metadata: authors: 0: author: Ferrazzi,Matteo
1: author: Tueske,Annamaria
count: Middle East and North Africa
docna: 0: docna: Small and Medium Enterprises in Emerging
            Economies : The Achilles’ Heel of Corporate ESG
            Responsibility Practices ?
docty: Policy Research Working Paper
bdmdt: 2022-06-14T00:00:00Z
abstracts: cdata!: The information contained in the
            Enterprise Survey—administered by the World Bank (WB), the
            European Bank for Reconstruction and Development (EBRD), and
            the European Investment Bank (EIB)—is used to build a
            firm-level “Corporate Environmental, Social, and Governance
            Responsibility” composite indicator. The novelty of the
            indicator, compared with the corporate social responsibility
            scores and environmental, social, and governance (ESG)
            scores already available, is due to its unique coverage,
            namely, a large number of private sector small and
            medium-size enterprises in selected emerging economies (more
            than 40 economies covered by the Enterprise Survey). The
            composite indicator summarizes information on private sector
            actions on environmental, social, and governance factors.
            The analysis shows that the actions of private sector small
            and medium-size enterprises in emerging economies to foster
            sustainability and green growth significantly lag in the
            transition to a more sustainable business environment, and
            large gaps persist. Among emerging economies, those in the
            Middle East and North Africa—which deserve special attention
            due to the urgent need to green their growth model—are among
            the worst performers. Larger companies in the Middle East
            and North Africa show better environmental, social, and
            governance performance than small and medium-size
            enterprises in other areas; but smaller firms in the Middle
            East and North Africa show extremely weak performance in
            many aspects, even if controlling for the relative level of
            economic development. The weakness of environmental, social,
            and governance practices among firms in the Middle East and
            North Africa is due to the social (with large gaps in female
            participation in the workforce and management) and
            environmental topics. This calls for urgent policy action to
            address such weaknesses and exploit the full potential of
            the region.
display_title: Small and Medium Enterprises in
            Emerging Economies : The Achilles’ Heel of Corporate ESG
            Responsibility Practices
closedt: 2022-06-14T00:00:00Z
listing_relative_url: /research/2022/06/33814473/small-medium-enterprises-emerging-economies-achilles’-heel-corporate-esg-responsibility-practices
topicv3: Environmental and Social Assessments
            m1325983 1388,Corporate Governance m1326968 417,Governance in Public Sector m1327255 831,Small and Medium-Sized Enterprises and
            Jobs m1504023 2720
publishtoextweb_dt: 2022-06-09T00:00:00Z
dois: 10.1596/1813-9450-10065
origu: Off of Sr VP Dev Econ/Chief Econ (DECVP)
author_keys: 0: author_key: NA
1: author_key: NA
model_extractions: Policy Research Working Paper 10065

**Unlocking SUStainable Private Sector growth in the Middle eaSt and north africa**

_Background Paper_ Small and Medium Enterprises in Emerging Economies The Achilles’ Heel of Corporate ESG Responsibility Practices?

_Matteo Ferrazzi Annamaria Tueske_ Middle East and North Africa Region Office of the Chief Economist June 2022
Policy Research Working Paper 10065

# **Abstract**

The information contained in the Enterprise Survey— administered by the World Bank (WB), the European Bank for Reconstruction and Development (EBRD), and the European Investment Bank (EIB)—is used to build a firm-level “Corporate Environmental, Social, and Governance Responsibility” composite indicator. The novelty of the indicator, compared with the corporate social responsibility scores and environmental, social, and governance (ESG) scores already available, is due to its unique coverage, namely, a large number of private sector small and medium-size enterprises in selected emerging economies (more than 40 economies covered by the Enterprise Survey). The composite indicator summarizes information on private sector actions on environmental, social, and governance factors. The analysis shows that the actions of private sector small and medium-size enterprises in emerging economies to foster sustainability and green growth significantly lag in the transition to a more sustainable business environment, and large gaps persist. Among emerging economies, those in the Middle East and North Africa—which deserve special attention due to the urgent need to green their growth model—are among the worst performers. Larger companies in the Middle East and North Africa show better environmental, social, and governance performance than small and medium-size enterprises in other areas; but smaller firms in the Middle East and North Africa show extremely weak performance in many aspects, even if controlling for the relative level of economic development. The weakness of environmental, social, and governance practices among firms in the Middle East and North Africa is due to the social (with large gaps in female participation in the workforce and management) and environmental topics. This calls for urgent policy action to address such weaknesses and exploit the full potential of the region.

