Estimates suggest ESG investing could surpass $50 trillion by 2025, as investors around the world look for opportunities for their investment capital to have a broader social impact. However, research suggests that ESG ratings suffer from a measurement trap that occurs when a metric used as part of the rating is systematically biased towards certain industries or types of companies. This trap can manifest in three ways: 1) The rater focuses on what can easily be measured; 2) The rater overly simplifies the feature to be measured into an existing categorical framework; or 3) The rater tries to distill rich multi-dimensional data into a single number. A two-pronged solution can improve transparency, efficiency, and effectiveness, creating a win-win-win-win scenario for firms, investors, policymakers, and the world more broadly.
