Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of Listed Companies on the German Stock Exchange (XETRA)

Abstract

As investors' knowledge on sustainability concerns rises, the concept and interest of sustainable investment continue to expand and become increasingly attractive as the global financial market is considered an effective and powerful tool in the process of developing sustainable economies. Although sustainability is not a new concept in the financial market, its recent recognition and wider adoption has increased as consumers, investors, businesses, and world leaders have become more sensitive and concerned about the future of the planet. Hence, this paper re-examines the impact of environmental, social, and governance (ESG) scores on the financial performance of the listed companies on the German Stock Exchange from 2011 to 2021. With a total of 450 listed firms and 4,950 observations sourced from the Refinitiv database, vector autoregressive (PVAR) together with the system-generalized method of moments (system-GMM) and robust panel multiple regression models were employed to examine the impact and causal relationship between ESG scores and corporate financial performance. The results suggest that ESG scores contribute to organizations' financial performance. We found that better ESG ratings increase companies' systematic risk (volatility), which could boost or increase their stocks' returns. The study however did not find Granger causality between ESG scores and the accounting-based financial performance (ROA), but it did for the market-based financial performance (Tobin’s Q). It showed that ESG scores negatively Granger cause firms’ financial performance. In a nutshell, organizations' financial performance may be improved by having a higher ESG score and performing better in the social dimension. Overall, the evidence supports the idea that a business case exists for sustainability and corporate social responsibility.