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

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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 reexamines 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.
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Science Journal of Business and Management
2023; 11(2): 74-92
http://www.sciencepublishinggroup.com/j/sjbm
doi: 10.11648/j.sjbm.20231102.12
ISSN: 2331-0626 (Print); ISSN: 2331-0634 (Online)
Examining the Impact of Environmental, Social and
Governance Scores on Financial Performance of Listed
Companies on the German Stock Exchange (XETRA)
Jacob Azaare
1, *
, Zhao Wu
2
, Socrates Kwadwo Modzi
3
, Ping Li
4
, Enock Mintah Ampaw
5
1
Department of Business Computing, CK Tedam University of Technology and Applied Sciences, Navrongo-Upper East, Ghana
2
School of Management and Economics, University of Electronic Science and Technology of China, Chengdu, China
3
Faculty of Business, Economics and Social-Sciences, University of Hamburg, Hamburg, Germany
4
School of Mathematics, Southwest Minzu University, Chengdu, China
5
Applied Mathematics Department, Faculty of Applied Science and Technology, Koforidua Technical University, Koforidua, Ghana
Email address:
*
Corresponding author
To cite this article:
Jacob Azaare, Zhao Wu, Socrates Kwadwo Modzi, Ping Li, Enock Mintah Ampaw. Examining the Impact of Environmental, Social and
Governance Scores on Financial Performance of Listed Companies on the German Stock Exchange (XETRA). Science Journal of Business
and Management. Vol. 11, No. 2, 2023, pp. 74-92. doi: 10.11648/j.sjbm.20231102.12
Received: March 9, 2023; Accepted: March 28, 2023; Published: April 18, 2023
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.
Keywords:
Environmental Social and Governance Scores, Corporate Financial Performance, Return on Assets, Tobin’s Q,
System-Generalized Method of Moments, Firm Systematic Risk
1. Introduction
As investors' knowledge of sustainability concerns rises,
the concept and interest of sustainable investment continue to
expand and become increasingly attractive. The global
financial market is considered an effective and powerful tool
in the process of developing sustainable economies [25, 64,
71]. On a global scale, over $7 trillion worth of annual
investment is needed to develop sustainable economies that
meet the objectives and goals of the United Nations
Sustainable Development Goals (SDG) and the Paris
Agreement [35]. The sustainable and responsible investment
75 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
markets have been acknowledged as a potential or viable
vehicle to help contribute to materializing these transitions [5]
due to their massive assets under management (AUM).
The sustainable investment market is a steadily growing
market segment [60, 72]. According to Atkinson [10], this
growth is roused by investors who integrate diverse social
and environmental screens into their investment decision-
making or process. Cognitive and normative influences
have stimulated the development of the sustainable
investment market [32, 44]. Climate change and changes in
societal values or ethics may be considered the driving
forces behind sustainable investment decisions. The
increasing legislations on sustainable investments and
double materiality in Europe and other parts of the world
emphasize this new market's recognition, acceptance, and
growing importance.
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. The United Nations (UN) Agenda 2030
sustainable development goals (SDG) and the Paris
Agreement’s (Accord de Paris) target to keep the average
global temperature below 2°C by 2030 have been
acknowledged as two of the major events that set the trend of
sustainability in motion [88, 102]. In Europe alone, it is
estimated that an additional €180 billion per year of climate-
related investments are required to meet the Paris Agreement
[35]. Furthermore, on a global scale, between $5-7 trillion
worth of annual investments are required to meet the targets
of the UN Sustainable Development Goals [35]. At a closer
look, meeting these targets calls for gargantuan channeling of
capital into sustainability-related investments- to decarbonize
economies, ensure prosperity, and make the environment a
better place. This requires collective effort and
transformational change in attitude, investment approaches,
and business practices. Goals 12 and 17 of the SDG
encourage companies to adopt and integrate sustainable
practices into their business models and further highlight the
need for multi-stakeholder partnerships to meet the targets of
the sustainable goals [93].
Central to this paper are the following questions: Can
businesses be more socially and environmentally responsible
without sacrificing profit maximization? Can companies do
well by doing good? Can businesses do well by adopting the
concept of the triple bottom line [21, 77]? Despite the ever-
increasing discussions and attention given to these questions
in the academic literature, business, and financial worlds,
they are hardly new. The shareholder and stakeholder
theories have influenced these questions over the last decades.
Both theories are normative theories of corporate social
responsibility that outline the ethical responsibilities of a
business [41]. Though each theory has its roots in business
ethics, the underlying assumptions of the two theories differ
significantly. According to the shareholder theory, the prime
objective of a business is to maximize profit [105], and it
criticizes businesses' obligations to society (as this reduces
profitability) [43]. On the other hand, the stakeholder theory
which builds on the idea of corporate social responsibility
(CSR) asserts that businesses should create value for all
stakeholders, not just shareholders [40]. These stakeholders
include its customers, investors, employees, communities,
and all other players who have a stake in the firm.
The question going forward is: how can one distinguish
between a business that only seeks to maximize profits and
one that also prioritizes social responsibility and
environmental sustainability? According to Andrews et al.,
[6], corporate sustainability is a strategy that focuses on the
ethical, social, environmental, cultural, and economic
dimensions of doing business with the goal of creating long-
term value for stakeholders [6, 75]. The activities that lead to
corporate sustainability can be referred to as corporate social
responsibility (CSR) [36, 106], and ESG is a way of
measuring corporate social responsibility [8]. According to
Refinitiv, a firm's ESG score measures its corporate
sustainability performance based on its resource use,
innovation, emissions, workforce, human rights, product
responsibility, management, shareholders, and CSR strategy
[80]. ESG score is, therefore, a measurement of a firm's level
of sustainability, which as well considers how well a firm
manages its environmental, social, and governance risks [73].
ESG scores measure a firm’s resilience to long-term,
financially relevant environmental, social, and governance
risks [73]. It has grown to become an influential investment
strategy, mostly driven by ideals of corporate accountability
and social responsibility. ESG investing has become
increasingly popular over the past decade [22]. The US
Social Investment Forum (SIF) reports that, the total amount
of US-domiciled assets managed using sustainable
investment strategies increased by 42%, from $12.0 trillion at
the beginning of 2018 to $17.1 trillion at the beginning of
2020 [97]. This represents one-third of all assets under
management. The Global Sustainable Investment Alliance
estimated that more than $30 trillion was invested in
applying ESG scores [53]. The growing demand has spurred
a proliferation of funds and strategies that integrate ethical
considerations into investment approaches (particularly
bottom-up ESG integration, top-down ESG integration, best-
in-class selection, thematic investing, and active ownership).