This paper is a product of the Office of the Chief Economist, Middle East and North Africa Region. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at m.ferrazzi@eib.org and a.tueske@eib.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Small and Medium Enterprises in Emerging Economies: The Achilles’ Heel of Corporate ESG Responsibility Practices?**

**Matteo Ferrazzi, Annamaria Tueske**<sup>1</sup>

JEL codes: C43, M14, Q56, R11 Keywords: ESG, environmental, social, governance, sustainability, corporate responsibility, SME, Middle East and North Africa, index aggregation 1 <u>m.ferrazzi@eib.org, Senior Economist, European Investment Bank, Economics Department; a.tueske@eib.org, Economist,</u> European Investment Bank, Economics Department. This paper was commissioned by the World Bank Middle East and North Africa Chief Economist office as part of the activity “Assessing the MENA formal Unlocking Sustainable Private Sector Growth in the Middle East and North Africa: Evidence from the Enterprise Survey." The opinions expressed in this paper do not represent the views of the World Bank Group, its Board of Directors or the Governments they represent. The opinions also do not reflect the views of the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB). All errors and omissions are the authors’ responsibility. We are thankful to Francesca Maritati (EIB Corporate Responsibility) and other colleagues from EIB, EBRD and World Bank for comments. We would also like to thank the participants of two workshops hosted by the World Bank, EBRD, and EIB for their feedback.

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# **1 Introduction**

Environmental, social and governance (ESG) considerations play a key role in companies’ business strategy worldwide. They guide investors, financial institutions, customers and suppliers to understand the capability of companies to produce value for a broad range of stakeholders (not only for companies’ shareholders, but also communities, workers, consumers, the environment, etc.) in a long-term perspective.

Investors are generating an increased and more sophisticated demand for ESG information, but producing such information is generally complex. Disclosure of ESG information by firm is very limited everywhere; it is mainly done by listed companies. However, SMEs not only represent 98% of firms, and 67% of total employment in Europe (Saez-Martinez, 2016) and even more in emerging countries (ILO, 2019), they are also responsible for 60%-70% of pollution globally (Hillary, 2017, and Miller, 2011). Smaller companies, despite a large number of initiatives,<sup>2</sup> have neither legal obligations, resources, nor relevant incentives to put in place systems to give full disclosure of ESG-relevant information. The picture is even more complex in emerging countries, where only a small number of firms is listed, the average company size is smaller, and ESG information is even more limited if not totally absent. For SMEs (typically not covered by ESG rating agencies) and especially for emerging countries, the urgent need for ESG firm-level information and disclosure is in sharp contrast with its scarce availability.

Between 2018 and 2020, the World Bank Group (WBG), the European Bank for Reconstruction and Development (EBRD), and the European Investment Bank (EIB) fielded the Enterprise Survey (ES) in 41 countries in the Middle East and North Africa (MENA), Southern Europe, Central, Eastern and Southeastern Europe, and Central Asia. More than 28,000 interviews were completed, answered by business owners and top managers. The survey addresses formal (registered) companies with more than 5 employees, in the manufacturing and (selected) services sectors. The ES covers a broad range of business environment topics, including access to finance, innovation, trade participation, and performance measures.

In various aspects, the ES questionnaire is compatible with some components of ESG ratings, even though the ES questionnaire has not been designed following any ESG standards, nor for possible use on any aspects of ESG topics. However, the questionnaire has a number of questions related to the environmental component of ESG in a special Green Economy Module, and useful inputs concerning the firms’ governance and social aspects as well. For this reason, the information derived from the ES can be a precious source of information regarding these topics: looking at the characteristics of ES firms in different macro-regions, sectors, and size classes can improve the understanding of where firms stand in terms of climate transition, social responsibility and sustainability.

Leveraging on the firm-level information of the ES, we built a “Corporate ESG Responsibility” composite indicator, which is an “ESG-type” and “sustainability-type” score, partially inspired by

> 2 On corporate climate governance, for instance, non-binding guidelines and reccomendations were put forward, for instance, by the Task Force on Climate-related Financial Disclosures (TCFD) of the Financial Stability Board; by the Network for Greening the Financial System (NGFS); and by the EU Technical Expert Group on Sustainable Finance (TEG, Haralampieva, 2020).

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ESG scores produced by ESG rating agencies. Our aim is not to reproduce ESG scores of listed, large companies to serve investors’ needs, but to shed some light on these aspects related to smaller unlisted companies in emerging countries. The indicator is unique, being the only one based on a wide sample of ES respondents.<sup>3</sup> By analyzing the actions of private sector SMEs in emerging countries to foster sustainability and green growth, we aim to better understand their contribution to the transition towards a more sustainable business environment. Given the increasingly ambitious social and environmental goals, measuring what matters for the planet and for people is something that cannot be ignored any longer, despite the obstacles of obtaining the relevant information for SMEs in emerging countries. The firm-level composite indicator helps to understand the performance of countries, sectors and size classes in each of the ESG pillars. Moreover, the determinants of the “Corporate ESG Responsibility” composite indicator can help to identify the drivers of the ESG performance in emerging countries as well as to understand how much ESG aspects are contributing to firms’ performance in the various dimensions.

In particular, we focus on MENA countries for a number of reasons. First, the region is significantly exposed to climate change - in terms of water scarcity, exposure to heat and in some cases to sea level rise - and to social developments (with relevant gender issues). Second, MENA countries need to green their growth model, as the region has seen CO2 emissions in absolute terms and even in per capita terms rising during the last years (between 2005 and 2018, absolute CO2 emissions increased by almost 50 percent). Finally, given the need to step up the climate ambition in MENA, there are relevant investment opportunities for adaptation and mitigation.

