[Opinion] Understanding ESG Evaluation

Jinyoung Shin, President of the Korea Corporate Governance Service and Professor at Yonsei University School of Business

In 2021, ESG (Environmental, Social, and Governance) has gained attention as a new paradigm for corporate management, and Korean companies are actively taking steps to fully incorporate ESG into their management practices. It is natural that ESG is still a relatively unfamiliar concept and that time and effort are required for it to become established. Amid this, not only credit rating agencies but also numerous media outlets are preparing ESG evaluations, and some media companies have already announced their results, causing confusion even before ESG management has properly begun.

The Korea Corporate Governance Service (KCGS), where the author is currently employed, has been conducting corporate governance evaluations since its establishment in 2002 and expanded to integrated ESG evaluations in 2011. The evaluations are conducted annually using a proprietary evaluation model developed based on the code of best practices established by KCGS, reflecting domestic laws and regulations, overseas standards, and the business environment. The evaluation targets include all companies listed on the Korea Stock Exchange and some KOSDAQ-listed companies, as well as approximately 1,000 companies including unlisted financial firms that undergo governance evaluations only. The evaluation is conducted by collecting publicly available information such as business reports, sustainability management reports, and media coverage, without requesting separate data submissions or conducting surveys with companies.

Before the evaluation begins, sessions are held to explain the evaluation model to companies, and all aspects including the evaluation model, criteria, and grading methods are disclosed. In October, when the initial evaluation is completed, individual companies are informed of their evaluation grades and feedback is collected to finalize the grades. Detailed evaluation reports are then prepared and provided to all evaluated companies. The integrated grade and the social, environmental, and governance grades are published on the website. The annual regular evaluation concludes with an awards ceremony for outstanding companies and a briefing session on the evaluation results. Subsequently, if ESG-related incidents occur in evaluated companies, quarterly grading committees are held in the following year to adjust grades accordingly. In 2020, the number of companies participating in feedback increased by about 50% compared to the previous year, but still, around 700 out of approximately 1,000 evaluated companies did not engage in the feedback process.

With growing interest in ESG, inquiries about evaluations have surged this year, and even unlisted companies are increasingly requesting voluntary evaluations. As a non-profit organization, KCGS does not charge companies any fees during the evaluation process and does not provide paid ESG management consulting to avoid conflicts of interest. Of course, responses to inquiries and communication with companies continue throughout the year.

The biggest controversy and dissatisfaction among companies regarding ESG evaluations stem from the fact that evaluation results for the same company differ among evaluation agencies, and the evaluation methods and processes are opaque, making it difficult for companies to accept the grades assigned to them. This issue is also raised by overseas companies where evaluations have been conducted for several years. Differences in evaluation results are inevitable due to the nature of ESG evaluations, which utilize non-financial information. Even in credit rating evaluations, which are quantitatively conducted using financial information, results vary among rating agencies, and the differences in ESG evaluations are naturally greater. Each evaluation agency has its own unique evaluation model and uses different information. Recently, some agencies have begun using artificial intelligence (AI) to collect relevant information in real time and adjust evaluation results, further increasing differentiation among agencies. Even with similar evaluation models, differences in evaluation criteria, scoring methods and scales, and weighting of criteria in the final grade calculation lead to varying results. While overseas evaluation agencies such as Morgan Stanley Capital International (MSCI) and Bloomberg evaluate companies worldwide using uniform standards for mutual comparison, domestic agencies like KCGS reflect the realities and characteristics of Korean companies, which results in differing evaluation outcomes.

On April 21, the Ministry of Trade, Industry and Energy held a 'K-ESG Indicator Industry Meeting' with major companies and unveiled a draft of the ESG indicators. Currently, about 600 evaluation indicators are in use domestically and internationally, and differing evaluations among agencies have caused confusion for evaluated companies, prompting the ministry to establish the K-ESG indicators. On April 29, Hong Nam-ki, Deputy Prime Minister and Minister of Economy and Finance, announced that the Korean-style K-ESG would be completed to meet global standards by next year. However, there is no precedent anywhere in the world for a government-led ESG evaluation indicator. ESG management fundamentally involves each private sector company establishing and pursuing its own goals and strategies for sustainable management according to its circumstances and characteristics. The moment ESG management is evaluated using government-created indicators, it becomes just another government regulation. Moreover, the fact that different government ministries discuss K-ESG indicators within a week only adds confusion to the nascent ESG management efforts.

From a corporate perspective, it is neither feasible nor helpful for management to respond to all domestic and international evaluations. Due to the nature of ESG evaluations, a high ESG evaluation grade is a necessary but not sufficient condition for superior ESG management. Companies should establish and pursue their own ESG management goals and strategies, and use evaluation results to understand how external parties view their ESG management, communicate with various stakeholders, and revise and supplement their ESG management accordingly.

Jinyoung Shin, President of Korea Corporate Governance Service and Professor at Yonsei University School of Business