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environmental, social and governance (ESG) performance and financial performance of companies
Investors are increasingly recognizing the fact that ESG (environmental, social, corporate governance) elements can substantially affect companies' security rates and financial performance. The aforementioned components' contribution to financial markets has been growing with the rise in number of ESG opportunities and risks within the contemporary international economy. Timely and improved organizational policy-related data access and the effect of organizational policy on communities have made it considerably convenient for customers to express their dissatisfaction by simply quitting a brand. When international brands' images are sullied by ESG-related problems, the resultant instantaneous backlash has the capacity of abruptly and negatively impacting income and demand (Eccles, Ioannou & Serafeim, 2014).
Organizations having a poor reputation when it comes to ESG related matters are vulnerable to monetary risks, including a very genuine threat of facing lawsuits in the future, greater remediation and regulatory expense, vulnerability to natural and manmade catastrophes and potential loss of competitive edge to more creative, forward-thinking firms. Meanwhile, sound corporate citizenship will typically result in reduced personnel turnover rates, increased personnel productivity, superior customer loyalty and improved brand image; these aspects successively improve financial performance.
Instead of chancing the dissatisfaction of clients, stockholders and regulators, or blows to organizational business strategies, organizations are engaging in progressive attempts to moderate likely ESG risks; this may be taken as one means of safeguarding brand value as well as making sure their offerings (services/products) have stable demand in the market. Further, corporations are coming up with novel solutions for dealing with the universal sustainability-related challenges over several sectors. These keys may help bolster businesses' long-run competitive edge as well as financial performance (Eccles et al., 2014). Investors aware of the significance of taking nonfinancial data into account in investment decision-making can effectively employ ESG factors for improved risk management and generation of surplus returns.
1.1. Background
Traditionally, ESG problems and externalities like air and water pollution, unethical corporate practices, inferior work environments, etc. negatively affected stock prices and business functionality only in extreme scenarios. Consequently, organizations often overlooked them in their normal investment appraisal policies and practices. In the same way, externalities also weakly influenced organizational executives' behavior owing to the lack of a perceptible feedback loop driving organizations to react to their non-financial problems and associated opportunities and risks to the company. Non-governmental organizations and regulators generally took care of negative externalities (Trunow and Linder, 2015).
However, the past twenty years have witnessed a drastic transformation in the above dynamic, thanks, largely, to the speed with which information is transmitted on social media and the World Wide Web. Additionally, corporate supply chain extension and globalization to encompass developing and sharp-end markets has contributed to increased focus on ESG externalities and issues as well, with corporate exposure to more geopolitical and geographical settings and regulatory systems. Developing economies' regulatory and legal systems are normally less effective as compared to industrialized economies' systems, rendering it more difficult for businesses to protect themselves from ESG issues. This leads to an added risk for businesses functioning in these parts (Ang, Lam & Zhang, 2016). As emerging economies are identified by multinationals as an important source of income growth, inadequately dealing with local ESG may disrupt corporate supply chains or cause them to lose market opportunities, thereby appreciably affecting business operations.
Firms' responses to the changing worldwide economic scene take the form of steps designed to tackle ESG opportunities and risks capable of affected corporate financial performance, which are coming to the attention of investors. According to 2014 estimates, approximately 21.4 trillion dollars of professionally controlled assets worldwide applied ESG measures to investment analyses and portfolio composition (Global Sustainable Investment Alliance, 2015). Related regional information depicts that American AUM (assets under management) worth 6.57 trillion dollars clearly took ESG factors into account when investing and engaging in associated decision-making; this constituted a 76% rise compared to 2012 figures. European investment plans taking ESG into account similarly made up almost ten trillion Euros which is a 46% growth between 2012 and 2014 (Eurosif, 2010; Trunow and Linder, 2015). While the above figures aren't to be trusted blindly, owing to the fact that most represent self-reported facts by individuals professionally managing assets and to the lack of an explicit definition of ESG criteria, the AUM data helps explain directional growth whilst offering a backdrop for market opportunities linked to responsible investing.
