The sectoral impact of ESG on financial performance of firms in emerging countries

Abstract

Purpose – The thesis aims to empirically investigate the impact of environmental, social and corporate governance (ESG) activities on corporate financial performance (CFP) of emerging countries’ listed firms operating in seven specific Global Industry Classification Standards (GICS) sectors. Design/methodology/approach – Using secondary data, this study covers 3999 observations from 635 listed companies in emerging countries for the period 2011- 2017. Our sample includes firms belonging to seven specified GICS sectors. The thesis uses panel corrected standard errors to estimate the effect of ESG on firm financial performance and thus addresses contemporaneous cross-correlations across the panel cross sections. We used overall ESG and its three separate individual components (Environmental, Social and Corporate Governance) disclosure scores from Thomson Reuters, while we used a combination of both accounting and market measures for the CFP measures. Accounting measures being Return on Assets (ROA) and Return on Equity (ROE) and market measures being Stock Return (RET) and Price-to-Book Ratio (PB). Our regressions were run on a consolidated sample including all seven GICS sectors at once and on each GICS sector sample separately to control for sectoral impact. Findings – Our findings confirm that the ESG-CFP relationship depends on three criteria: (1) ESG Pillar (2) CFP measure (3) GICS sector. Three types of relationship dominate these findings: linear (positive, negative), neutral, non-linear (convex Ucurve, concave inverse U-curve, semi-concave and semi-convex). For the consolidated sample (i.e. combining all seven GICS sectors), we find that ESG overall score only negatively impacts ROA. However, the impact of each pillar on CFP is different. While environmental (ENV) and governance (GOV) scores negatively affect the two accounting measures, the social (SOC) score displays a concave relationship. Moving to the two market measures (RET and PB), they react differently to the same pillar. Only SOC score affects RET with a semi-concave relationship, while the three pillars affect PB. More specifically, there is a negative, positive and concave relationships with ENV, SOC and GOV respectively. Furthermore, sectoral analysis also shows varied results depending on each sector’s characteristics and the type of CFP measure. While ESG investments yield accounting profits in consumer discretionary, it does the contrary in communication services and industrials and it has no effect on accounting-based CFP in information technology, materials and utilities sectors. Alike the overall score, its three ESG pillars also show mixed relationships with each CFP measurement within the same sector except for SOC in communication services where it has no impact whatsoever on all CFP measures and for GOV in energy sector where it negatively impacts all four CFP measures. Research limitations – The results should be interpreted with caution because of the following limitations. First, our independent variables (disclosed ESG score and disclosed ESG components scores) might not truly reflect the actual sustainability actions a firm undertakes. Second, the sample is restricted to 635 companies out of 874 and four GICS sectors were omitted due to lack of data availability. Third, price to book ratio (PB) was used instead of Tobin’s Q due to data availability. Fourth, the sample was heterogeneous by including firms operating in different countries and in different sectors and this research only control for the sectoral impact. Fifth, the control variables included in the research are the most factors used previously by scholars yet it is possible that other factors could affect the ESG-CFP link. Practical implications – This study does not only serve as a reference work for subsequent research regarding the impact of ESG on firm performance in emerging countries but also serves as a guide to policymakers on the financial impact of ESG adoption. The findings of this research could be very enlightening for managers in the process of ESG integration. Strategic managers can clearly decide whether ESG investment is necessary to create value and which particular ESG pillar should firms of developing countries invest depending on the GICS sector to which they belong. Furthermore, it is important to examine the threshold point beyond or above which ESG damages firms’ performance. Not only managers, but also investors and policymakers are affected by understanding how ESG can be efficiently implemented to benefit all stakeholders. Originality/value – This study fills a gap in the empirical evidence of ESG-CFP link since it is the first to study the sectoral (i.e. separately within seven GICS sectors) impact of both overall ESG score and ESG pillars scores on accounting-based and market-based CFP measures of emerging countries firms.