This contribution is structured as follows. Section 2 underlines the challenges of assessing ESG components and presents a high level literature review on ESG topics. In section 3, we discuss the methodology and in section 4, we show some results for emerging economies with a particular focus on the MENA region, where firms are showing the worst results across emerging markets.

# **2 The challenges of assessing ESG: A review of existing methodologies**

Under increasing regulatory and market pressure, firm-related ESG disclosure developed significantly over the last couple of years. However, while ESG topics require consistent and comparable metrics in order to compare firms’ performances, a consensus has not been reached on the relevant dimensions to assess the performance of firms.

Typically, ESG rating agencies<sup>4</sup> use firm-level quantitative and qualitative information to produce ESG ratings. They engage with firms directly – often using questionnaires to obtain financial and

> 3 Survey information is widely used for assessing ESG/Sustainability ratings. It is normally complementing financial information, hard data and public domain information.

> 4 The main ESG rating agencies are the following: Vigeo Eiris, which is part of Moody's (Moody's acquired a majority stake of Vigeo Eiris in April 2019); ISS-oekom (Institutional Shareholder Services group of companies - “ISS”) which has been integrated

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non-financial data – and they also review public information (produced by the company or by other sources of information). Such direct, full assessment of the ESG practices of each counterpart is not always feasible given the large amount of information to be processed and the large number of firms. The spectrum of firms covered by the main rating agencies is very wide, as each agency may cover from 1,000 to 10,000 companies (Moody’s, 2021). However, the coverage of smaller companies, less regulated industries and emerging countries by the main rating agencies is particularly patchy.

To address the data constraints issues related to SMEs, Moody’s is complementing its firm-level approaches with another methodology, namely with a “deductive” top-down approach (“ESG Score Predictor”). It developed a model of ESG ratings for a set of companies whose metrics are known, which it then applies to “unscored” companies (Moody’s, 2021). By this method, it enlarges the spectrum of companies with an ESG rating (potentially to an infinite number). It does so by leveraging on only 3 firm-level dimensions: company size (based on assets or turnover), location and industry (615 NACE4 industries). The firm-level information (size, location and industry) is complemented with numerous country level data (more than 50 criteria) on socioeconomic indicators and scores. If size, location and industry are known, the model leverages on these three inputs to generate an ESG rating for any company. Hence the Moody’s ESG Score Predictor methodology, which is very partial (with less information available, it generates an output covering by far more firms compared to “traditional” ESG ratings), does not rely on any firmlevel ESG-related information, as the full assessment of each company is not possible. This is different from our methodology, which is entirely based on firm-level information of the Enterprise Survey and does not leverage any country data, despite the availability of ESG country data for numerous emerging countries (World Bank, 2021).

The rating methodologies provided by the main ESG rating agencies differ from each other significantly (in terms of building blocks, materiality assessment, weights used to aggregate the information, etc.) and cannot be reconciled under one single approach. The main building blocks utilized by the ESG rating agencies are typically the following (sometimes similar concepts appear under different names):

- Environmental:

- Environmental strategy or green management

- Environmental impact or footprint

- Social

- Gender

- Human resources, including education and training

- Labor conditions

- Community involvement

- Governance

- Corporate governance and stakeholders

with oekom research in 2018; Sustainalytics, which is part of Morningstar; MSCI ESG Rating (which in 2019 acquired Carbon Delta, a Zurich-based environmental fintech and data analytics firm specializing in climate change scenario analysis).

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- Audit and internal controls

- Management remuneration policies

- Business ethics and business behavior

In all these aspects, ESG rating agencies are using significantly different approaches (Berg et al., 2020; Chatterji et al., 2016; Gibson, 2019; Durand and Touboul, 2014). ESG scores provided by different agencies have very low correlation with one another (Berg et al., 2019) and there are widespread changes to the historical ratings, generating an “unpredictable past” of ESG ratings (Berg et al., 2020).

This lack of an “industry standard”, or “surprising lack of agreement” among agencies (Chatterji et al., 2016), or even “aggregation of confusion” (Berg et al., 2020) which is determining the “alphabet soup” (derived from the acronym-heavy measurement and reporting standards) in the ESG rating realm makes it problematic to build an indicator relying only on one of the agencies’ methodologies.

Even the choice of a standard among the various, existing frameworks is a challenge, as the field is populated by different players and frameworks. The main ones include:

- i. The Sustainability Accounting Standards Board (SASB) guides companies to disclose sector-specific and financially-material sustainability information to investors. In November 2020, SASB announced that it would merge into a unified organization with the International Integrated Reporting Council (IIRC) to create the Value Reporting Foundation (VRF).

- ii. The Global Reporting Initiative (GRI) is an independent, international organization providing the world’s most widely used standards for sustainability reporting – the GRI Standards.

- iii. The Carbon Disclosure Project (CDP) runs a global disclosure system for investors, companies, cities, states and regions to manage their environmental impacts.

- iv. The Task Force on Climate-related Financial Disclosures (TCFD), which was created by the Financial Stability Board, aims to improve and increase reporting of climaterelated financial information (rather than to develop standards) to support informed capital allocation.