As such, companies with high ESG scores become the target
of these socially responsible or conscious investors (Socially
Responsible Investment, SRI). The pressing question is: does
it worth the investment for companies to pursue the journey
of achieving higher ESG scores? Is there a link or
relationship between firms’ ESG scores performance and
their financial performance? In terms of causality, do ESG
scores cause or drive firms' financial profitability?
1.1. Related Literature
Establishing a relationship between corporate social
responsibility (CSR), corporate social performance (CSP),
ESG Scores and corporate financial performance (CFP) has
been a long-standing debate in the financial markets and in
management science [22]. The heterogeneity, inconsistency
Science Journal of Business and Management 2023; 11(2): 74-92 76
and ambiguity in these research findings have fueled the
debate. Researchers have identified positive, negative, and
neutral relationships between ESG scores and financial
performance [42, 48, 74, 84, 91]. Moreover, numerous
studies have also identified possible causes for the variation
in the results [14, 22, 23, 78]. Hence, the purpose of this
paper is to contribute and bring clarity to the ESG-CFP
literature by investigating the impact and causal relationship
between scores of the former and corporate financial
performance.
1.2. Environmental, Social and Governance Criteria (ESG)
ESG investing can be defined as an investing approach that
prioritizes optimal environmental, social, and governance
(ESG) factors [29, 51]. It is widely recognized as sustainable
investing—where investments are made taking into account
the environment and human welfare, and the economy. It is
founded on the increasing conviction that social and
environmental elements have an increasing impact on an
organization's financial success [21, 42, 91]. Table 1 illustrates
varieties of topics that normally fall under ESG in the literature.
Table 1. Common themes under ESG (ADECESG, 2022; Daugaard, 2020).
Environment (E) Social (S) Governance (G)
Climate change Working conditions Business ethics
Greenhouse gas (GHG) emissions Equal opportunities Executive pay
Resource depletion Human rights Board diversity and structure
Waste and pollution Employee diversity Bribery and corruption
Water and energy efficiency Health and safety Political lobbying and donations
Biodiversity Child labor and slavery Tax strategy
Deforestation Community engagement Compliance
Philanthropy
The inclusion of ESG factors in investment decisions has
been one of the most significant recent advances in the
financial markets. Investors of today are beginning to look
beyond the financial bottom line [85], to understand firms’
value, impact (double materiality), and the long-term
sustainable performance of their portfolios [24]. ESG
disclosure provides investors with a way to identify and
grasp key issues that are not typically captured and accounted
for on a traditional balance sheet yet have a critical impact on
a business’s risks and opportunities [7]. Investors are
increasingly adopting ESG, and it is forecasted to continue to
play an integral part in investment strategies moving forward.
As the market for ESG grows, investors are requesting new
tools to evaluate how firms perform from an ESG perspective
[8], as a measure to estimate or project the long-term
performance of the company (and their portfolios as well)
[15, 87]. In order to determine whether there is even a
relationship between firms' ESG scores and their financial
performance, the following hypotheses are tested in this
paper using the overall ESG score:
H
1
: There exists a statistically significant positive
relationship between the overall ESG scores and the
corporate financial performance of the listed firms on the
German stock exchange.
H
1a
: There exists a statistically significant positive
relationship between the distinct E-S-G pillar scores and the
corporate financial performance of the listed firms on the
German stock exchange.
A firm’s ESG score is a reflection of how well it is doing
in terms of environmental, social, and governance best
practices [85]. Jun et al., [65] argue that investors turn to
ESG scores for insights into firms’ sustainability
performance, and describe ESG criteria as the integration and
consideration of environmental and social factors, such as
income inequality, diversity, and climate change into
business strategies and practices. Bandini et al., [12] define
ESG as “extra-financial material information about the
challenges and performance of a company on these matters”,
and refer to it as key information that allows investors to
better measure and assess risks and opportunities, which
allows for additional differentiated investment decisions.
Gregory [53] estimated that over $30 trillion in assets under
management in 2018 were invested using sustainable
strategies that apply ESG scores from data providers. In the
US alone, $17 trillion as shown in Figure 1 in sustainable
investments were recorded at the beginning of 2020, an
increase of 42%; representing 33% of the $54 trillion in total
US assets under management [97].
Figure 1. Sustainable Investing in the United States from 1995-2020.
Source: US-SIF, 2020.
According to Larcker, et al. [67], due to some unanswered
fundamental sustainable business questions that have not
been captured by traditional financial analysis although their
material financial impacts have been recognized, the authors
believe that capital markets are inadequately pricing the cost
of ESG criteria on sustainable portfolios. How vulnerable are
77 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
firms to climate change? What is the effect of persistently
unhappy employees? Investors and portfolio managers alike
are turning towards ESG to assess the performance of non-
financial metrics on corporates’ financial success, especially
in the long term. ESG investing is “the consideration of
environmental, social and governance factors alongside
financial factors in the investment decision-making process”
[63]. He postulates that ESG investing ensure and enhance
long-term risk-adjusted returns through Thematic investing
(investing based on trends or structural shifts, such as social,
industrial, and demographic trends). ESG ratings have been
acknowledged as a tool to assist investors in taking
governance, social, and environmental issues into
consideration when making investment decisions [9, 70].
ESG rating agencies are third-party firms that specialize in
ESG scoring [34, 52]. Although there are many rating
agencies that offer ESG scores, some of the well-known ones
are Bloomberg ESG, Data Services, Sustainalytics, S&P
Global, Dow Jones Sustainability Index, Thomson Reuters
ESG Research Data, MSCI ESG Research, Fitch Ratings,
ISS ESG and Moody's Investors Service [34]. These agencies
examine companies and evaluate their performance in terms
of corporate sustainability using their own research
methodology. ESG rating agencies are becoming an
important resource [92], a key reference for businesses, the
financial markets, investors, and the academic community
when it comes to evaluating a company's sustainability.
Given the increasing influence of rating agencies [34], the
differences in their rating methodologies, and the different
components (criteria) they consider in scoring are key to
understanding the level of sustainability of a firm [49].
According to Galbreath [50], investors' spending on ESG
ratings from data providers increased from $200 million to
$500 million between 2014 and 2018. An analysis of the
historical development, evolution, expansion, and
consolidation of ESG rating agencies and their strategies, as
well as their frameworks for evaluation and weighting
systems, has previously been addressed in previous research
[32, 49]. Considering the remarkable evolution the rating
industry has undergone in the last decade, has raised some
concerns [34, 49].
Figure 2. The FTSE ESG ratings framework. Source: (FTSE, 2020).
Shown in Figure 2, ESG score calculated by considering a
firm’s environmental impact, governance practices, and
social responsibilities is measure of a firm's exposure to long-
term environmental, governance, and social risks which are
often not captured by traditional financial analyses [32].
