Impact of ESG Performance on Firm Value

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1		Shiyu Wu	--	1729	2022-11-25 07:34:46	\|
2	format correction	Dean Liu	-20 word(s)	1709	2022-11-28 03:16:55	\| \|
3	format correction	Dean Liu	Meta information modification	1709	2022-11-28 03:17:27	\|

This entry is adapted from the peer-reviewed paper 10.3390/su142114507

The integration of Environmental, Social and Governance (ESG) factors has attracted a great deal of attention from the business media. The reason for this is that ESG is regarded as a method of increasing firm value and improving financial performance. Companies are gradually recognizing the importance of ESG.

ESG performance firm value ownership concentration

1. Introduction

ESG performance is particularly important in the manufacturing industry due to industry specificity. The manufacturing industry has a significant positive impact on economic development ^[1], but it also causes some damage to the environment ^[2]. Because the manufacturing industry obtains economic benefits by converting resources into outputs and there will be pollutants released during the transfer process, the environmental problems in the manufacturing industry cannot be neglected ^[3]. It, consequently, requires the manufacturing industry to pay more attention to ESG performance ^[4]^[5]. While natural resource scarcity and environmental insecurity have become increasingly serious ^[6]^[7]^[8], the manufacturing sector still uses huge amounts of resources and produces waste worldwide ^[1]. Compared to the US and EU, developing countries in Asia and Africa are not very concerned about environmental issues, but most of the world’s industrial production and processing is concentrated in these countries ^[2]^[9]. Thus, as a major supplier of global raw materials and commodities and a hub of global supply chains, the fulfillment of ESG in China’s manufacturing industry is a valuable research topic ^[10].

Ownership structure demonstrates the characteristics of the distribution of rights of the owners of a business ^[11]. In most Chinese literature, ownership structure and equity structure have the same meaning, but there are some practical differences between the two. With the development of social economy, traditional ownership and equity are no longer seen as the same concept. The organizational form of enterprises has been separated from ownership and operation through continuous improvement and the operational risks borne by shareholders have been dispersed to stakeholders, such as managers, creditors and employees ^[12]. As a result, ownership includes equity and other stakeholders’ rights and the management goal of maximizing shareholders’ interests becomes maximizing stakeholders’ rights and interests ^[13]. Currently, most foreign scholars measure the ownership structure by the number and nature of shares held by natural and legal persons in the enterprise ^[14]. It is necessary to analyze ownership structure because it is crucial in corporate governance.

Researchers aim to investigate the relationship between ESG performance and firm value and the moderating role of ownership structure on the relationship between them. Researchers take Chinese manufacturing listed companies from 2016 to 2020 as the sample. Sino-Securities ESG Rating is adopted to measure ESG performance. Ownership concentration, equity balances, executive shareholding and institutional investor shareholding are taken to measure ownership structure.

Researchers contributes to the existing literature in the following ways. Firstly, previous studies on ESG have mainly focused on developed countries, such as the US, France and Italy, and little has been done in developing countries. Researchers extends the existing literature and provides evidence by using the sample of Chinese manufacturing listed companies. In addition, a heterogeneity analysis is conducted to help better understand the impact of ESG on firm value under different regions. Secondly, this is the first study to investigate the moderating effect of ownership structure on the relationship between ESG performance and firm value, filling the gap of existing literature. Finally, researchers provides informative conclusions and recommendations to investors and companies to make them aware of the role of ESG in corporate governance and its contribution to corporate value, thus, contributing to the direction of green and sustainable development of Chinese manufacturing companies.

2. ESG Performance Influences Firm Value Positively

One reason might be that excellent ESG performance helps alleviate corporate financing constraints, improve operational efficiency and reduce corporate financial risk, thereby enhancing firm value ^[15]. Similar to researcher's study, Lin et al. (2021) ^[16], using Fin-Tech companies in China from 2017 to 2019 as the sample, proved that good ESG performance significantly improves firm value. Wong et al. (2021) ^[17] also found that ESG performance is positively correlated with firm value. However, there is research arguing for conflicting results. For example, the study of Buallay (2019) ^[18] showed that there is a negative relationship between ESG and corporate value.