- v. The Principles for Responsible Investment (PRI) were developed by an international group of institutional investors reflecting the increasing relevance of environmental, social and corporate governance issues to investment practices. In signing the six Principles, investors commit to adopt and incorporate ESG factors into their investment and ownership decisions.

While most of the above organizations are collaborating to achieve a more standardized version of sustainability reporting (World Economic Forum, 2020), there are still significant differences and deviations in their approaches. Different accounting requirements in terms of ESG may add costs, complexity and risk to companies and investors, and they cannot be ignored. Moreover, the idea of standardized ESG reporting remains highly contested, as companies argue that the unique nature of their operations will make comparisons difficult (Financial Times, 2021). At the same 5
time the “Big Four” accounting firms (KPMG, EY, Deloitte, PwC), responding in part to a rise in clients’ budgets for developing net zero emissions plans and other sustainability initiatives, have been working to set new international principles for measuring sustainability and to push forward the sustainability consulting business (Financial Times, 2021).

SASB has developed a complete set of 77 globally applicable industry standards, providing sectorspecific guidance on an extensive range of ESG topics. The main building blocks of SASB standards are the following: Environmental (E), Social and Human Capital (S), Business Model & Innovation and Leadership & Governance (G). We have aggregated these five dimensions into the three main dimensions of E, S and G. Next, we adapted the SASB methodology to take into account the structure of the ES questionnaire. In particular, the SASB subcategories were converted and aggregated into broader categories (for example, Energy Management, Water & Wastewater Management and Waste and Hazardous Material Management appear under a unified category called Green Management). This eclectic approach - which reflects the SASB framework, takes into account the approach of ESG rating agencies, and adapts to the structure of the ES questions – made it possible to match the survey’s questions with the ESG frameworks already in use.

# **SASB Dimensions and Categories**

|**Dimension**|**General Issue Category**|
|---|---|
||GHG Emissions|
||Air Quality<br>|
|**Environment**|Energy Management|
||Water & Wastewater Management|
||Waste & Hazardous Materials Management|
||Ecological Impacts|
||Human Rights & CommunityRelations|
||Customer Privacy|
||Data Security|
|**Social Capital**|Access & Affordability|
||ProductQuality& Safety|
||Customer Welfare|
||SellingPractices & Product Labeling|
||Labor Practices|
|**Human Capital**|Employee Health & Safety|
||Employee Engagement,Diversity& Inclusion|
||Product Design & Lifecycle Management|
|**Business Model**|Business Model Resilience|
|<br>**& Innovation**|SupplyChain Management|
||Materials Sourcing& Efficiency|
||Physical Impacts of Climate Change|
||Business Ethics|
|**Ldhi &**|Competitive Behavior|
|**eaersp**<br>**G**|Management of the Legal & RegulatoryEnvironment|
|**overnance**|Critical Incident Risk Management|
|Source: SASB|Systemic Risk Management|

ESG regulation is also evolving fast and is becoming more ambitious. Sustainability disclosure is among the priorities of the world’s largest investors, and the evolution of regulation is accompanying it. In most of the cases, these new regulations or standards are not only regulatory requirements, but “business imperatives” for companies and financial institutions, to serve the growing needs of investors and consumers.

The European Union is in the lead on ESG disclosure and the European Commission is developing extensive regulation both to provide a common language for environmentally sustainable activities, and to accelerate mainstreamed ESG disclosures:

- The Taxonomy Regulation (in force since July 2020) provides a common classification system for determining whether an economic activity qualifies as “environmentally sustainable”. The Taxonomy applies to (i) financial market participants, (ii) entities in scope of the Non-Financial Reporting Directive (NFRD), and (iii) Member States and the Union when setting out requirements for financial products considered environmentally sustainable.

- The European Green Bond standard proposal (July 2021) will create a voluntary “gold standard” for issuers seeking to use green bonds to raise funding on the capital markets.

6
<!-- Start of picture text --> The Taxonomy defines which<br>economic activities can be<br>ieegulation= sustainable”.considered. These“environmentallydefinitions are<br>used for both the SFDR and CSRD*<br>The SFDR specifies how financial The CSRD applies to all large<br>market participants. should disclose. companies and all companies listed<br>re P CSRD on regulated markets. It ensures that<br>sustainability information to end . . .<br>. . : (replacing investee companies report the<br>investors. To do so, financial market . : . i<br>. NFRD) information that financial market<br>participants need adequate - . :<br>. : . . participants need to fulfil their own<br>information from investee companies . .<br>SFDR reporting requirements<br>*The Taxonomy applies to (i) financial market participants, (ii) entities in scope of the NFRD, and (iii) Member States and the EU<br><!-- End of picture text -->
depend on their size or legal status, and (ii) the redirection of investments towards green activities should not be limited to listed firms.

