What Will Become of Corporate Sustainability Ratings?

What Will Become of Corporate Sustainability Ratings?

The "Rate the Raters: Phase 2" report released last week presents a welcome and legitimate challenge to the status quo of corporate responsibility ratings and to those of us who stand behind the ratings that our organizations produce. As a rating agency, the challenges summarized in the report are not a surprise to us, in fact recent issues from SAM and the DJSI highlight these challenges. But overall, the report is a good distillation and comparison of the enormous population of ratings that currently exist.

As a rater, I thought that this would be a good opportunity to weigh in about how we have attempted to address (with varying degrees of success) some of the challenges this report seeks to document. With Two Tomorrows, I co-directed the Tomorrows Value Rating for three years (originally known as the Accountability Rating) and continue to serve as a key contributor to the criteria development and annual research.

Launching a New Rating

When the Accountability Rating was launched in 2004 it was based on three principles:

1) Companies with the largest revenues have the greatest potential impact on global sustainability;
2) Transparency is fundamental to responsibility; and
3) Corporate responsibility is in essence a stakeholder-driven practice, so responsible companies must address stakeholder principles of responsiveness, completeness and materiality.

The resulting rating criteria were based on domains for responsible governance (who at the company is accountable?), material issues (what is the company accountable for?), stakeholder engagement (is engagement effective?) and strategic alignment (does the company's self-interest align with societal interests on those material issues)?

Report coverBased on our principles, we rated the largest 100 companies in the world (based on revenue) using only publicly available information. We felt that this was the most effective means to build a credible database of information, especially after feedback from rated companies already indicated severe survey fatigue.

At the same time, we committed to contacting every company during the research to ensure we had all of the relevant and appropriate documents we might need. Results of the Tomorrows Value Rating were published in Fortune magazine from 2006-2009 and our revenue model was based on benchmark sales using the database of information.

How a Rating System Evolves

Since its launch, the Tomorrow's Value Rating methodology has been in constant evolution. For instance, we've had to balance the desire of our benchmark clients who want year-over-year comparability and consistent criteria with our desire as leaders in the sustainability field to keep the criteria updated and to maintain pace with changing best practices.

In the end, we struck a compromise by maintaining a mostly consistent structure for the analysis domains, but we adjust the underlying criteria to match emerging trends such as new material issues, greater emphasis on value chain aspects, improved measurement of performance etc.

Questions regarding performance and comparability have been another area of challenge. Our Rating has been focused on the systems and practices that underlie reporting, based on the belief that "good" systems will result in "good" performance over the long run. We were challenged on this assumption -- primarily on the question of whether we could ever identify the specific aspects of a given system that might result in better performance.

In response, we have explored effective means to include comparable performance data into the Tomorrows Value Rating. For example this year we have partnered with Trucost to factor in estimates of external costs of companies' environmental impacts.

These environmental impacts costs are a good proxy for company performance, while simultaneously offering a good indication of how well companies are positioned as more and more of these environmental externalities are having a price attributed to them (as is already happening on carbon markets) and thereby making their way onto the corporate balance sheet.

We have also struggled with how to achieve scale without comprising what we feel are robust criteria. SRI analysts, and some clients, have pressed us to expand coverage of the Tomorrow's Value Rating from hundreds of companies into the thousands of companies. But our research model is based on the expert ability of the rating team, and we have not found a model by which senior-level analysts could feasibly generate so large a number of assessments. This decision to aim for quality and in-depth analysis over coverage has resonated well with our benchmark clients (and revenue model).

Comparability has also been an ongoing challenge. How do we compare an oil and gas major to a bank? How do we compare Chevron's GHG inventory to ExxonMobil's? Perhaps surprisingly, we find many aspects of corporate responsibility translate well between sectors. Good management systems share common characteristics whether at a centralized bank, or a de-centralized extractives company, and an experienced analyst can identify leading practices that companies in various sectors will benefit from being benchmarked against.

However, each sector also faces its own and often very specific sustainability issues that represent big risks and opportunities to its companies, and in our opinion this is where most major ratings fall short -- they simply fail to take adequate account of the crucial sector-specific sustainability challenges. Therefore, our focus over the last several years has been to hone material issues and best practice indicators for individual sectors.

One final challenge fundamental to all rating criteria and assessment teams was cast into the limelight by the Gulf of Mexico oil spill this year: How, by only "seeing through the window of publicly available information," can we fully evaluate the effectiveness of company's or industry's sustainability initiatives?

If financial auditors could not predict events like the Enron and WorldCom malfeasances and other incidents that have followed, expecting corporate responsibility raters to do so is probably a tall order. While we rely on transparent disclosures, corporate reports, media reports or survey results are prone to some bias that the criteria and the rater must be able to "see through" to make a valuable judgment.

For now, no rating can claim to have achieved an indisputable ability to assess and rate the responsibility or sustainability of companies. Nevertheless, the ability of of ratings -- to identify good practices and promote continuous improvement is still a worthy cause of current efforts.

So where does all this leave us going forward? For our part, we believe the ratings industry will evolve in several positive ways to address some of these year-on-year challenges.

Partnership building: Whether it is for better performance data or improving the underlying criteria, we believe the most valuable ratings will build on meaningful partnerships, e.g. between different rating agencies, between raters and data analysts, etc.

Complementing depth with scale: It might be a quick and dirty screening tool supported by more in-depth analysis for clients or specific cross-sections, but to achieve impact and value, rating agencies will need to find the tools to achieve both scale and depth.

Increasing transparency of criteria: Purely transparent criteria have a knack for rewarding companies that 'test well' rather than strong corporate citizens. Nevertheless, ratings will slowly need to become more transparent so that consumers of information can fairly evaluate the value that the rating brings.

Some investors and rating agencies are increasingly considering social and environmental performance information collected by regulators, which are proving to be a valuable third-party repository of data. For us, this gives rise to a key question: Is there a need for new public institutions that can play a larger role in more comprehensively collecting, assuring and assessing data on corporate responsibility performance?

As a rating agency, we acknowledge that we do not have the answers yet, but we look forward to being an active participant and catalyst in these changes.

Todd Cort is CEO of Two Tomorrows North America.