Researchers Hongtao Chen, Yunlang Wu and Jun Huang, all from the Shanghai University of Finance and Economics found an interesting link between ESG ratings and audit fees.
Along the way they note nearly 600 agencies are now providing ESG rating services globally with roughly 20 [Surely more? Ed.] of those in China. The problem with all these self appointed arbiters of good practice is that few agree on standards (yet, some are trying) for good behavior.
The problem with this absence of consensus is it creates the thing markets, always and everywhere abhor, uncertainty.
The paper looks at the negative effect through the lens of audit fees. Usually an auditor requires more compensation the more work they have to do and that’s often a function of the perceived risk a company presents.
What the researchers found was a wide dispersion of ESG ratings for a particular company resulted in higher audit fees for that enterprise . The paper doesn’t go down this alley but I think there are useful implications for investors.
If, when performing a regular due diligence, we find audit fees higher than peers and ESG rating agencies can’t agree on whether a company is a rogue or a Dudley Do-Right then extra care should be taken with analysis.
Moreover, it seems a proliferation of ESG rating agencies rather than providing the natural disinfectant of sunlight onto a company’s operations is instead having the effect of muddying the waters and by implication raising the long term cost of capital.
In short, too many watchers attempting to provide third-party clarity are in fact producing exactly the opposite effect. Which doesn’t mean they should either stop trying or that their work isn’t of some use.
This work also provides a useful reminder for one of my long held tenets i.e. when it comes to company analysis there’s no substitute for your own work and you should NEVER, EVER rely on the work of others.
You can read the work in full via the following link How ESG Rating Divergence Affect[s] Corporate Audit Fees.
Happy Sunday.