In the United States, any implementation of an ESG disclosure framework by a company remains voluntary (Clarkin, Sawyer and Levin, 2020), despite public companies facing mounting pressure from investors.<sup>5</sup> The picture is direr for emerging countries, which tend to have less stringent regulations and lag in implementing them (Moody’s, 2021). While in the EU, current and upcoming regulation will gradually bring some standardization of ESG information, in other countries (and particularly emerging economies) this could take much longer, in same countries even decades.

# **3 Methodology**

The aggregation of the components of ES to obtain “sustainability-type” scores is an exercise facing problems similar to those encountered by the ESG rating agencies, and in most of the cases not fully solved by the same ESG rating agencies, i.e. i) how to assess materiality, ii) what weight to put on the components, iii) the relevance of company size.

**Materiality** : When selecting the relevant dimensions, it is of primary importance to assess the materiality: what is relevant for one business or one sector may be less important for another (for instance, the consumption of gasoline is significantly impacting a company active in the transport sector, but is not so relevant for an IT company). In addition, the concept of materiality should be interpreted in a dual way (the “double materiality”), accounting for both the impact that a given company has on the environment and the society, as well as the impact that ESG factors have on the company itself. Materiality typically differs across sectors: sustainability issues are likely to affect the financial conditions or operating performance of companies in a very different way across sectors.<sup>6</sup> The ES has information on the 4-digit industry the firm generates most of its revenue in, but in most countries, the sample is representative at the level of Manufacturing, Retail and Other Services<sup>7</sup> (in bigger countries, the sample representativeness is more detailed, both within manufacturing and other services).

**Weights:** Weighting the different components (i.e. attributing importance to each component) to obtain an aggregated score is a non-trivial exercise (OECD-JRC, 2008). The ES is composed of more than 200 questions, with a subset relevant for this exercise. The redundancy of indicators may cause an underestimation of the relevant ones, as their weight in the score decreases. The main ESG rating agencies attribute significantly different weights to each component. For instance, the weight of the E component may vary from 12% to 60%. However, the divergence in ratings across the different ESG rating agencies is mainly driven by the scope of categories and their different measures, and less by the weights (Berg, Kölbel, Rigobon, 2020).

> 5 Many influential institutional investors have indicated that they are in support of companies making ESG disclosures aligned with SASB and TCFD frameworks.

> 6 This is recognized by some ESG rating agencies and some Standards. For instance, the Sustainability Accounting Standard Board provides a matrix for assessing the materiality (SASB Materiality Map).

> 7 Utilities, financial companies, and public sector entities are excluded from ES.

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**Relevance of companies’ size:** Firm size is a determinant of ESG practices: larger companies typically have better ESG ratings compared to SMEs. This is partially due to not only their intrinsic ability to have more sustainable business models and better management practices, but also their ability to provide the ESG rating agencies with adequate information (Berg, Kölbel, Rigobon, 2020).

Our novel “Corporate ESG Responsibility” composite indicator derived from the ES is inspired by the ESG ratings produced by the ESG rating agencies, but it does not follow any of them closely. It relies more on the structure of the Sustainability Accounting Standards Board (SASB).

Taking into account the above mentioned challenges and the available benchmarks, the “Corporate ESG Responsibility” composite indicator has been built taking the following steps:

- i. Assess the entire questionnaire of the Enterprise Survey (more than 200 questions) and select the questions related to ESG practices, allocating them to each pillar (E, S, or G).

- ii. Identify the sub-pillars of E, S and G, and the respective variables, based on relevant frameworks such as SASB and on their relevance in the assessments of the main ESG rating agencies, aiming at identifying a “common denominator” among agencies and standard frameworks.

- iii. Match the topics (i.e. set of questions) covered by the ES with the main building blocks and the sub-pillars used by SASB and ESG rating agencies.

- iv. Align the sub-pillars with SASB standards to the maximum possible extent. We included 3 sub-pillars for E (Environmental awareness, Green management practices, Green measures<sup>8</sup> ), 3 for S (Gender, Education & skills, Training), and 5 for G (Corporate governance, Management practices, Internal controls & audit, Compensation, Innovation).

- v. Manage missing data,<sup>9</sup> use imputation when possible (in line with the OECD-JRC Handbook on Constructing Composite Indicators methodology; OECD-JRC, 2008). In the case of filter questions, answers are imputed to replace some missing values when this is logically straightforward. Answers in the Enterprise Survey can be binary (yes/no), discrete (when various answers are possible), or continuous (a percentage for instance). Others were transformed into percentages.

- vi. Reduce the 60 ESG-related initial questions to 40, for one of the following reasons: i) too many missing data: if more than 55% of answers are missing, (e.g. because some questions are not asked from all firms due to eligibility or based on the sector they belong to), the component is excluded; ii) redundancy of some of the questions: if highly correlated with other variables/questions, they are not adding relevant information.

- vii. Transform the variables (21 related to E, 6 to S and 13 to G for a total of 40) into z-scores with mean 0 and standard deviation 1 (a z-score of 1.0 would indicate a value that is one

> 8 “Environmental awareness” is related to monitoring and target setting; “Green management” is related to the strategic objectives, to managerial responsibility of green targets and to green certifications; “Green measures” are the investments done by firms to improve their environmental impact. The latter can be _pure_ green investments (energy management, waste minimization, air pollution control measures, more climate-friendly energy generation on site, etc.) or _mixed_ green investments (that reduce the environmental impact as a byproduct of achieving other objectives: heating and cooling improvements, machinery and equipments upgrades, upgrade of vehicles, improvements of lighting system, etc.) (EBRD, 2020).

