient semiconductors, which are very popular with consumers. In addition, sustainability metrics help them choose better suppliers. Says Tim Mohin, director of corporate responsibility for AMD: "When a potential supplier opens up to a third party to rate them on sustainability, it usually means they are well-managed in other ways."
Most importantly from a financial standpoint, the discipline of sustainability reduces risks. BP's disaster with Deepwater Horizon might not have happened had the company been rigorously rated on its environmental practices. They would have found the weaknesses in their systems and processes before the disaster occurred. Wal-Mart's recent connection with a tragic factory fire at one of its suppliers might also have been avoided.
We have not yet reached the point where investors raise sustainability issues on quarterly earnings calls. But that day is approaching, as more companies understand that sensible, well-constructed sustainability metrics pay off in financial terms. Certifying raters against a world class standard is an important step toward making ratings more credible, more pervasive, and ultimately more effective.