COUNTRY GOVERNANCE SCORES AS MODERATORS OF ESG IMPACT ON FIRM PERFORMANCE IN THE EUROPEAN CONTEXT

Abstract

Purpose- Engaging in ESG activities entails significant costs that, without a doubt, impact the firm's financial performance and ultimately its market performance. However, it is believed that these costs are offset by the positive impact ESG brings in terms of improved reputation and public perception, including current and potential customers and investors. Research on the relationship between ESG scores and firm performance has produced mixed results, raising concerns about whether the positive effect of ESG is enough to counter the negative effect of associated costs, or whether there are other factors that may moderate this relationship. The purpose of this study is to explore the moderating effect of the World Bank’s Governance Indicators on the relationship between a firm’s ESG scores and its financial and market performance. Methodology- To achieve the aim of the study, we have collected data for all listed firms from the European continent with ESG scores available on the Refinitiv database. After cleaning the data for missing values, we obtained an unbalanced and cross-sectional panel of 13,043 firm-year observations from the 2,083 firms used in the study. We have employed 2SLS Regression, using published financial information spanning over a period of 12 years, from 2011 to 2022. Findings- The results suggest the World Bank’s Worldwide Governance Indicators have a moderating effect on the relationship between ESG and firms’ financial performance and market performance. Conclusion- Our findings suggest that the positive impact of ESG activities on financial performance is more pronounced in countries rated higher in Worldwide Governance Indicators. The implementation of ESG practices is generally valued by investors affecting positively the market performance, however, this may not be as strong in countries with high Governance scores where expectations for sustainable business practices are already high.

Keywords

• World Bank Governance Indicators
• Europe
• ESG
• financial performance
• market performance

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