Relationship of ESG Scores with Firm Performance: A Study of Indian Listed Companies

Abstract

This study seeks to explore whether there is a substantial correlation between corporations’ ESG (Environmental, Social and Governance) ratings and their profitability, specifically return on assets (ROA). It aims to determine whether this correlation is positive, negative or neutral in nature. The research methodology involved an investigation of companies listed on the BSE500 stock index, analysing their ESG ratings for the years 2020 and 2021. The final dataset encompassed 148 companies, resulting in 296 observations for the two years, sourced from the Ace equity database. Panel regression analysis was employed to assess the link between ESG ratings (the independent variable) and ROA (the dependent variable), while also considering financial leverage and firm size as control factors. The results revealed a statistically significant negative linkage between ESG ratings and firm performance, as indicated by ROA, at a 5% significance level. The negative relation between ESG scores and firm performance (ROA) could be attributed to several factors. Organisations that prefer ESG initiatives often incur additional costs in areas like environmental compliance and employee welfare, which can temporarily reduce profitability. Moreover, ESG-conscious firms may make long-term investments that take time to generate returns, impacting short-term ROA. Additionally, stringent ESG standards may deter certain investors or customers, affecting revenue. However, over the long run, robust ESG practices can enhance sustainability and resilience, potentially leading to improved performance and risk mitigation.