Energy efficiency, worker safety, and board diversity are a
few of these risks, all of which have potentially serious
financial repercussions [85, 87]. A firm with a good ESG
score manages its ESG risks better than its peers, whereas a
company with a bad ESG score has a larger exposure to
unmanaged ESG risks on average. Financial analysis and
ESG evaluations and scores can work together to provide
investors with a better picture of a company's long-term
prospects or potential [1, 23]. Moreover, ESG score and its
data allow investors to understand a firm’s exposure to risk,
and management of ESG-related issues in multiple
dimensions [32]. The authors posit that ESG score comprises
of an overall (aggregate) score that breaks down into
underlying pillar scores (sub-scores) and themes which are
built on numerous individual indicator assessments that are
peculiar to each firm’s unique circumstances. As shown in
Figure 3 the sub-scores and themes are built on over 100
individual indicator measures [80], that are applied to each
firm’s unique context or circumstances. ESG scores are
normally ranked per percentile or its letter grades equivalent
[46, 73, 80].
Science Journal of Business and Management 2023; 11(2): 74-92 78
Figure 3. Environmental, social, and governance scores framework from Refinitiv. Source: (Refinitiv, 2022).
As interest in ESG criteria grows, investors need a
mechanism to objectively assess a company's ESG
performance. Hence, when selecting and evaluating asset or
portfolio managers, institutional and retail investors are
increasingly assessing how far they integrate ESG criteria into
their processes. Companies that score highly on ESG criteria
are thought to be better at predicting future risks and
opportunities, more inclined to long-term strategic thinking,
and more focused on long-term wealth development [7, 92].
The scores enable investors to select and identify where the
greatest ESG exposures exist in a portfolio by identifying
securities with the highest exposures and poorest ratings [1].
As a result, investors may wish to further analyze such
securities, engage with the firms, or even exclude such
securities from their portfolios [46, 73]. Conventional exposure
analysis and ESG scores can be used alongside to provide a
comprehensive and complementary perspective on risks [85].
ESG rating agencies provide a comprehensive data set for
research and analysis for identifying and evaluating the risk
and return relationships of various ESG factors [22]. In that
regard, companies in understanding their ESG scores embark
on a journey to continuously improve them year-over-year in
view to attracting ESG-conscious investors [9]. As a result,
ESG ratings serve as an extremely useful internal
benchmarking tool for guiding decision-making and
improving sustainability performance [32].
It is assumed that a high ESG score has the potential to
increase a firm’s wealth or value by means of increasing cash
flows (i.e., corporate financial performance) and or a
reduction in the cost of capital [79]. Hence, in light of the
fact that risk plays a significant role in determining the cost
of capital, environmental, social and governance factors can
have an impact on shareholder value if it affects firm risk
[18]. Therefore, integrating ESG factors into investment
decisions or business strategies fits into the overall concept
of risk management.
The impact of ESG on firm risk as a significant
determinant of corporate financial performance is an
intriguing part of the academic literature that this paper also
seeks to investigate. Despite the recognition of ESG factors
in risk mitigation [18], only a small part of the literature has
addressed the link between ESG and its risk mitigation
factors on corporate financial performance [17, 77]. The
paper aims to fill this research gap by examining the impact
of firms’ ESG scores on systematic market risk (Beta) using
data provided by the Thomas Reuters Refinitiv database.
Beta measures the volatility of a portfolio or a security
compared to the market as a whole [95]. It gives insights into
an individual's stock’s returns against those of the market as
a whole [96]. Investors can determine whether a stock moves
in the same direction as the market by using the beta.
Additionally, it reveals how risky or volatile a stock is in
comparison to the rest of the market [69].
A security is considered to be theoretically less volatile
than the market if its beta value is less than 1.0 [69, 95]. This
means that including this stock or security in a portfolio
makes it less risky or volatile than the same portfolio without
the stock. On the other hand, a beta value that is more than
1.0 indicates that the stock or security's price is theoretically
more volatile than the market [69, 95]. Betas that are higher
than the market benchmark are typically found in small-cap
and technology stocks [96]. This implies that including such
stocks in a portfolio will raise the portfolio's risk while also
possibly raising its expected return [33]. Lastly, a beta value
of negative means that the stock is inversely correlated to the
market [69]. In response, this paper therefore proposes the
following hypothesis:
H
2
: There exists a statistically significant positive
relationship between the overall ESG scores and the betas of
the listed firms on the German stock exchange.
1.3. ESG and Corporate Financial Performance Nexus
The pressure from the government, non-profit
organizations, and green consumers has increased the
attention and focus of businesses and researchers on the
pursuit of sustainability. As a result, numerous studies have
investigated the relationship between a firm’s sustainability
practices and their financial performance [27, 62, 86, 91].
The findings have been inconclusive, confusing, and
79 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
sometimes ambiguous [42]. Some of these studies have
found a significant positive relationship between ESG-CFP,
stating that a firm’s engagement in CSR improves its
financial performance. Several studies have found a
significant and negative relationship between ESG-CFP,
stating that a firm’s engagement in CSR weakens its financial
performance [27, 62, 86, 91]. Still, other studies have
identified no significant relationship between ESG-CFP,
explaining that a firm’s participation in CSR has no effect or
does not influence its financial performance [89]. In view of
the above ambiguities, this paper aside from investigating the
relationship between ESG scores and CFP, further dives
deeper to understand the causality between ESG scores and
CFP. Is it ESG scores that cause financial performance, or
vice versa? Therefore, we further propose that:
H
3
: ESG scores positively cause (causality) financial
performance.
2. Materials and Methods
The data, variables considered, and techniques utilized to
produce the desired outcomes are addressed in this section.
2.1. Database and Sample Selection
Both the financial and ESG data were collected from the
Thomas Reuters Refinitiv database (2011-2021). Refinitiv's
ESG scores are made to measure a firm's relative ESG
performance, commitment, and effectiveness based on
information provided by the company. This addresses ten
major topics, including emissions and the environment. The
scores are based on ten main themes categorized under the
Environmental Pillar (resource use, emissions, and product
innovation), the Social Pillar (workforce, human rights,
community and product responsibility), and the Governance
Pillar (Management, Shareholders, and Corporate Social
Responsibility, CSR strategy). Their combined ESG score
measures and illustrates the sustainability level of a company.
Measured in percentile (or grades from D- to A+) (see Figure
4), the combined ESG score is the sum total of a company’s
Environmental, Social, and With minimal transparency and
company biases, the Refinitiv ESG scores are based on the
relative performance of environmental, social, and
governance factors that are material to the particular
company, industry, and its country of incorporation.