Researchers also finds that executive ownership and institutional ownership both have a significant positive impact on firm value, while ownership concentration and equity balance do not have any effect on firm value. Regarding executive ownership, one explanation might be that executives are better informed about a company’s real business situation than outside investors on the basis of information asymmetry. When the company operates in good condition, executives will tend to increase their stake in the company and also release signals to the outside world about the future growth of the company’s value. Therefore, the higher the percentage of executive shareholding, the greater the value of the company. Inconsistent with the research, the study conducted by Qi et al. (2022) ^[19] revealed that the proportion of executive shareholding in petroleum and petrochemical companies is positively but insignificantly related to firm value. For institutional ownership, it could be explained by the fact that as the shareholding ratio increases, the rights and status that institutional investors enjoy in corporate governance also rise. This gives institutional investors the strength to contend with company management, increasing their motivation to participate in corporate governance and achieving the effect of enhancing company value. In line with researchers, Azmi et al. (2021) ^[20], taking 595 firms listed in Malaysia between 2013 and 2017 as samples, investigated the relationship between institutional ownership and firm value and pointed out institutional ownership and firm value are positively related. In terms of ownership concentration, the shareholding ratio of controlling shareholders is the result of competitive selection and there is no optimal shareholding ratio applicable to every company. Each firm chooses its shareholding in accordance with the profit-maximization principle based on the environment in which it operates. When there are important changes in the environment, the controlling ratio will change, but the firm’s value may not change much. Contrary to researcher's study, Saona and Martín’s study (2016) ^[21] illustrated that ownership structure has a U-shaped effect, which means ownership concentration initially increases the value of most firms. However, after a certain threshold, the risk of wealth appropriation by large shareholders at the expense of minority shareholders increases in firms with growth opportunities. Greater private gains in control for controlling shareholders could explain why equity balance does not increase firm value. As for equity balance, different degrees of equity balances have different effects on corporate performance. When the degree of equity balances is low, the counterbalancing shareholders do not fully play their governance role. Specifically, the counterbalancing shareholders do not constrain the controlling shareholders, nor do they restrain management behavior. When the degree of equity balances is high, shareholders bargain with each other, thus, reducing the efficiency of decision making. Contrasting from researcher's study, the study conducted by Chen (2019) ^[22] showed that equity balance can help companies increase firm value.

Institutional ownership positively moderates the relationship between firm value and ESG performance and executive shareholding negatively moderates the relationship between these two, but ownership concentration and equity balance have no impact on the relationship between firm value and ESG performance. Consistent with researcher's study, the study of Tuerhong (2021) ^[23] revealed that there is no relationship between ESG and ownership concentration and equity balance. However, unlike the results of Tuerhong’s study (2021) ^[23], in researcher's study results, the sign of the interaction term between ESG and institutional shareholding is positive, while the sign of the interaction term between ESG and executive shareholding is negative.

Researchers also tested the relationship between ESG performance and firm value in three regions and found that ESG has a positive impact on firm value in the eastern and western regions. One reason might be that the economic development and institutional environment vary greatly across regions and companies in the eastern region are more willing to use ESG to reduce the cost of environmental management and the pressure of social opinion. Since China is in the process of shifting manufacturing to the west, the government provides more support to the western manufacturing sector, thus, giving the western manufacturing sector more incentive to improve their ESG performance.

Institutional ownership has a strong and positive effect on firm value in all three regions, while both ownership concentration and equity balance have no impact on firm value in all three regions. For executive ownership, it only influences firm value in the middle region. In terms of institutional ownership, it can be explained by the fact that institutional investors, who hold more shares, are more professional and have more means to obtain effective information and have more motivation and ability to intervene in the governance of listed companies. Institutional investors can directly participate in the decision-making process of the company by communicating with the management, electing directors and supervisors, attending shareholders’ meetings and submitting shareholder proposals, thus, increasing the value of the company. For ownership concentration and equity balance, one of the reasons may be that China’s capital market is in the early stage of development, the level of standardization is not high and the stock issuance system, trading system and market regulation system are still in the process of continuous evolution and improvement, while any change in the system may affect factors related to equity structure and company value, thus, having an impact on the relationship between the two. Institutional ownership positively and significantly moderates the relationship of firm value and ESG performance in the eastern and western regions and executive ownership only moderates the relationship between firm value and ESG performance in the middle region, while ownership concentration and equity balance moderate the relationship between firm value and ESG performance in all three regions. It can be explained by the fact that higher executive ownership implies that corporate executives are highly competent and visionary. Compared with the eastern and western regions, the middle region has poor ESG performance and visionary executives will pay more attention to corporate ESG development, so in the middle region, executive ownership plays a significant negative moderating effect between ESG performance and corporate value. For institutional ownership, ESG performance is relatively better in the eastern and western regions, so investors are more willing to pursue the long-term interests of enterprises, while in the central region, with a relatively poor ESG performance, corporate investors are more concerned with the short-term interests of their companies.

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Shiyu Wu

Xinyi Li

Xiaosen Du

Zexin Li

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Update Date: 28 Nov 2022

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1. Introduction

2. ESG Performance Influences Firm Value Positively

References