ESG AND FINANCIAL PERFORMANCE 1
ESG AND FINANCIAL PERFORMANCE
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ESG AND FINANCIAL PERFORMANCE 2
Literature Review: Relationship Between Economic, Social and Governance Practices and
Financial Performance
The relationship between social, economic and governance practices and financial
performance has attracted attention in the academic world. Various scholars have tried to give
their views concerning the issue to determine the focal point on the matter. The growing
awareness of social awareness and corporate responsibility has caused attention to the matter. As
such, the review aims to explain how ESG influences financial outcomes by reviewing
theoretical frameworks and literature to determine an absolute relationship.
Stakeholder theory
The stakeholder theory asserts that organizations should create value for all stakeholders
and not just shareholders. According to the theory, creating value for employees, communities
and suppliers can improve the financial performance of an institution. Friede, Busch and Bassen
(2015) emphasize that providing value for shareholders builds a company’s reputation, increases
efficiency and improves customer loyalty, which is essential for the financial performance of a
company.
Agency Theory
The agency theory explains the conflict that exists between managers, who are considered agents
by the theory, and shareholders, who are the principals. This theory suggests that ESG practices
can effectively mitigate agency problems by streamlining the interests of managers to align with
the broader expectations of stakeholders. Kumar and Firoz (2022) believe that without the
incorporation of ESG, managers would pursue their interests at the expense of shareholders'
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wealth. However, the incorporation of the ESG framework will improve the firm's performance
and guarantee good financial performance.
Resource-Based View
The resource-based view emphasizes on a company’s competitive advantage based on its
internal resources. According to Li et al. (2024), firms that instill inimitable strategies with their
internal resources have advantages in the market due to their competitiveness. The ESG practices
have enabled organizations to enhance their reputation improve competitiveness and innovation
to align with the demands of the 21st century(Zhou, Lin and Luo, 2022). The demands of the 21st
century have enabled firms to invest in innovation, which has increased efficiency and improved
financial performance.
Institutional Theory
The institutional theory delves into how firms conform to the values of their
surroundings. LIU, Nemoto and Lu (2023) suggest that firms adopt ESG practices to conform
with the regulatory environment, meet social expectations and gain legitimacy. This conformity
to regulatory frameworks enables a company to build a reputation and, therefore, improve
financial performance. Research shows that companies adhering to ESG are likely to face less
risk due to good financial performance (Xu et al., 2023)
. Tripple-Bottom Line Framework
The triple-bottom-line framework, introduced by Elkington, expands traditional financial
performance to include environmental and social dimensions. The framework enables firms to
view their performance based on three pillars: people, profit, and planet (Tarmuji, Maelah, and
Tarmuji, 2016). The TBL approach enables firms to build sustainable environments for
ESG AND FINANCIAL PERFORMANCE 4
flourishing in economic activities, thereby improving financial performance (Zhou and Zhou,
2021). Research has proven that companies embracing the TBL approach tend to outperform
competitors due to their sustainable approach and enhanced stakeholder engagement, which
contributes to good financial performance.
Empirical Studies
Friede et al. suggest that firms with well-aligned ESGs are superior to their competitors.
This shows that ESG practices enhance the performance of companies, making them competitive
(LIU, Nemoto and Lu, 2023). Friede et al. also suggest that over 2000 empirical studies revealed
that 90% of firms showed a positive correlation between ESG practices and corporate social
responsibility. In addition, ESG practices offer stakeholders confidence levels, and this stabilizes
the risk of stock price fluctuations (Li et al., 2024). Empirical studies by the authors show that
under the influence of the COVID-19 pandemic, ESG performance was suppressed, and
organizations saw it as a cushion for good financial performance (Kumar and Firoz, 2022). It is
evident that firms with good ESG exhibit solid financial performance due to operational
sustainability (LIU, Nemoto and Lu, 2023)
.
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Reference list
Friede, G., Busch, T. and Bassen, A. (2015). ESG and Financial Performance: Aggregated
Evidence from More than 2000 Empirical Studies. Journal of Sustainable Finance &
Investment, 5(4), pp.210–233. doi:https://doi.org/10.1080/20430795.2015.1118917.
Kumar, P. and Firoz, M. (2022). Does Accounting-based Financial Performance Value
Environmental, Social and Governance (ESG) Disclosures? A detailed note on a
corporate sustainability perspective. Australasian Business, Accounting and Finance
Journal, 16(1), pp.41–72. doi:https://doi.org/10.14453/aabfj.v16i1.4.
Li, Y., Liu, D., Xu, Z. and Guo, F. (2024). ESG and Stock Price Volatility Risk: Evidence from
Chinese A-Share Market. [online] doi:https://doi.org/10.2139/ssrn.4769839.
LIU, L., Nemoto, N. and Lu, C. (2023). The Effect of ESG performance on the stock market
during the COVID-19 Pandemic – Evidence from Japan. Economic Analysis and Policy,
[online] 79, pp.702–712. doi:https://doi.org/10.1016/j.eap.2023.06.038.
Tarmuji, I., Maelah, R. and Tarmuji, N.H. (2016). The Impact of Environmental, Social and
Governance Practices (ESG) on Economic Performance: Evidence from ESG Score.
International Journal of Trade, Economics and Finance, [online] 7(3), pp.67–74.
doi:https://doi.org/10.18178/ijtef.2016.7.3.501.
Xu, N., Chen, J., Zhou, F., Dong, Q. and He, Z. (2023). Corporate ESG and resilience of stock
prices in the context of the COVID-19 pandemic in China. Pacific-Basin Finance
Journal, 79, pp.102040–102040. doi:https://doi.org/10.1016/j.pacfin.2023.102040.
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Zhou, D. and Zhou, R. (2021). ESG Performance and Stock Price Volatility in Public Health
Crisis: Evidence from COVID-19 Pandemic. International Journal of Environmental
Research and Public Health, 19(1), p.202. doi:https://doi.org/10.3390/ijerph19010202.
Zhou, G., Lin, H. and Luo, S. (2022). COVID-19 Impact, ESG Performance and Stock Price
Volatility Risk. SSRN Electronic Journal. doi:https://doi.org/10.2139/ssrn.4205774.