The listed firms on the German Stock Exchange (XETRA),
GSE, were the primary focus of this paper. The panel data
was compiled from the above mentioned database because of
its most comprehensive ESG scores, which covers over 80%
of the global market capitalization across over 630 different
ESG metrics [80]. It consists of 450 listed companies with
4,950 observations across the 11 industrial sectors of the
GSE from 2011 to 2021. The German Stock Exchange
platform Xetra was chosen for this study because of its high
traded volume. Xetra holds a 60% market share in Europe for
listings on the Deutscher Aktienindex- the German Stock
Exchange, DAX [103]. Hence, Xetra was selected as the
universe for this paper because of its significant market
dominance across Europe.
Figure 4. Refinitiv’s ESG scoring range.
2.2. Refinitiv ESG Scoring Methodology
Refinitiv ESG ratings integrate and take into consideration
industry materiality and business size (market cap) biases,
reflecting the underlying ESG data methodology and
providing a transparent, data-driven evaluation of companies'
relative ESG performance and capability. The ESG scoring
system used by Refinitiv adheres to a number of important
calculating principles. Moreover, an overall ESGC score is
also calculated which discounts the ESG score for news
controversies that materially impact companies. The
underlying metrics are granular enough to distinguish
between firms that have limited reporting, and or who lack
transparency, and firms that 'walk the walk' and become
market leaders in their fields.
According to Refinitiv model in Figure 5, consists of two
overall ESG scores namely; ESG score (a measure of firms'
ESG performance based on verifiable reported public data)
and ESGC score (comprising of the ESG score and ESG
Science Journal of Business and Management 2023; 11(2): 74-92 80
controversies (score) to provide a comprehensive assessment of firms’ sustainability conduct and impact over time).
Figure 5. Compositions of Refinitiv’s ESG score methodology. Source: (Refinitiv, 2022).
The ESG combined (ESGC) score is used for this thesis
since it is the only factor that considers a company's
involvement in controversies when calculating its sustainable
performance score. Accordingly, if a corporation is
embroiled in ESG controversies, the overall ESG combined
score will be a weighted average of the ESG score and the
ESG controversies score for that year. The ESG controversy
score is assessed based on topics like fines, lawsuits, and
ongoing legislation settlements or disputes. The particular
firm gets penalized in the year of the scandal, which lowers
their total ESG combined score, ESGC.
The scores are calculated using a percentile rank scoring
approach which is based on the ten category scores (see
Figure 5) and the ESG controversies score. According to
Refinitiv [80], the percentile is based on the following three
factors; firms which are worse than the current one, firms
with the same value and firms with a value at all. These three
factors are mathematically computed as:
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,
. 
According to Refinitiv, this approach is more robust and
not sensitive to outliers. The TRBC industry group is used as
the baseline in calculating the Environmental, Social, and
Controversies scores.
2.3. Research Design
A quantitative analysis seemed to be the most appropriate
approach given that the goal of this paper to look into the
relationship between ESG scores and corporate financial
performance [16]. In essence, the paper aims to investigate
whether sustainable investments (that is if firms with higher
ESG scores) improve their financial performance.
A multi-dimensional method, using panel data was used to
investigate the relationship between ESG and corporate
financial performance in this research. When compared to
cross-sectional and time-series data, panel data typically have
more degrees of freedom and sample variation, which
increases the efficiency of the estimators [58]. The authors
further argue that panel data is more suited to capturing the
complexity in general and specific human behaviors. Finally,
Bouslah et al., [20] showed that panel data results can be
more generalized since its multi-dimensional method reduces
the effects of potential temporal errors that could affect the
data. Furthermore, a panel data approach is a more suitable
method as it provides insights into the long-term effect of this
relationship [16, 20]. A multi-dimensional panel data
approach is therefore employed in this study to investigate
the relationship between ESG and corporate financial
performance.
The study employs the ordinary least square multiple
regression (OLS) model and the panel vector autoregression
(PVAR) methods along with a system-generalized method of
moment (System-GMM) to investigate the correlation and
dynamic causal relationship, primarily between ESG scores
and corporate financial performance.
In this paper, multiple regression was utilized to
investigate the relationship between ESG scores and
corporate financial performance. Our motivation for
employing this tool in our analysis was by using independent
variables whose values are known to predict the value of the
single dependent value [76, 94]. Moreover, this model
removes bias by accounting for the correlation between the
dependent variable and propensity scores [83]. The
regression equation for this paper is expressed as;
81 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
Y = a + β
1
X
1
+ β
2
X
2
+ β
3
X
3
+ … + β
n
X
n
+ ε
i
Where Y is the dependent variable, a is the intercept, X
1
, …,
X
n
are the n independent variables, and
ε
i
is the stochastic
error term. In calculating the weights, a,
β
1
, …,
β
n
, regression
analysis ensures maximal prediction of the dependent
variable from the set of independent variables through the
least squares estimation.
In satisfying the conditions for regression analysis, the
model’s linearity, independence of residuals,
multicollinearity, homoscedasticity, and autocorrelation were
checked [76, 82, 94]. Finally, the Granger causality test was
also conducted to establish the direction of causality between
ESG score and CFP.
2.4. Models’ Variables Definition and Description
The components of firm financial performance are of central
importance to management research because explaining
variation in firm performance is a key subject in the study of
organization [62, 100]. The relationship between accounting-
based (such as return on assets (ROA), return on equity (ROE),
and return on sales (ROS)) and market-based measures (such
as Tobin’s Q and market returns) has significant implications
for organizational research [13], since it concerns whether
firms’ financial performance should (or can) be treated as a
one-dimensional construct or not [11, 62, 81, 100]. For a
comprehensive understanding of the impact of ESG on firm
financial performance, this study considers both the
accounting-based and market-based measures as indicators of
firm financial performance (dependent variables). In theory,
accounting-based measurements reflect past or short-term
financial performance, whereas market-based indicators are
reflections of future or long-term financial performance [100].
ROA and Tobin's Q are employed as independent variables in
this study as recommended by some previous studies [2, 26, 56,
98].
Moreover, the total Environmental, Social, and
Governance (ESG) score and its component pillar scores
(Environmental, E Score, Social, S Score, and Governance,
G Score) are regarded as the primary independent variables.
According to related literature in this field, Total Assets,
Price-to-Cash Flows, Book Value Per Share, and Total Debts
are major financial variables that affect the performance of
stock returns and are thus, identified as control variables in
this study [13, 98]. Table 2 below shows the summary of the
regression variables.
Table 2. Summary of regression variables.
