Does industry matter in terms of ESG? The impact of ESG on corporate financial performance - Evidence from Europe

In recent years, corporate social responsibility has increasingly gained significance within academic literature and the business world. Environmental, Social, and Governance (ESG) factors are progressively being integrated into the identification of risks and opportunities associated with business operations. The growing understanding of the importance of corporate social responsibility has led to an increase in related regulations, with ESG initiatives no longer being solely voluntary. The European Union is a forerunner in sustainability and has actively sought to enhance related regulations to ensure continued progress. A recent example of increased regulation in the EU is the Corporate Sustainability Reporting Directive (CSRD), which requires companies to report on sustainability-related practices as part of their annual reports. While the impact of ESG on corporate financial performance (CFP) has been extensively studied, the industry-specific variations in European companies have not been equally addressed. This study aims to increase understanding of the effects of ESG performance on CFP by examining over 800 publicly listed companies operating in EU countries between 2012 and 2022. The objective is to determine whether the relationship between ESG and CFP varies across different industries. The financial performance is assessed using return on assets (ROA) and Tobin's Q, with panel regression employed as the research methodology. The findings reveal that ESG asymmetrically affects CFP, depending on the performance metric used. The impact of ESG on ROA is positive, whereas its effect on Tobin's Q is negative. Furthermore, the results indicate that the relationship between ESG and financial performance is asymmetric across different industries. The findings suggest that the relationship between ESG and financial performance is more favorable in industries where ESG investments are clearly observable from the perspective of external stakeholders and in so-called ESG-sensitive industries. In contrast, the relationship between ESG investments and financial performance in non-sensitive industries is less favorable. Since the results are asymmetric, they partly support the stakeholder and legitimacy theory perspectives, positing that ESG investments enhance corporate transparency and increase trust from stakeholders, thereby positively influencing financial performance. On the other hand, the results also partly support the shareholder theory and principal-agent theory, which suggest that ESG investments increase firm costs and are thus undertaken at the expense of shareholders.