Abstract
The primary aim of this chapter is to investigate the influence of ESG factors on the financial well-being of Indian companies. Research utilizes a sample of 352 Indian firms that are consistently included in the Thomson Reuters Asset 4 ESG database. To assess the impact of ESG on firm profitability, an empirical multivariate panel data model is developed. The study endeavors to determine if firms with high sustainability rankings outperform their low-ranked counterparts, a comparison made through the application of parametric t-tests. The investigation uncovers a statistically significant positive correlation between ESG factors and a firm's financial well-being, as measured by indicators such as return on invested capital, return on equity, return on assets, and earnings per share. Empirical data indicates that firms implementing robust sustainable development strategies tend to exhibit higher profitability and maintain lower levels of leverage.
TopIntroduction
Environmental, social, and governance (ESG) encompass the criteria used in corporate decision-making to evaluate a company's performance. ESG information disclosure involves the transparent release of a company's environmental, social, governance, and financial management details within a legal framework, enabling investors to make informed assessments and protect stakeholders' interests. The United Nations Environmental Programme Financial Initiative (UNEP FI) has advocated for integrating ESG factors into financial institutions' decision-making processes since 1992. Over time, ESG has evolved into one of the primary benchmarks for assessing the sustainable development capabilities of businesses globally.
ESG investing has gained significant popularity recently, driven by increasing interest from investors globally. Research indicates that well-performing ESG companies are rewarded by investors, while poor ESG disclosure signals potential risks. Inadequate ESG transparency can lead to investments in high-risk sectors that harm the environment or mistreat employees. Integrating ESG considerations into investment decisions helps investors focus on overall performance rather than just financial metrics. ESG encompasses a firm's responsibility to enhance social welfare and create sustainable wealth for stakeholders. ESG-compliant firms typically exhibit better governance, environmental consciousness, sustainable practices, lower earnings volatility, and access to more affordable funding. The United Nations aims for firms to disclose their ESG practices by 2030, emphasizing the importance of government support through tax incentives.
Numerous studies highlight the positive impact of integrating Environmental, Social, and Governance (ESG) factors into a firm's valuation model, leading to improvements in non-financial indicators like consumer satisfaction, market acceptance, lower debt costs, and enhanced societal value for stakeholders. This integration can contribute to a firm's competitive advantage over time, as evidenced by research by Schramade and Schoenmaker (2018). Research also indicates that incorporating ESG factors into valuation and investment decisions results in a significant increase in equity premium and overall firm value (Schramade, 2016). Nelson (2017) further notes that firms with competitive advantages due to ESG integration experience reduced investment risks, improved governance practices, and a stronger commitment to environmental and social responsibilities. For instance, in the Malaysian telecommunications industry, ESG disclosures have enabled firms to gain a competitive edge, as observed by Jasni et al. (2020). However, there is a concern that some firms only disclose ESG matters to meet regulatory requirements and enhance their reputation, rather than genuinely prioritizing ESG efforts. Porter et al. (2019) argue that some companies use ESG disclosures primarily to improve their acceptance among investors and reduce regulatory constraints on their investment portfolios. This focus on reputation management may overshadow the actual impact of ESG initiatives on a firm's performance and value creation for shareholders. The central question remains whether improving ESG disclosure efforts genuinely contributes to shareholder wealth and firm profitability or if it primarily serves to enhance a firm's reputation. Our analysis delves into the interaction between competitive advantage and ESG disclosure and its influence on firm performance. Using the resource-based competitive advantage model and stakeholders' theory, we conduct cluster regression analysis to explore these dynamics based on industry, year, and combined industry-year clusters.
Sustainable development plays a crucial role in both corporate and economic resource management. Embracing sustainable strategies such as ethical codes of conduct, environmental conservation, human capital development, and social responsibility can enhance brand reputation and improve business management practices. This is supported by research from various scholars (Husted, 2000; Shrivastava, 1995; Orlitzky et al., 2003).
Key Terms in this Chapter
Earnings Per Share (EPS): EPS is a financial metric that indicates the portion of a company's profit allocated to each outstanding share of common stock. It is calculated by dividing net income minus preferred dividends by the average number of outstanding shares. EPS is important for investors as it helps assess a company's profitability on a per-share basis.
Return on Assets (ROA): ROA is a financial ratio that measures a company's ability to generate profits from its total assets. It is calculated by dividing net income by average total assets. ROA shows how efficiently a company uses its assets to generate earnings.
Return on Invested Capital (ROIC): ROIC is a financial metric that measures a company's efficiency in generating profits from its capital investments. It is calculated by dividing a company's after-tax operating income by its total invested capital (both equity and debt). ROIC is used to assess how effectively a company utilizes its capital to generate returns.
Return on Equity (ROE): ROE AU114: Reference appears to be out of alphabetical order. Please check is a financial ratio that measures a company's profitability by revealing how much profit a company generates with the money shareholders have invested. It is calculated by dividing net income by shareholders' equity. ROE indicates how efficiently a company uses shareholders' funds to generate profits.
Total Debt to Equity (LEV): Total Debt to Equity is a financial ratio that measures a company's leverage by comparing its total debt to its total shareholders' equity. It is calculated by dividing total debt by total equity. LEV shows the proportion of a company's financing that comes from debt compared to equity and indicates the level of financial risk.
Environment, Social, and Governance (ESG): ESG refers to a set of criteria used by investors and analysts to evaluate a company's sustainability and ethical impact. Environmental criteria assess a company's impact on the environment, social criteria evaluate its relationships with stakeholders and communities, and governance criteria examine its leadership, policies, and accountability.