ESG AND FINANCIAL PERFORMANCE: DO ESG FACTORS CREATE VALUE FOR COMPANIES?
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Аннотация 3
ABSTRACT 4
INTRODUCTION 6
CHAPTER 1. IMPACT OF ESG FACTORS ON FINANCIAL PERFORMANCE: THEORETICAL
BACKGROUND 9
1.1 THE CONCEPT OF ESG: MAIN THEORIES AND IMPACT MECHANISMS 9
1.2 ESG TRANSFORMATION: MARKET OVERVIEW 14
1.3 THE RELATIONSHIP BETWEEN ESG AND PERFORMANCE: LITERATURE REVIEW AND
HYPOTHESES STATEMENT 19
CHAPTER 2. EMPIRICAL ANALYSIS 24
2.1 DATA 24
2.2 METHODOLOGY 25
2.3 DESCRIPTIVE STATISTICS AND SAMPLE ANALYSIS 27
2.4 DIFFERENCE-IN-MEANS ANALYSIS 33
2.5 REGRESSION ANALYSIS RESULTS 37
DISCUSSION 40
CONCLUSION 42
LITERATURE 43
APPENDIX 53
ABSTRACT 4
INTRODUCTION 6
CHAPTER 1. IMPACT OF ESG FACTORS ON FINANCIAL PERFORMANCE: THEORETICAL
BACKGROUND 9
1.1 THE CONCEPT OF ESG: MAIN THEORIES AND IMPACT MECHANISMS 9
1.2 ESG TRANSFORMATION: MARKET OVERVIEW 14
1.3 THE RELATIONSHIP BETWEEN ESG AND PERFORMANCE: LITERATURE REVIEW AND
HYPOTHESES STATEMENT 19
CHAPTER 2. EMPIRICAL ANALYSIS 24
2.1 DATA 24
2.2 METHODOLOGY 25
2.3 DESCRIPTIVE STATISTICS AND SAMPLE ANALYSIS 27
2.4 DIFFERENCE-IN-MEANS ANALYSIS 33
2.5 REGRESSION ANALYSIS RESULTS 37
DISCUSSION 40
CONCLUSION 42
LITERATURE 43
APPENDIX 53
Sustainability and ESG are growing trends of the last few years in business and society. ESG is a set of characteristics used to assess the social and environmental responsibility of a business, as well as actions to improve the environment, working conditions for employees and transparency of interaction between management and external stakeholders. Before the coronavirus crisis ESG issues were already on the agenda of many companies, but with the pandemic, their importance has skyrocketed. Thus, the majority of investors realized that non - financial risks may have even a greater impact on portfolio returns and began to pay more attention to companies' non-financial metrics when developing investment strategy and making decisions. As for the society, the pandemic has only increased social inequality and poverty. Besides, after the lockdown, people began to value the environment and social interaction more than ever. Generally, the culture of consumption of goods and services has also changed. More and more consumers are getting to appreciate companies for the values they create, not for the lower price or discounts available. All this becomes irrefutable evidence that ESG comes to the fore, forcing companies to redefine their strategies and identify new approaches to consumers and investors.
With the help of ESG-sensitive investing the investors are able to create portfolios that are consistent with their own values, thus influencing the market and the economy by supporting companies with a mission close to them. At the same time, ESG investing turns out to be no less profitable than traditional investing. More than $650 billion has been invested in ESG funds, most of which have outperformed conventional funds in terms of profitability and financial performance (Kerber, Jessop, 2021). The current green bonds market also continues to expand with the bond issuance exceeding $500 billion (Jones, 2022). Many research papers also confirm that accounting for the ESG criteria improves portfolio returns, creating long-term growth prospects (Kenan Insight, 2022, Stotz, 2022). This is explained by lower reputational, political and regulatory risks, which in turn leads to more stable cash flow and increased profitability. According to the Morgan Stanley Institute for Sustainable Investing, from 2004 to 2018, the decline in downside risk volatility in ESG funds was 20 percent less than in conventional funds (Morgan Stanley, 2019).
However, the actual profitability of ESG investing has its own ambiguities. For example, many companies may simply use notional environmentalism to improve their reputation in the eyes of investors and hide the real harm from their operations. It seems that ESG rhetoric formally generates benefits for the company in the form of investments, but actual actions to improve sustainability do not bring returns and only increase costs. Many sceptics of ESG even believe that corporate executives are still trying to satisfy shareholders and maximize their wealth, only
nominally proclaiming sustainable goals that are unlikely to be achieved, thereby intensifying the controversy surrounding the topic of ESG. Similarly, there is no consensus on the impact of the inclusion of ESG factors in the company's strategy on its financial performance in the existing literature.
One thing becomes clear for sure - ESG will stay with us for a long time. This indicator is becoming more and more important, especially in connection with climate change and the efforts of companies to find competitive advantages and differentiation. Now it is significant for managers to think about creating value beyond the purely economic, so social and ecological situation requires business to focus value creation on all stakeholders (including communities, employees and customers) and not just shareholders. Such a broader interpretation of value may ensure the long-term competitiveness, profit and health of the business, since it simultaneously reduces risks and allows the maximum use of limited resources. The effectiveness of ESG and their application in management decisions are becoming a form of indirect measurement of the governance quality along with its financial data. However, the most important question remains - is it possible to turn ESG transformation into positive financial performance for companies?
...