> 9 Missing values partially result from directly instructing companies to answer only questions relevant to them rather than receiving non-response from them. Answers can include refusal or don’t know, which are also typically treated as missing in the analysis, but can sometimes be used as valid information – this is determined on a question-by-question basis.

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<!-- Start of picture text --> 0.4<br>mEmS eG<br>0.3<br>0.2<br>°<br>g2 O21 | I<br>. 0.0 a - =<br>-0.1 1 “tT iyi<br>-0.2<br>-0.3<br>-0.4<br>-0.5<br>-0.6<br>South CEE CA EN WB MENA Russia Turkey Lower Upper<br>EU Middle Middle<br>Income Income<br>0.6<br>BEm@S G<br>0.4<br>0.2<br>3<br>8 0.0 =<br>“ae-0.2 my<br>-0.4<br>-0.6<br>-0.8<br>JOR TUN MAR LBN PSE EGY Lower Upper<br>Middle Middle<br>Income Income<br><!-- End of picture text -->
Note: Z-scores are calculated based on the entire Enterprise Survey sample. Corporate ESG _weighted_ : 40% for E, 25% for S, 35% for G. Source: Authors’ calculations based on Enterprise Survey data.

MENA countries’ social component score, on the other hand, is the lowest among all regions. The gender subcomponent – which, together with education and training of the workforce, is determining the S component – is particularly weak. Female participation in the workforce in MENA countries is low: the share of female workers in MENA (considering the firms that are part of the Enterprise Survey) is 25%, significantly lower than in the other areas (apart from Turkey). The female representation in management is poor: only 5% of MENA firms have females in management, while this ratio is more than 20% in Russia, Central and Eastern Europe and Central Asia. At the country level, Morocco and Tunisia have more female participation in the workforce (higher than 30% of total workforce in the Enterprise Survey sample) and Tunisia has a better performance in terms of presence of female management as well (10% of the firms). In this respect, the West Bank and Gaza and Jordan have the lowest presence of females in management (1% and 3% of firms respectively), with Lebanon, Morocco and Egypt around 5%6%.

**Figure 10 – Female participation** (percentage on total)

<!-- Start of picture text --> 50%<br>Firms with female in<br>management<br>40% Share of female<br>workers<br>30%<br>20%<br>10%<br>0%<br>Russia CEE CA EN WB MENA Turkey<br><!-- End of picture text --> Source: Authors’ calculations based on Enterprise Survey data.

As described earlier, ESG practices differ by sector. Since the ES sample is representative in a relatively small number of sectors, there is limited room for deeper analysis. Firms in the manufacturing sector tend to have the highest “Corporate ESG Responsibility” composite indicator, while firms in the retail sector tend to have the lowest. Firms in MENA countries have a poor performance across all sectors, with the retail segment - where small companies are more prevalent - showing the worst results. The manufacturing sector in MENA is significantly weaker than manufacturing in most of the other regions in terms of ESG practices.

**Figure 11 - Average quality of Corporate ESG Responsibility, by sector and region** (composite indicator, z-score)

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<!-- Start of picture text --> 0.45<br>0.40<br>0.35<br>0.30<br>0.25<br>0.20<br>0.15<br>0.10<br>0.05<br>-0.05<br>-0.10-0.15 t<br>-0.20<br>-0.25<br>-0.30<br>Customer Exporter Large Pollution Foreign Wostner Energy young frm Old SME Usted Emission- propsetarshij<br>pressure old firm ownership tax intensive<br><!-- End of picture text -->
The main advantage of such approach is indeed related to its unique coverage, as it captures 28,000 firms, mainly Small and Medium Enterprises (SMEs), in selected emerging countries (more than 40 countries covered by the Enterprise Survey), which is exceptional among the ESG scores already available on the market. Indeed, ESG disclosure covers mainly large, listed firms, while the large majority of companies is neither subject to it nor is assessed regarding ESG aspects. EU regulation, which is the most advanced worldwide on ESG topics, will gradually enlarge the spectrum of companies covered, but SMEs’ disclosure will remain extremely limited. In the United States, any ESG disclosure remains voluntary, while the situation in emerging countries is by far worse (no visibility on ESG topics of non-listed firms).

