Impact on ESG performance in profitability and firm value

Investors are now interested in non-financial factors and environmental aspects such as proper governance and social responsibility where the priority of non-financial factors are enforced in a financial environment. A wide variety of professional people now need to report effectively and take the necessary mitigation measures. Firms now report their performance on risks through a trending topic known as Environmental and Social Governance (ESG) but through a firm or financial perspective.

What is ESG?

According to Blackrock, one of the most successful global investment and risk management advisory firms mentions that ESG is  through analysing a company’s Environmental, Social and Governance risk by practising sustainable investing. Further, there are sustainable metrics which a firm has to abide by in order to achieve sustainable investing. The confusion in analysing non-financial indicators is that it makes financial sense. The research by Mahmut Aydoğmuş, Güzhan Gülay, and Korkmaz Ergun tries to fill in the objective if Environmental and Social Governance  performance can be attached to the financial return for a firm. There is a stakeholder theory that is put forward where successful firms are able to gather the interests of all stakeholders which is known to be more sustainable. Therefore, the focus is not only on maximising profits but also taking into account the interests of other stakeholders. A business that has their stakeholders at best interest is Business Roundtable. Further, to see ESG performance the ESG metrics need to be applied in the firms, which brings forward important issues to the stakeholders of the company. ESG has become of preference in recent years as stakeholders are included in the discussions. By applying ESG, you are also applying sustainability practices and are applied in decision-making. Whether ESG increases a firm value and its profitability is a question that still needs to be unpacked.

ESG performance and a firms profitability

Today, researchers are investigating the impact between ESG performance and financial performance in a firm. The research unpacked the following: “We start the analysis by selecting the largest 5000 publicly listed firms in the world from Bloomberg database spanning 9 years from 2013 to 2021. We match and filter for Refinitiv ESG score and end up with 1720 companies. Our final panel data entails 14043 firm year observations.” The results show that ESG has a positive effect on financial performance whereby ESG needs to be implemented in a firm to increase their profitability. 

The topics covered in the literature review

The following topics were unpacked in the literature review:

1. “Papers with findings of positive relationship between ESG performance and firm value - profitability”

2. Papers with findings of negative relationship between ESG performance and firm value - profitability

3. “Papers with findings of mixed relationship between ESG performance and firm value - profitability”

Further there were two hypotheses in the study:

1. “ESG scores have positive and significant impact on firm value”

2. “ESG scores have positive and significant impact on profitability”

There were dependant and independent variables in the study

Dependant variable - Tobin's Q  and Return on Assets (ROA) to view prfitability

Independent variable - All ESG scores are from Refinitiv which are ESG combined score, Social Score Environment score, and Governance score. 

The concluding statements of the research

The purpose of the paper is to analyse the impact of ESG performance of the firm's profitability. The sample in the study varies from 2013 to 2021 over 1720 firms. It has been noticed that the environmental aspects take longer to produce results than the social and governance aspects in ESG. The results showed the following: “Based on the results of the four models where profitability was the dependent variable; we find that ESG combined score (ESG_CS) has a positive and highly significant relationship with profitability. Environment (ENV), Social (SOC) and Governance (GOV) all have highly significant positive relationships with profitability as well. From a theoretical point of view, these results support the stakeholder theory, in line with the findings of several researchers in the extant literature.” The research helps corporate managers look into ESG and for policy makers to incorporate ESG in the policies.