Abstract
Increasing interest in sustainability performance (environmental, social, and governance pillar performance [ESGP]) and corporate financial performance (CFP) is noteworthy. However, we do not find any all-inclusive study that employs both individual components of environmental, social, and governance pillars (ESG) as well as the cumulative ESG score on both the accounting and market performance of firms. Furthermore, we do not find any study that puts forth “best practices” in the ESGP-CFP nexus. Therefore, our study intends to provide additional empirical evidence in this debate by including all three pillars of ESG as well as the overall ESG score by employing a unique sample of “100 best corporate citizens” in the United States declared by 3BL Media during 2009 to 2018. For this purpose, we employ panel vector auto regression (PVAR) that allows us to overcome the methodological challenges faced by some earlier empirical studies. The core findings are: (a) for market-based financial performance (market-to-book ratio [MTB] and Tobin’s Q), our results only confirm ESGP–CFP relationship and suggest that sustained higher commitment to the environmental pillar, consistent socially responsible conduct, and rationalized governance mechanism of the sampled firms are perceived value additive by the market players. (b) For accounting-based financial performance (return on equity [ROE] and return on assets [ROA]), we find a mix of ESGP–CFP and CFP–ESGP relationship for ROE only. Furthermore, factor error variance decomposition (FEVD) analysis reveals that environmental, social, and overall ESG performances of the sampled firms are quite good predictors of future CFP in the market. These findings assert that actively pursuing ESG endeavors can assist firms in achieving superior financial performance.
Highlights
Intertwining and interdependence of resources across time and space and consequent short-term versus long-term tradeoffs experienced by the firms and the societies have forced their policymakers to devise sustainable practices without forgoing the core corporate objective of value maximization
We used a recently developed econometric technique panel vector auto regression (PVAR) based on generalized method of moments (GMM) (Abrigo & Love, 2016) to address the challenges such as causality factor and simultaneity encountered in the past literature
These results suggest that there exists an ESG performance (ESGP)-corporate financial performance (CFP) relationship whereas there is no CFP–ESGP relationship for our market-based measure MTB, indicating the relevance of the stakeholder, and irrelevance of the slack resources theory and the managerial opportunism hypothesis to explain the behavior of the sampled firms
Summary
Intertwining and interdependence of resources across time and space and consequent short-term versus long-term tradeoffs experienced by the firms and the societies have forced their policymakers to devise sustainable practices without forgoing the core corporate objective of value maximization. Starting with “use of corporate resources for any cause other than profit maximization would constitute a form of theft” (Friedman, 1962) to “creating a shared value” ESG (Environmental, Social, and Governance pillars) has emerged as a meta-construct (Orlitzky et al, 2003), and investigation about the relationship between ESG performance (ESGP) and corporate financial performance (CFP) is still inconclusive The slack resources theory suggests a positive CFP–ESGP
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