The “Corporate ESG Responsibility” composite indicator suggests that firms in emerging economies lag significantly in terms of ESG practices. South EU and Central and Eastern Europe perform better, followed respectively by Central Asia, the Eastern Neighborhood, and the Western Balkans, while firms in Middle East and North Africa (MENA), Russia and Turkey are among the worst performers. Among emerging economies, our analysis focused on firms in the Middle East and North Africa as some of those countries are in urgent need to decarbonize their economies. They have seen their CO2 emissions rising in absolute terms and also in per capita terms during the last years, and are significantly exposed to climate change (especially to climate “chronic” risk, and heat and water scarcity in particular) and the social development (including gender issues) is lagging. MENA economies are the worst performers across the entire spectrum of the economies covered by the ES in terms of Environmental, Social and Governance practices. Egypt and the West Bank and Gaza appear to be the worst among the MENA economies, followed by Lebanon, but also the worst among the 40 economies covered by the ES. MENA economies’ poor performance is mainly driven by the social component (worst performer among all regions, especially due to the gender subcomponent, as female representation in the workforce and among management is much lower than in other areas) and by the environmental component (second worst performer after Russia). Jordan, Tunisia and Morocco have ESG scores more in line with their level of economic development (represented by their per capita income).

Our composite indicator shows that SMEs’ Corporate ESG Responsibility practices lag those of large firms, particularly in emerging economies such as those in MENA. SMEs, which provide a staggering 70% of employment worldwide (ILO, 2019), face major challenges when it comes to working conditions, productivity and informality. Small firms in MENA are the worst performers across all economies and categories.

Poor ESG practices in emerging countries, especially for SMEs, call for urgent policy action to address such weaknesses: SMEs’ ESG aspects, but also those of micro enterprises, cannot be neglected or addressed at a later stage. The challenges of the green and social transitions cannot be met without the timely involvement of SMEs.

ESG practices should not be left solely in the realm of financial investors: commercial banks also need to assess the ESG performance of borrowers, SMEs included; insurance companies need to evaluate the ESG risks; and public authorities, national and local, must also be interested in the 19
ESG risks of the non-listed companies in their territories. Consequently, disclosure and target setting on ESG topics cannot be confined to large, listed firms (mainly in developed markets), as is currently happening. And it cannot be confined to the European Union markets, which is setting numerous standards in this regard.

ESG information disclosure should become “ _at par_ ” with financial information – sharing the same rigor, level of implementation and enforcement, quality control systems and IT infrastructures.

In this sense, it is important to evaluate and quantify the gaps and take action subsequently, designing a roadmap for SMEs and emerging markets on ESG topics.

Governments or international financial institutions should scale up support to improve SMEs’ ESG practices and provide help on the ground to fill the biggest gaps.

In conclusion, the transition towards a more sustainable business environment at the global level cannot be successful unless a broader spectrum of companies - including SMEs in emerging economies - are fully part of the game.

# **6 References**

Berg, F., K. Fabisik, and Z. Sautner, Is History Repeating Itself?: The (Un)Predictable Past of ESG Ratings (August 24, 2021). European Corporate Governance Institute – Finance Working Paper 708/2020 Berg, F., J. F. Koelbel, and R. Rigobon, Aggregate Confusion: the Divergence of ESG ratings, MIT Sloan School of Management, August 2019 Chatterji, A. K., R. Durand, D. I. Levine, and S. Touboul, Do ratings of firms converge? Implications for managers, investors and strategy researchers. Strategic Management Journal, 37(8):1597–1614, 2016.

Clarkin, C.M., M. Sawyer and J. L. Levin, The Rise of Standardized ESG Disclosure Frameworks in the United States, Harvard Law School Forum on Corporate Governance, June 2020 The Rise of <u>Standardized ESG Disclosure Frameworks in the United States (harvard.edu)</u> Drempetic, S., C. Klein and B. Zwergel, "The Influence of Firm Size on the ESG Score: Corporate Sustainability Ratings Under Review," Journal of Business Ethics, Springer, vol. 167(2), pages 333360, November 2020.

Durand, R., S. Touboul, "Do Ratings of Firms Converge? Implications for Managers, Investors and Strategy Researchers," HEC Research Papers Series 1076, HEC Paris, 2014.

European Banking Authority (EBA), On management and supervision of ESG risks for credit institutions and investment firms, EBA Discussion Paper, EBA/DP/2020/03, 2020 EBRD, Transition report 2020.

Financial Times, Big Four accounting firms rush to join the ESG bandwagon, 30 August 2021Big <u>Four accounting firms rush to join the ESG bandwagon | Financial Times (ft.com)</u>

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Financial Times, Measuring what matters: the scramble to set standards for sustainable business, 14 May 2021 <u>Measuring what matters: the scramble to set standards for sustainable business | Financial Times (ft.com)</u>

Gibson, R., P. Krueger, N. Riand, and P. S. Schmidt, ESG Rating Disagreement and Stock Returns. SSRN Scholarly Paper ID 3433728, Social Science Research Network, Rochester, NY, 2019.