Dependent variable Independent variables Control variable
Return on Assets (ROA) ESG score Total Assets
Tobin’s Q E score Total Debts
S score Book Value Per Share
G score
The panel data regression model for the studies is given as:
RA = α + β
1
ESG + β
2
TA + β
3
BV + β
4
TD + ε (1)
RA = α + β
1
E +β
2
S +β
3
G + β
4
TA+ β
5
BV + β
6
TD + ε (2)
TQ = α + β
1
ESG + β
2
TA + β
3
BV + β
4
TD + ε (3)
TQ = α + β
1
E +β
2
S +β
3
G + β
4
TA + β
5
BV + β
6
TD + ε (4)
Where RA is the return on assets, ESG is the Environmental, Social, and Governance scores, TA represents Total Assets, BV is
Book Value Per Share, TD is Total Debts,
α
the y-intercept, β
is the coefficient of the respective independent variables, and
ε
is
the stochastic error term. Table 3 illustrates the definition and description of the variables.
Table 3. Definition and Description of regression variables.
Definition/Description of variables
Return on Assets (RA) Return on assets (ROA) is a measure of how efficiently a company uses the assets it owns to generate profits.
ROA = (Net Profit / Total Assets) x 100
Tobin’s Q (TQ)
Tobin’s Q is the ratio between the market value of physical assets and their replacement value or cost.
TQ = Total Asset Value of Firm / Total Market Value of Firm, or
TQ = Equity Book Value / Equity Market Value
Environmental Social and
Governance (ESG) scores ESG scores indicate a firm’s aggregated environmental, social and corporate governance pillars scores.
Total Assets (TA) Total assets refer to the sum of the book values of all assets owned by a firm. The value of a company’s total assets is
obtained after accounting for depreciation associated with the assets.
Book Value Per Share (BV)
Book value per share (BVPS) is the ratio of equity available to common shareholders divided by the number of
outstanding shares. This figure represents the minimum value of a company's equity and measures the book value of a
firm on a per-share basis.
Total Debts Total debt is the sum of all balance sheet liabilities that represent principle balances held in exchange for interest paid.
Science Journal of Business and Management 2023; 11(2): 74-92 82
This research also adopts the dynamic panel vector
autoregression (PVAR) methodology to investigate the
relationship between ESG scores and corporate financial
performance. The dynamic nature solves the issues of serial
correlation and endogeneity of the explanatory variables. The
system-GMM approach will be applied since it produces
efficient estimators [19, 70]. The PVAR combines the
conventional VAR method, which treats all system variables
as endogenous, and with the panel data method, which allows
unobserved individual variations [1, 69]. System-GMM
transforms equation (5) into first differences and uses the
lagged values of the endogenous variables as instruments that
create efficient regression estimates.
Following [1, 6], the first-order PVAR model which is
used to determine the ideal lag for the model selection as
shown in (5).
Z
it
= µ
i
+ Φ(I) Z
it-1
+ ν
i
+ θ
t
+ ε
i
(5)
Where i = 1, 2, 3, …, N, t = 1, 2, 3, …, T, Z
it
represents the
dependent variables, Z
it
is the independent variables,
Φ
(I) is
the lag operator of the endogenous covariates, v is an
individual specific effect, θ is fixed time effect and ε is the
stochastic error term. Following [1], the first difference
equation which addresses the country-specific fixed and time
effects is given by equation (6).
Z
it
= ∆µ
i
+ Φ(I) Z
it-1
+ ∆ν
i
+ ∆θ
t
+ ∆ε
I
(6)
as the difference operator, this study estimates the
PVAR by using the robust system-GMM estimator
developed by [19] and also tests the Granger causality
between ESG scores and corporate financial performance.
Unlike the conventional VAR, the system-GMM PVAR
expands the estimation sample and improves the consistency
and robustness of the results [1].
2.5. Robustness Measures
Numerous robustness checks were carried out to guarantee
that the relationships identified by this study are efficient,
reliable, and unaffected by spurious relationships. The Gauss
Markov assumptions that make Ordinary Least Squares (OLS)
the best linear unbiased estimators (BLUE) were used to
diagnose the variables and the regression estimations [45].
The assumptions of normality, multicollinearity, and
heteroscedasticity were tested to ensure the efficiency of the
regression estimates [54]. The assumption of normality was
tested using the Jarque-Bera test. The Jarque-Bera test is a
goodness-of-fit test that determines if sample data have
skewness and kurtosis that are close to those of a normal
distribution. The Variance Inflation Factor (VIF) and the
White test were utilized to identify and address the presence
of multicollinearity and heteroscedasticity respectively.
3. Analysis and Results
3.1. Descriptive and Summary Statistics
Table 4 presents an overview of the descriptive statistics of
listed companies on the German Stock Exchange (Xetra)
from 2011 to 2021. With a total of 450 firms and 4,950
observations, the Industrial, Information Technology, and
Consumer Discretionary industry sectors represent the top-
ranked industries with the highest frequencies of firms,
representing 88, 85, and 59 firms respectively.
Figure 6. The evolution of ESG scores of the listed companies on the GSE from 2011 to 2021.
0
10
20
30
40
50
60
2011 2012 2013 2 014 2015 2016 2 017 2018 2019 2020 2 021
Average ESG Scores of the listed firms on the German Stock Exchange (XETRA) from 2011-2021.
Communication Services Consumer Discretionary Consu mer Staples Energy
Financials Health Care Industrials Information Technology
Materials Real Estate Utilities
83 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
Table 4. Summary statistics of the industrial sectors on the German Stock Exchange.
Industry Sectors the German Stock Exchange, Xetra No. of firms Freq. Percent Cum.
Communication Services 31 341 6.89 6.89
Consumer Discretionary 59 649 13.11 20.00
Consumer Staples 11 121 2.44 22.44
Energy 7 77 1.56 24.00
Financials 55 605 12.22 36.22
Health Care 48 528 10.67 46.89
Industrials 88 968 19.56 66.44
Information Technology 85 935 18.89 85.33
Materials 21 231 4.67 90.00
Real Estate 37 407 8.22 98.22
Utilities 8 88 1.78 100.00
Total 450 4950 100
Figure 6 shows the evolution of the average ESG scores of
the 11 industrial sectors of the German Stock Exchange
(GSE) from 2011 to 2021. The average ESG score for the
Consumer Staples sector rose from 14.8 in 2011 to become
an industry leader in 2021 with an average score of 48.8.
With a total revenue of 20.7 billion EUR (2021), Henkel AG
& Co. KGaA had the highest ESG average score of 73.7
from 2011 to 2021 followed by Beiersdorf AG with an
average ESG score of 59.5.
The Material sector which has been the industry leader
from 2011 to 2020 had an average ESG score of 44.7 in 2021.
Heidelberg Cement AG recorded the highest average ESG
score of 70.6 in the Material sector from 2011 to 2021.