1.2. Problem of the study
Despite several decades of studies into the link of organizational economic performance with corporate social responsibility, a number of researchers continue to maintain that considerable investigation is still needed before they can thoroughly comprehend the aforementioned link. In particular, there is a need to construct models encompassing variables that are overlooked (Chong & Phillips, 2016).
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Hence, this research work aims at bridging the gap in literature, with regard to effects of management ESG elements combined, on corporate performance, to some extent (Schadewitz and Niskala, 2010). This will be attempted through an inclusion of the synergistic influence of ESG's three facets in the above relationship. For examining ESG synergistic impacts, this research suggests an "inter-dimensional consistency" among ESG aspects, examining the way such consistency potentially impacts the economic performance-ESG linkage.
1.3. Study significance
The research adds various elements to corporate practices and related literature. First and foremost, it furthers emergent works on consistency via an examination of the effect of ESG factors' correlations on overall company performance. Furthermore, it develops numerous consistency measures on the basis of ESG factor strengths, comparing company results relative to peer groups. Additionally, it suggests three-tier ESG consistency for gauging corporate dedication and efficacy in establishing a competitive edge. It also employs, with regard to methodology, years 2011-14 panel data sets of EU-15 nations' listed companies. GMM (generalized method of moments) estimation will be applied for addressing dynamic endogeneity and probably unnoticed heterogeneity. Lastly, it will confirm the fact that organizations displaying first-rate ESG performance won't essentially outdo rivals in every non-financial element of performance. The study outcome implies that every outstanding ESG firm doesn't retain inter-dimensional steadiness; however, they will be able to counterbalance the strengths in certain areas with their failings in other areas.
1.4. Research questions
How far does an organization's ESG performance impact its performance in financial terms? Will this link be diluted by the organization's industry type?
2. Theoretical framework
2.1. Corporate Social Responsibility
ESG performance value is founded on the following two elements' convergence and interface: SRI (sustainable, responsible investment) and CR (corporate responsibility). The latter may be described as intentional organizational action geared at improving environmental and social performance, beyond minimum legal requirement (Freeman et al., 2010). Corporate responsibility investments are a type of intangible corporate asset associated with long-run performance and acquired through image and functioning linked advantages. Functional advantages resulting from internal organizational activity (such as cost-cutting, output, and functional efficacy) will probably not display any certainty of success in the future. They will also be slow to surface. Concurrently, every corporate responsibility forms a prospective cause for positive client and market views of the organization (reputational advantages). This indirectly impacts future revenue, as a good image boosts sales, reduces opportunity cost of investment, helps acquire and retain competent individuals from the labor market, and increases the readiness of customers to purchase products at a higher price and of investors to hold or purchase company stocks. Positive client and stockholder (existing and potential) attitudes to effective CR performance as well as executive team competence are included under reputational impacts (Ramiah, Martin and Moosa, 2013).
Besides, the distinctive aspect of corporate responsible as an accrual (contingent liability) is: its ability to alleviate litigation actions' severity if the future holds more rigid norms and increased number of taxes on account of increased social and environmental concerns (Godfrey, Merrill and Hansen, 2009). With new laws and standards, businesses within at-risk ESG segments are normally faced with further uncertainty, since corporate bottom lines are instantly impacted and cost pressures are enforced upon them. A connected CR function deals with reduction of future costs or income outflows linked to legal requirements. But it is hard to ascertain the precise timing of these risks' occurrence.
Stakeholder theory puts the CR aspect into operation. The theory describes a company stakeholder and combines stakeholder interests and corporate profit maximization objectives. Clients, stockholders, supplying entities, workforce, special interest organizations, non-government organizations, communities and regulators typically make up a company's stakeholders. The contemporary CR concept has basically developed into the following 3 key stakeholder relation classes: environmental (E), social (S), and governance (G). For instance, workforce satisfaction enhances their motivation and retention rates, in addition to increasing development of novel patents, products, or deals. Via such long-run performance improvements, personnel satisfaction proves beneficial to stockholders (Edmans, 2011).
Experts in the field have described organizational ESG performance with respect to corporate responsibility principles, CSR processes, and organizational policies, initiatives and organizational behavioral outcomes (Wood, 1991). CEP or companies' environmental performance largely denotes organizational environmental management. This entails pollution….....
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