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Governance Metrics

How ESG Governance Ratings Are Constructed

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How Are ESG Governance Ratings Constructed?

Governance ratings aggregate complex, multi-dimensional governance assessments into comparable scores. The major providers — ISS, MSCI, Sustainalytics, and Glass Lewis — use different methodologies, weights, and data sources, producing scores that often diverge significantly for the same company. Understanding what each rating measures, where providers agree and disagree, and how to use them appropriately within a proprietary governance assessment framework is essential for governance-integrated ESG analysis.

ESG governance ratings are quantitative scores that aggregate multiple governance quality indicators — board structure, compensation alignment, shareholder rights, transparency, anti-corruption — into comparable cross-company metrics used for portfolio screening, engagement prioritization, and governance quality assessment.

Key Takeaways​

  • ISS QualityScore (1–10) and Glass Lewis Grade assess governance primarily from a shareholder accountability perspective.
  • MSCI Governance Score (0–10) is one pillar of the composite MSCI ESG Rating, covering corporate behavior and corporate governance categories.
  • Governance rating disagreements are common: companies scoring well on ISS QualityScore sometimes score poorly on Sustainalytics governance risk, because the two systems measure different things.
  • No rating captures culture quality, management behavior, or the substance behind formal governance structures.
  • Proprietary governance analysis using the metrics discussed throughout this chapter produces more nuanced and company-specific assessments than commercial ratings alone.

ISS QualityScore​

What It Measures​

ISS QualityScore rates governance quality on a 1–10 scale (1 = least governance risk) across four pillars:

  • Board Structure: Independence, composition, committee quality, diversity
  • Shareholder Rights: Anti-takeover defenses, shareholder rights mechanisms, voting rights
  • Compensation: Pay-for-performance alignment, compensation governance, clawback policies
  • Audit and Risk Oversight: Audit committee quality, auditor independence, financial statement risk

Methodology​

ISS scores are primarily structural — they assess formal governance document characteristics, proxy statement disclosures, and shareholder meeting outcomes. Quantitative inputs include director independence ratios, board tenure data, non-audit fee ratios, and poison pill characteristics.

ISS QualityScore is most useful for: identifying companies with obvious structural governance deficiencies; comparing governance structures within peer groups; proxy season preparation when engaging on specific governance issues.

MSCI Governance Score​

MSCI's governance assessment contributes approximately one-third of the overall MSCI ESG Rating (CCC–AAA scale). The governance pillar is divided into:

Corporate Behavior: Anti-competitive practices, corruption and instability, financial system instability (for financial companies), tax transparency.

Corporate Governance: Board quality, pay quality, ownership structure.

MSCI uses a combination of company disclosure data, regulatory enforcement records, media signals, and proprietary models. The Corporate Behavior component differentiates MSCI's governance assessment from ISS — addressing ethics and anti-corruption alongside structural governance.

Sustainalytics Governance Risk​

Sustainalytics evaluates governance within its broader ESG Risk Rating framework. The management risk assessment for governance covers:

  • Corporate governance programs (board independence, audit quality)
  • Business ethics programs (anti-corruption, ethics hotline)
  • ESG reporting quality (disclosure standards, assurance)

Sustainalytics is notable for integrating business ethics more explicitly into governance scoring than ISS, which focuses primarily on shareholder accountability structures.

Glass Lewis​

Glass Lewis produces governance analysis primarily in the context of proxy vote recommendations, not as standalone governance ratings. Their Governance QualityScore (piloted and discontinued at various points) assessed board composition, compensation structure, and audit quality. Glass Lewis's primary governance output is the vote recommendation letter for each AGM agenda item, which contains detailed governance reasoning.

Rating Disagreements in Governance​

Academic studies of ESG rating divergence (Berg, Koelbel, and Rigobon, 2022) find that governance ratings from different providers disagree significantly — correlations of 0.5–0.6, meaning approximately one-quarter to one-half of governance variance is provider-idiosyncratic rather than reflecting genuine company characteristics.

Sources of governance rating disagreement:

  • Scope differences: ISS focuses on shareholder accountability; MSCI includes ethics and anti-corruption; Sustainalytics includes ESG reporting quality. Different scope = different scores for the same company.
  • Weight differences: A company with strong board independence but controversial executive compensation scores differently depending on the weight each system gives to each pillar.
  • Data vintage: Providers update governance data at different frequencies; governance changes take different times to be reflected.
  • Qualitative interpretation: Two providers applying judgment to the same ownership structure may reach different conclusions about governance risk.

Using Governance Ratings Effectively​

Appropriate uses of commercial governance ratings:

  • Portfolio screening to identify companies with obvious structural governance deficiencies
  • Peer group comparison within sectors
  • Proxy season preparation — understanding which directors and resolutions face scrutiny
  • Coverage gap filling for smaller companies where proprietary analysis capacity is limited

Inappropriate uses:

  • As the primary or sole governance quality metric
  • As substitutes for engagement (understanding company-specific context)
  • For cultures and ethics assessment (ratings miss this dimension almost entirely)
  • For private company governance assessment (ratings cover listed companies only)

Common Mistakes​

Treating ISS QualityScore 1 (lowest risk) as a governance quality endorsement. ISS QualityScore measures structural governance relative to ISS policy expectations. It does not measure whether the board is genuinely effective, whether management is honest, or whether the company will make good long-run decisions.

Choosing funds based on portfolio governance score averages. A portfolio's average ISS QualityScore does not predict the fund's governance risk-adjusted returns. Individual company-level red flags matter more than average scores.

Not checking rating vintage. Governance ratings from earlier in the year may not reflect post-AGM governance changes, new director appointments, or recent compensation plan amendments.

Summary​

ISS QualityScore, MSCI Governance Score, Sustainalytics, and Glass Lewis each assess governance from different angles — structural accountability, ethics behavior, and disclosure quality — producing scores that frequently diverge significantly for the same company. Commercial ratings are useful for screening, peer comparison, and proxy season preparation but miss culture quality, management behavior, and substantive governance effectiveness. The most robust governance analysis combines commercial ratings with the proprietary assessment framework developed across the articles in this chapter — board quality beyond formal independence, culture proxies, ownership structure context, capital allocation discipline, and anti-corruption program depth.

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