Followed by BasfSe with an average ESG score of 68.4%,
the energy sector has consecutively recorded the lowest
average ESG over the period with 4.0 in 2021. In a nutshell,
the industry has recorded a 2.3% growth in average ESG
scores from 2011 (of 98.956) to 2021 (of 327.491).
The summary statistics of the ESG and financial variables
used in this study are presented in Table 5. The table
indicates the total number of observations used for this study,
their mean, standard deviation, and the minimum and the
maximum number of observations. The table indicates that
the listed firms have an average Tobin’s Q or Q ratio of
0.999. A low Q ratio between 0 and 1 means that the cost to
replace a company’s assets is greater than the value of its
stock. This means that the stock is undervalued. On the other
hand, a high Q ratio (greater than 1) implies that a firm's
stock is more expensive than the replacement cost of its
assets, which means that the stock (or market) is overvalued.
In this case, the market’s Q ratio of 0.999 implies that the
companies are undervalued suggesting that the market looks
attractive to investors, potential purchasers, or corporate
raiders, as they may want to purchase firms instead of
creating similar companies. This would likely result in
increased interest in the firms, which would increase their
stock prices and increase its Tobin's Q ratio. The correlation
test also indicates that both the total ESG scores and its pillar
scores have significant and negative relationship between the
independent (financial) variables, return on assets (ROA) and
Tobin’s Q [30, 89]. However, as found in the appendix, the
ESG variables resulted significant and positive correlations
between total assets (TA) and book value per share (BV).
Table 5. Summary statistics of regression variables.
Variable Obs. Mean Std. Dev. Min Max
ROA 4,950 .0181477 .073807 -1.1399 1.12439
TQ 4,950 .9994972 3.274939 0 177.8022
ESG Score 4,950 13.32012 23.73813 1 92.75507
E Score 4,950 13.2573 25.78059 1 98.31469
S Score 4,950 15.18925 27.64224 1 98.24187
G Score 4,950 13.52111 24.85359 1 96.86117
Total Debt 4,950 3.24e+09 2.05e+10 0 26.92618
Book Value Per Share 4,950 13.18895 37.57828 -76.25214 921.3256
Total Assets 4,950 1.71e+10 1.15e+11 0 2.80e+12
Market Risk (Beta) 4,950 .3642754 .5062403 -4.275566 4.527875
3.2. Robustness Tests
To ensure the accuracy of the estimates, the model's
normality, multicollinearity, and heteroscedasticity test were
checked. Robust standard errors were used to estimate all the
models to address the possibility of heteroscedasticity.
Transforming the data into natural logs to ensure its normal
distribution [102], the presence of multicollinearity was also
accounted for and addressed using the Variance Inflation
Factor (VIF) [3, 38, 39, 47]. The eigenvalue stability
condition after estimating the parameters of the panel
autoregression was also checked. Gregory [55] showed that if
the modulus of each individual eigenvalue of the estimated
model or matrix is less than one, the estimated panel VAR is
considered stable. Therein, since each eigenvalue's modulus
is strictly less than 1, the estimates for this paper met the
eigenvalue stability requirement as shown in Figure 7 and
Table in the appendix.
Science Journal of Business and Management 2023; 11(2): 74-92 84
Figure 7. Stability of Return on assets PVAR (Left) and Tobin’s Q PVAR (Right).
3.3. Regression Results
The study used different robust multiple (panel) regression
models, to investigate: the impact of ESG scores on corporate
financial performance (CFP), the impact of ESG scores on
market risk (Beta), and the causality between ESG and CFP
(using the PVAR Granger causality test). It is worth noting
that both accounting-based (ROA) financial performance and
market-based (Tobin’s Q) financial performance were also
examined.
3.4. Regression Results of ESG-CFP Link
Table 6. Regression output investigating the impact of ESG scores on CFP.
Independent variables
Dependent variables
Model 1 (ROA) Model 2 (Tobin’s Q)
ESG Score .1316985 *
(.0157681)
.2376158 *
(.0144785)
E Score ** -.0942853 *
(.0432311)
-.1432742 *
(.0337002)
S Score ** .1644868 *
(.0726071)
.4220051 *
(.0603117)
G Score** .0524279
(.0644075)
-.0655919
(.0526852)
Total Debts -.0686653 *
(.0179408)
-.0889766 *
(.0145815)
Book Value Per Share .0817154 *
(.029862)
-.0052151
(.0234544)
Total Assets -.1657615 *
(.0284173)
-.2500099 *
(.0244316)
Heteroskedasticity robust standard errors in parenthesis,*p-value <0.05.
**Variables estimated separately with the other independent variables and
without the total ESG score.
Model 1 of Table 6 reports the relationship between ESG
scores and corporate financial performance (return on assets,
ROA). The ESG score’s regression coefficient of 0.132
indicates a positive relationship between it and CFP. With a
p-value of less than 0.05, this shows that there exists a
statistically significant relationship between ESG scores and
CFP. This means that a unit increase in ESG scores will
increase ROA by 0.132 units. The remaining independent
variables were all statistically significant at 5% significance
level. The table shows a negative relationship between Debts
and Total Assets and ROA. The table shows that a unit
increase in debts and total assets will decrease return on
assets by 0.067 and 0.166 respectively. There is, however, a
statistically positive relationship between book value per
share and ROA. A one unit increase in book value per share
increases returns on assets by 0.082. Regarding the ESG
pillar scores of Model 1, aside from the Government score,
all the other independent variables were statistically
significant at 5%. A unit increase in Environmental score
reduces ROA by 0.094. Also, a unit increase in the Social
score increases ROA by 0.164. Despite a positive
relationship between the Government score and ROA, the
result was statistically insignificant at 5%.
In the same way, Model 2 of Table 6 presents the findings
of the relationship between ESG scores and CFP (Tobin’s Q).
Like the ROA, the table shows a positive and statistically
significant relationship between the firms’ ESG scores and
their financial performance. It shows that a unit performance
increase in ESG scores will increase Tobin’s Q by 0.238.
Aside from Book-value per share, all the other independent
variables were statistically significant. The table shows a
statistically significant negative relationship between Debts,
Total Assets and Tobin’s Q. Aside from the Government
score and Book value per share, all the other variables were
statistically significant. A unit increase in the Environmental
score reduces Tobin’s Q by 0.143. On the contrary, a unit
increases in the Social pillar score increases Tobin’s Q by
0.422. Although statistically insignificant, there was a
negative relationship between the Government score and
Tobin’s Q.