Haralampieva, V., Ramping Up Climate Action by Enhancing Companies' Governance Framework, - Law in Transition Journal, 2019 Articles | EBRD LiT 2019 (lit <u>ebrd.com)</u>

ILO, Small matters, Global evidence on the contribution to employment by the self-employed, micro-enterprises and SMEs, International Labour Organization, 2019 ILO, The power of Small: Unlocking the potential of SMEs, International Labour Organization, October 2019 OECD-JRC, Handbook on Constructing Composite Indicators, 2008, <u>https://www.oecd.org/els/soc/handbookonconstructingcompositeindicatorsmethodologyanduser guide.htm</u> Moody’s, ESG Score Predictor: Applying a Quantitative Approach for Expanding Company Coverage, July 2021

- <u>60ec66d0af57878032604495_ESG Score Predictor_090721.pdf (website files.com)</u>

SASB, SASB Conceptual Framework and Rules of Procedure <u>Academic ESG data review | PRI Web Page | PRI (unpri.org)</u>

World Economic Forum, Statement of Intent to Work Together Towards Comprehensive Corporate Reporting (Summary of alignment discussions among leading sustainability and integrated reporting organisations CDP, CDSB, GRI, IIRC and SASB), September 2020 Statement-of-Intent-to-Work- <u>Together-Towards-Comprehensive-Corporate-Reporting.pdf (netdna-ssl.com)</u> Oh, S., D. Noh, Are Corporations feeling the heat?, World Bank Sovereign ESG Data Framework, September 2021 <u>Sovereign ESG Data Framework | Sovereign Environment Social Governance Data | World Bank</u>

# **7 Annex**

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|**Enterprise**<br>**Componen**|**Survey: questio**<br>**t Sub-Component**|**ns used to build the “Corporate ESG Responsibility” composite indicator**<br>**Question**<br>**N.**|**Observations**|
|---|---|---|---|
|**S**|Gender|Amongst the owners of the firm, are there any females?|28,161|
|**S**|Gender|What percentage of the firm is owned by females?|8,136|
|**S**|Gender|Is the Top Manager female?|28,161|
|**S**|Gender|How many full-time seasonal or temporary employees were female (in %)?|6,666|
|**S**|training|Did this establishment have formal training programs for its permanent, full-time employees?|28,157|
|**S**|education|% of full-time permanent workers employed which completed secondary school|15,710|
|**G**|Corp Governance|Does this firm have formalized, written business strategy with clear key performance indicators?|27,732|
|**G**|Corp Governance|Does the firm have a board of directors or a supervisory board?|27,732|
|**G**|Corp Governance|Was this establishment formally registered when it began operations?|28,161|
|**G**|Corp Governance|In a typical week, how often does the top manager meet with suppliers?|8,553|
|**G**|Manag. Practices|how many performance indicators were monitored at this establishment?|9,476|
|**G**|Manag. Practices|Did this establishment have production targets?|14,825|
|**G**|Manag. Practices|What was the primary way non-managers were promoted?|14,825|
|**G**|Audit|Does this establishment have an internationally-recognized quality certification?|28,161|
|**G**|Audit|Did this establishment have its financial statements checked and certified by an external auditor?|28,158|
|**G**|Compensation|Did this establishment have performance bonuses for managers?|14,825|
|**G**|Innovation|Does this establishment use technology licensed from a foreign-owned company (excl. software)?|28,160|
|**G**|Innovation|Did this establishment spend on research and development activities within the establishment?|27,731|
|**G**|Innovation|Did this establishment purchase any new or used fixed assets (such as machinery, vehicles, etc.)?|28,159|
|**E**|Green manag.|did this firm have strategic objectives that mention environmental or climate change issues?|27,383|
|**E**|Green manag.|whom did the manager responsible for environmental issues directly report to?|2,823|
|**E**|Green manag.|did any of the customers require environmental certifications as a condition to do business?|27,383|
|**E**|Environ. Awarenes|s How often did this establishment monitor its energy consumption?|14,620|
|**E**|Environ. Awarenes|s Did this establishment complete an external audit of its energy consumption?|14,620|
|**E**|Environ. Awarenes|s Over the last three years, did this establishment emit CO2?|27,381|
|**E**|Environ. Awarenes|sdid this establishment monitor CO2 emissions along its supply chain?|27,383|
|**E**|Environ. Awarenes|swhat sort of targets for energy consumption did this establishment have?|7,158|
|**E**|Environ. Awarenes|swhat sort of targets for CO2 emissions did this establishment have?|1,355|
|**E**|Environ. Awarenes|sDid this establishment adopt any measures to enhance energy efficiency?|27,383|
|**E**|Environ. Awarenes|s Did this establishment use energy from its own renewable sources?|27,383|
|**E**|Green measures|Measures adopted: Heating and cooling improvements|27,383|
|**E**|Green measures|Measures adopted: More climate-friendly energy generation on site|27,383|
|**E**|Green measures|Measures adopted: Machinery and equipment upgrades|27,383|
|**E**|Green measures|Measures adopted: Energy management|27,383|
|**E**|Green measures|Measures adopted: Waste minimization, recycling and waste management|27,383|
|**E**|Green measures|Measures adopted: Air pollution control measures|27,383|
|**E**|Green measures|Measures adopted: Water management|27,383|
|**E**|Green measures|Measures adopted: Upgrades of vehicles|27,383|
|**E**|Green measures|Measures adopted: Improvements to lighting systems|27,383|
|**E**|Green measures|Measures adopted: Other pollution control measures|27,383|

Note: number of observations is representing the number of firms answering to the specific question (before imputation – see chapter 3 on methodology) 22