With the help of ESG-sensitive investing the investors are able to create portfolios that are consistent with their own values, thus influencing the market and the economy by supporting companies with a mission close to them. At the same time, ESG investing turns out to be no less profitable than traditional investing. More than $650 billion has been invested in ESG funds, most of which have outperformed conventional funds in terms of profitability and financial performance (Kerber, Jessop, 2021). The current green bonds market also continues to expand with the bond issuance exceeding $500 billion (Jones, 2022). Many research papers also confirm that accounting for the ESG criteria improves portfolio returns, creating long-term growth prospects (Kenan Insight, 2022, Stotz, 2022). This is explained by lower reputational, political and regulatory risks, which in turn leads to more stable cash flow and increased profitability. According to the Morgan Stanley Institute for Sustainable Investing, from 2004 to 2018, the decline in downside risk volatility in ESG funds was 20 percent less than in conventional funds (Morgan Stanley, 2019).
However, the actual profitability of ESG investing has its own ambiguities. For example, many companies may simply use notional environmentalism to improve their reputation in the eyes of investors and hide the real harm from their operations. It seems that ESG rhetoric formally generates benefits for the company in the form of investments, but actual actions to improve sustainability do not bring returns and only increase costs. Many sceptics of ESG even believe that corporate executives are still trying to satisfy shareholders and maximize their wealth, only
nominally proclaiming sustainable goals that are unlikely to be achieved, thereby intensifying the controversy surrounding the topic of ESG. Similarly, there is no consensus on the impact of the inclusion of ESG factors in the company's strategy on its financial performance in the existing literature.
One thing becomes clear for sure - ESG will stay with us for a long time. This indicator is becoming more and more important, especially in connection with climate change and the efforts of companies to find competitive advantages and differentiation. Now it is significant for managers to think about creating value beyond the purely economic, so social and ecological situation requires business to focus value creation on all stakeholders (including communities, employees and customers) and not just shareholders. Such a broader interpretation of value may ensure the long-term competitiveness, profit and health of the business, since it simultaneously reduces risks and allows the maximum use of limited resources. The effectiveness of ESG and their application in management decisions are becoming a form of indirect measurement of the governance quality along with its financial data. However, the most important question remains - is it possible to turn ESG transformation into positive financial performance for companies?
...
The main goal of this study, as noted earlier, was to examine the relationship between ESG and financial performance for the period 2015-2021. The study found a correlation between ESG and the financials of companies. The empirical results confirmed the effect of ESG on S&P500 index companies, as evidenced by significant regression analysis estimates. Thus, increasing E and S scores respectively increases Tobin's Q and ROE, indicating improved market and operating efficiency, while increasing G score positively affects ROE only. The paper also examined the effect of ESG on the industrial sector separately and found a significant effect only on the G-score side.
Initial difference-in-means analysis revealed no better financial performance of companies with ESG scoring higher than median. Moreover, it was found that companies with higher ESG scores may be currently undervalued in the market. However, the t-test shows rough estimates, without taking into account the influence of other control factors and industry characteristics, so a regression analysis was conducted. As stated above, the results were the following: market performance is significantly influenced by environmental and social factors, while operational performance is positively influenced by all ESG components. At the same time, no impact on industrial companies from environmental or social factors was found, probably because these companies are still failing in significantly improvement of ESG standards, or the positive effect takes longer time horizon to be paid back.
The regression analysis performed allowed us to determine the degree of contribution of ESG factors to financial performance, as well as provide insight into the positive direction of influence, being the first step in the follow-up mechanism of decision-making. Based on this knowledge, companies can conduct ESG transformation faster and implement more sustainability initiatives. Thus, examining the relationship between ESG factors and the company's financial performance can be beneficial to its business in several ways, including identifying priority areas for action, gaining market advantage and managing ESG-related risks. This study makes a significant contribution to the current understanding of ESG, eliminating the confusion and controversy of the current debate. By shedding light on this important topic, this study can inspire business practitioners to be more receptive to introducing innovative changes to their business models and to be more proactive in implementing sustainability initiatives. In addition, the results of the study show that companies adopting ESG practices can strengthen their stakeholder relationships and increase public trust, which can help them meet the challenges of today's global economy and political landscape.
Initial difference-in-means analysis revealed no better financial performance of companies with ESG scoring higher than median. Moreover, it was found that companies with higher ESG scores may be currently undervalued in the market. However, the t-test shows rough estimates, without taking into account the influence of other control factors and industry characteristics, so a regression analysis was conducted. As stated above, the results were the following: market performance is significantly influenced by environmental and social factors, while operational performance is positively influenced by all ESG components. At the same time, no impact on industrial companies from environmental or social factors was found, probably because these companies are still failing in significantly improvement of ESG standards, or the positive effect takes longer time horizon to be paid back.
The regression analysis performed allowed us to determine the degree of contribution of ESG factors to financial performance, as well as provide insight into the positive direction of influence, being the first step in the follow-up mechanism of decision-making. Based on this knowledge, companies can conduct ESG transformation faster and implement more sustainability initiatives. Thus, examining the relationship between ESG factors and the company's financial performance can be beneficial to its business in several ways, including identifying priority areas for action, gaining market advantage and managing ESG-related risks. This study makes a significant contribution to the current understanding of ESG, eliminating the confusion and controversy of the current debate. By shedding light on this important topic, this study can inspire business practitioners to be more receptive to introducing innovative changes to their business models and to be more proactive in implementing sustainability initiatives. In addition, the results of the study show that companies adopting ESG practices can strengthen their stakeholder relationships and increase public trust, which can help them meet the challenges of today's global economy and political landscape.