Insofar, the empirical results from the multivariate
regression analysis support the study’s main hypothesis (H
1
)
which states “There exists a statistically significant positive
85 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
relationship between the overall ESG scores and the
corporate financial performance of the listed firms on the
German stock exchange”. The overall ESG score from Table
6 in Model 1 and Model 2 shows a positive and statistically
significant relationship between ESG scores and corporate
financial performance for both accounting-based financial
performance (return on assets) and market-based financial
performance (Tobin’s Q). Further analysis indicates that
there is weak support for hypothesis H
1a
which states that
“There exists a statistically significant positive relationship
between the distinct ESG pillar scores and the corporate
financial performance of the listed firms on the German stock
exchange”. Aside from the Social score that showed a
positive and statistically significant relationship between both
financial performance measures, the rest of the pillar scores
showed mixed findings as presented in Table 6.
3.5. ESG and Systematic Market Risk (Beta) Link
Table 7 below presents the regression output investigating
the relationship between ESG scores and beta- which
measures the volatility of a security, portfolio, or stock
compared to the total market. The table shows that at the 5%
statistically significant level, there exists a positive
relationship between ESG and beta. It states that a unit
increase in ESG will increase beta by 0.089. This means that
ESG scores increase the volatility of stocks in the market.
Which indicate that adding high-performing ESG score
stocks to a portfolio will increase the portfolio’s risk, which
may also increase its expected return. Aside from the
Government score, all the other independent variables were
statistically insignificant at 5% significance level. The table
shows that a unit increase in Government score will increase
beta by 0.098.
3.6. System-GMM Pvar Causality Results
Table 8 presents the causal relationship between return on
assets (ROA), Tobin’s Q, ESG scores, total debts, book value
per share, and total assets. The results from Panel A of Table
8 show that financial performance measured by ROA does
not cause ESG scores and vice versa. However, book value
per share Granger causes both financial performance and
total assets. A one-unit increase in book value per share
increases ROA by 0.27 and total assets by 0.155. On the
other hand, Panel B of Table 8 shows the causal relationships
between market-based financial performance (Tobin’s Q),
ESG scores, total debts, book value, and total assets. The
results show that ESG scores Granger cause financial
performance (Tobin’s Q). In a way that, a unit increase in
ESG scores decreases Tobin’s Q by 0.314. However, Tobin’s
Q does not Granger cause ESG score performance. ESG
score however Granger causes book value per share. Thus,
book value per share will increase by 0.146 when ESG scores
improve by a unit. However, book value per share does not
Granger cause ESG score. Total debts and total assets both
Granger cause ESG scores. A one-unit increase in total debts
and total assets increases ESG scores by 0.06 and 0.009
respectively.
Insofar, hypothesis 3 which states that “ESG scores
positively cause (causality) financial performance” is not
supported. Since ESG scores do not positively Granger cause
any of the financial performance.
Table 7. ESG-beta link regression output.
Dependent variable
Beta
ESG score .0886738 *
(.0113883)
E score ** -.0138639
(.0249314)
S score ** .0073573
(.0399314)
G score ** .0983078 *
(.0374105)
Total debts .0036246
(.0119434)
Book value per share .0035489
(.0161295)
Total assets .0084985
(.1998503)
Heteroskedasticity robust standard errors in parenthesis. * p-value < 0.05. **
Variables estimated separately with the other independent variables and
without the total ESG score.
Table 8. Estimated causality results from the dynamic panel system-GMM.
Panel A: ROA Dependent variables
Independent variables ROA ESG Score Total debts Book value per share
Total assets
ROA .0379596
(.0360163)
-.017373
(.0268824)
.0352996
(.146026)
.2015752
(.2114974)
ESG Score .0606122
(.0538058) -.0352211
(.0520534)
.1031821
(.1598255)
-.0941502
(.2753782)
Total debts .0393176
(.0340797)
.0205143
(.0238999) .1678004
(.1243006)
.0889969
(.2329332)
Book value per share .0268791 *
(.0118353)
.0179099
(.0092853)
-.0093321
(.0082948) .1553317 *
(.0604318)
Total assets -.0084513
(.0092796)
.0029936
(.0080723)
-.006823
(.0060943)
.0010368
(.0295748)
Panel B: Tobin’s Q Tobin’s Q ESG Score Total debts Book value per share Total assets
Tobin’s Q 0174103
(.0162508)
-.0111176
(.0152065)
-.0927102 *
(.0422385)
-.3906436 *
(.1153117)
ESG Score -.3136894 *
(.0739317) -.0454039
(.0415625)
.1457614 *
(.0533793)
.082217
(.2447583)
Science Journal of Business and Management 2023; 11(2): 74-92 86
Panel A: ROA Dependent variables
Independent variables ROA ESG Score Total debts Book value per share
Total assets
Total debts -.1580889 *
(.0646357)
.0619743 *
(.0282503) -.0152144
(.0622603)
.5721241 *
(.1802001)
Book value per share .0785673
(.0258931)
-.0151468
(.0086933)
-.000691
(.0139363) .2269902
(.090062)
Total assets .0494033
(.0135477)
.0087966 *
(.006411)
.0088968
(.0073261)
.0256757
(.0145404)
* Heteroskedasticity robust standard errors in parenthesis. * p-value < 0.05.
4. Discussions
Previously, empirical studies on the ESG-CFP relationship
have been inclusive and mixed. According to Freeman [42],
in majority of cases, statistically significant positive
outcomes are observed regarding the impact of total ESG
scores on firms’ financial performance. The findings of this
paper are not different as a positive and statistically
significant relationship was found between the total ESG
scores and the various financial performance measures. Our
findings are consistent with those of [27, 60, 84, 90], who
established that in the advancement of time, the positive
impact of ESG scores on financial performance gradually
begins to offset the cost of ESG investment which eventually
increases firms’ financial performance.
Moving forward, the environmental score (E) showed a
statistically significant but negative relationship between both
ROA and Tobin’s Q. This component comprises a firm’s
performance regarding climate change, natural resources, level
of greenhouse gas emissions, pollution and waste, and
environmental opportunities. The findings suggest that
environmental aspects somewhat have negative on firms’
financial performance. A possible explanation could be the high
upfront infrastructure and investment costs required by
companies to acquire and install pollution-controlling
technologies which could have a huge dent on firmsfinancial
balance sheets. This finding might also be explained by the fact
that waste disposal costs are higher as a result of stricter rules
and/or the fact that businesses may frequently run the danger of
failing to comply with the law and face legal actions which
could be expensive. The regression with the Government score,
G did not show any significant results with both financial
measures. This finding contradicts the report that the G
component contributes to firms’ value creation [37, 56].
The only positive and statistically significant component
score finding with both financial measures was the Social
score, S. This component (S) assesses how firms treat their
employees and their communities. Working conditions,
employee relations, organizational diversity, employee
equality and justice, human rights, inclusion, product
responsibility, and community health and safety are some of
the key points. The findings suggest that it’s a win-win
situation when companies take the effort to better the
working conditions of their employees and as well improve
the communities they operate. This finding is consistent with
the findings of [98, 105].
