Country Governance Scores as Moderators of ESG Impact on Firm Performance in the European Context

Abstract

Purpose – It is believed that engaging in ESG activities has a positive impact on the financial and market performance of firms mainly due to the positive perception of the public, including current and potential customers and investors. However, research on the relationship between ESG scores and firm performance has produced mixed results, raising concerns about greenwashing. We posit that greenwashing is harder to occur in the context of sound governance practices. Hence, the purpose of this study is to explore the moderating effect of governance indicators on the relationship between a firm’s ESG scores and its financial and market performance.

Methodology – To achieve the aims of the study, we have collected data from a sample of 2012 listed firms from the European continent. We have employed 2SLS and Panel Regression models, using published financial information spanning over a period of 12 years, from 2011 to 2022. After cleaning the data for missing values, we obtained an unbalanced and cross-sectional panel of 12,508 firm-year observations from the 2,012 firms used in the study.

Findings – The findings reveal that individual components of governance represented by the worldwide governance indicators have a positive moderating effect on the relationship between ESG and firms’ market performance.

Conclusion – The study findings imply that firms operating in countries with higher governance scores are likely to see a greater positive impact from their ESG efforts on market performance compared to those in lower-scoring countries. The implementation of ESG practices is perceived to be more reliable and effective in countries with higher governance scores, making investors more inclined to invest in firms operating in such countries.