Previous studies provide limited evidence on the
relationship between ESG scores and firms’ systematic
market risk (beta) [87], which this paper sort to bridge. The
findings show that total ESG scores increase the volatility
(beta) of the listed firms. This means that adding stocks with
better ESG scores to a portfolio might increase the portfolio’s
risk, which might also increase its expected return. In
contrast, securities or portfolios with less volatility are less
risky and award lower returns. Hence, as the saying goes, the
higher the risk the higher the returns. However, it is worth
noting that, in reality, financial returns are not always
normally distributed. Therefore, what a stock's beta may
suggest about its potential future movement should always be
taken with caution [58, 65]. It is of interest to point out that,
the Government score, G showed statistically significant and
positive relations with the beta. However, both the
Environment score, E and Social score, S were statistically
insignificant at the chosen 5% significance level.
Furthermore, the Granger causality test was as well
introduced to investigate the direction of causality between
ESG scores and corporate financial performance. The results
suggest that return of assets, ROA does not Granger cause
ESG scores, and vice versa. The second-panel model showed
that ESG scores Granger cause Tobin’s Q, and their
relationship is negative.
5. Implications of the Study
This paper contributes to the emerging field of how
sustainability and corporate social responsibility affect firms'
financial performance. Specifically, by focusing on how ESG
scores (a proxy for firms' sustainability performance) affect
the financial performance of German-listed firms. Practically,
this paper highlights how to integrate ESG data into financial
portfolios. The results provide further and deeper knowledge
on how to further incorporate ESG data into investment
decisions. This will be of interest to investors in general, and
particularly to socially responsible investors. Thus, the paper
could provide motivation for portfolio managers of SRI funds
to expand their strategies without losing focus on ESG
criteria with ambiguity issues concerning ESG-CFP findings
over the years being addressed.
On the other hand, only the effect of ESG Scores on the
financial performance of firms listed on the German Stock
Exchange is being studied. Hence, these findings might not
represent or apply to all areas because of the firms' selection
criteria and the various methodological approaches and
baselines used by different rating agencies in calculating
ESG scores.
87 Jacob Azaare et al.: Examining the Impact of Environmental, Social and Governance Scores on Financial Performance of
Listed Companies on the German Stock Exchange (XETRA)
6. Conclusion
In light of the increasing awareness among investors and
academic researchers regarding firms' ESG performance and
corporate financial performance nexus, this study explores
the link between ESG scores and corporate financial
performance by focusing on the listed firms on the German
Stock Exchange, Xetra from the year 2011 to 2021. Previous
empirical findings on this subject have been inconclusive and
mixed. This paper takes the matter a step further by first
investigating the relationship between ESG scores and
corporate financial performance. Grounding on the fact that
volatility plays a crucial part in stock returns (their financial
performance), the study further examines the role of ESG
scores on stock volatility. The causality between ESG and
corporate financial performance is as well investigated in the
research.
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.
Funding
This work was supported by the National Science
foundation of China (project No: 71871044), Sichuan
Science and Technology program (2023NSFSC1293).
Conflicts of Interest
The authors declare no conflict of interest.
ORCID ID
Jacob Azaare – http://orcid.org/0000-0001-5547-3786
Appendix
Table A1. Correlation matrix between the total ESG scores and the other variables.
ROA TQ ESG T. Debt BV T Assets
ROA 1.0000
TQ 0.6688* 1.0000
ESG -0.1058* -0.1174* 1.0000
T. Debt -0.3134* -0.3935* 0.5859* 1.0000
BV -0.1324* -0.2857* 0.3767* 0.4484* 1.0000
T. Assets -0.3337* -0.4579* 0.6675* 0.8596* 0.5879* 1.0000
*p ≤ 0.05
Table A2. Correlation matrix between the ESG pillar scores and the other variables.
ROA TQ E Score S Score G Score Debt BV TA
ROA 1.000
TQ 0.669* 1.000
E Score -0.141* -0.157* 1.000
S Score -0.106* -0.117* 0.967* 1.000
G Score -0.108* -0.122* 0.9550* 0.9861* 1.000
Debt -0.313* -0.394* 0.599* 0.590* 0.588* 1.000
BV -0.132* -0.286* 0.385* 0.378* 0.375* 0.448* 1.000
TA -0.334* -0.458* 0.678* 0.670* 0.668* 0.860* 0.588* 1.000
*p ≤ 0.05
Table A3. Variance inflation factor (VIF) of the regression variables.
Variables ROA Tobin’s Q
VIF 1/VIF VIF 1/VIF
Total Assets 6.15 0.162594 6.35 0.157357
Total Debt 4.18 0.223049 4.46 0.224326
Book Value 1.82 0.549441 2.03 0.492541
ESG 1.52 0.658048 1.55 0.646935
Mean VIF 3.49 3.60
Science Journal of Business and Management 2023; 11(2): 74-92 88
Table A4. Return on assets PVAR stability table. Source: Author’s calculation.
Eigenvalue
Real Imaginary Modulus
-.2190349 0 .2190349
-.1322748 0 .1322748
-.0532543 -.0387222 .065844
-.0532543 .0387222 .065844
-.0089799 0 .0089799
Table A5. Tobins Q PVAR stability table.
Eigenvalue
Real Imaginary Modulus
-.2871545 0 .2871545
-.1185983 .1434348 .1861158
-.1185983 -.1434348 .1861158
-.1833846 0 .1833846
.0386973 0 .0386973
Table A6. ESG criteria of major index providers. Source: Refinitiv, MSCI, Bloomberg, FTSE; OECD assessment.
Pillar Thomas Reuters MSCI Bloomberg
Environmental
Resource use Climate change Carbon emissions
Emissions Natural resources Climate change effects
Innovation Pollution & Waste Pollution
Environmental opportunities Waste disposal
Renewable energy
Resource depletion
Social
Workforce Human capital Supply chain
Human rights Product liability Discrimination
Community Stakeholder opposition Political contributions
Product responsibility Social opportunities Diversity
Human rights
Community relations
Governance
Management Corporate governance Cumulative voting
Shareholders Corporate behaviour Executive compensation
CSR strategy Shareholders’ right
Takeoever defence
Staggered boards
Independent directors
Key metrics and submetrics 186 34 >120
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... Recent studies like Naffa and Fain (2020), Mansouri et al. (2021), Cui (2022), Gupta (2022), Vasiu and Bratu (2022), Azaare et al. (2023), and Suttipun (2023) highlighted the increasing relevance of ESG considerations in financial performance and the innovative potentials of fintech in redefining corporate sustainability practices. Nonetheless, this study served as the first to underscore the role of Scope 3 carbon emissions within the context of fintech and market performance. ...
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