CORRELATION OF ESG AND THE VALUE OF THE ORGANIZATION

КОРРЕЛЯЦИЯ ESG И СТОИМОСТЬЮ ОРГАНИЗАЦИИ

Бородин Александр Иванович

д-р экон. наук, проф. кафедры финансов устойчивого развития, РЭУ им. Г.В. Плеханова,

РФ, г. Москва

Зайцев Владислав Александрович

аспирант кафедры финансов устойчивого развития, РЭУ им. Г.В. Плеханова,

РФ, г. Москва

Статья подготовлена и финансируется в рамках исполнения Государственного задания Минобрнауки России в сфере научной деятельности № FSSW-2023-0003 «Методология адаптации публичных и корпоративных финансов к принципам «зеленой экономики».

ABSTRACT

The article analyzes the relationship between ESG factors and the value of the organization. While many articles attempted to explore the relationship between ESG performance and financial performance, the simultaneous influence of ESG performance and disclosure has been largely undiscovered. According to the results, stakeholders account for both ESG performance and ESG disclosure while valuing the company. ESG strengths positively impact valuation, while ESG concerns impair the overall market value. ESG disclosure taken solely also negatively impacts firm value. Together with ESG strengths, higher ESG reporting weakens the beneficial effect of firm’s strengths on firm valuation, while ESG disclosure together with ESG concerns mitigates negative effects on firm value. When a company performs well in terms of ESG, prioritizing ESG issues might negatively influence firm value, probably because investors may perceive wide ESG agenda to be a sign of inefficient spending.

АННОТАЦИЯ

В статье проведен анализ взаимосвязи между факторами ESG и стоимостью организации. Хотя во многих статьях исследовали взаимосвязь между эффективностью ESG и финансовыми показателями, одновременное влияние ESG показателей и ESG отчетности широко не рассматривалось. Согласно результатам, заинтересованные стороны учитывают, как эффективность ESG, так и раскрытие ESG информации при оценке компании. Сильные стороны ESG оказывают положительное влияние на рыночную стоимость, в то время как ESG недостатки снижают стоимость компании. Раскрытие ESG информации негативно влияет на стоимость фирмы, если рассматривается отдельно от других факторов. Результаты показывают, что более высокий уровень ESG отчетности смягчает ESG недостатки, и снижает положительный эффект от ESG преимуществ на стоимость фирмы. Когда компания имеет хорошие показатели ESG, приоритезирование ESG вопросов может негативно повлиять на стоимость фирмы – возможно потому, что инвесторы могут воспринимать излишний фокус на ESG как признак неэффективности инвестиций компании.

Keywords: ESG; correlation, the value of the organization.

Ключевые слова: ESG; корреляция, стоимость организации.

This study investigates the relationship between a firm’s ESG performance, ESG-related disclosure and firm value. Meanwhile, numerous articles addressed the determinants of ESG disclosure and the influence of disclosure on overall company performance and its value. However, the combination of ESG disclosure and ESG performance factors regarding impact on firm value seems to be largely undiscovered. Although the relationship between these factors is not well explored, the hypothesis suggests ESG disclosure mitigates the impact of ESG activities on value of the company. There are 2 views on effect of ESG disclosure: first one refers to decrease in information asymmetry that improves stakeholders’ understanding of ESG strengths and weaknesses; second one regards the situation when companies use ESG disclosure to appear more socially responsible than they are – this tactic is also known as “greenwashing”. On the one hand, weaker asymmetry should positively influence firm value, and on the other hand, if investors perceive ESG disclosure as “greenwashing”, it might impair company value.

Voluntary ESG activities imply additional costs. The costs of a firm increase which inevitably result in reduced profits. Nevertheless, the strategies of many companies demonstrate that significance of implementing ESG activities increases. This implies that these policies should be beneficial to enterprises, for instance, they may be valued higher for reduced risks in the long term and thus increase valuation. Firms can also benefit from better efficiency appearing from better relationships with all stakeholders (e.g. better conditions from suppliers).

So far academic literature could not provide unanimous position. In early studies, it was universally accepted that environmentally or socially oriented investments that exceeded minimum legal standards bring about additional costs, decrease profitability and overall value. This concept is known as shareholder theory, first formulated by [1]. Successors of this theory point out that the paradigm of legal constraints which bind organizations to stick to minimal environmental standards developed behind no payback of CSR activities [2]. In contrast to this idea, more recent studies reveal versatile benefits and additional profits for companies integrating ESG activities into business, developing stakeholder theory (or resource-based theory) [3-4]. For instance, according to this theory, ESG activities have potential to increase firm value by widening management team capability, improving reputation in eyes of business partners, customers and potential employees, as well as reducing reputation risks and accordingly cost of capital. All these factors can influence performance of the company and provide one of competitive advantages.

Сoncluded that long-term value maximization and winning position in the market is only possible when interests of all stakeholders surrounding the company are satisfied [5]. However, equivocal vision of ESG factors importance has not been found yet. Although some studies reported a negative relationship or absence of any influence, a meta-analysis [6] found the overall effect to be positive, though declining over time.

Taking into consideration the potential endogeneity of the company’s disclosure strategy, 2SLS regression method has been chosen. The first stage of the regression analysis comprises 3 equations that perform the determinants of ESG reporting and cross variables of ESG disclosure with ESG strengths and ESG concerns. The second stage concerns the relationship between firm market value (proxied by Tobin’s Q) and ESG performance, ESG disclosure. Moreover, 3 pillars of ESG performance – ecological, social and governance performance – are considered separately as an extension of the current analysis.

While fewer than 20 companies provided publicly available ESG data in the early 1990s, by 2016 the number of companies issuing sustainability or integrated reports had increased to approximately 9000.

From theoretical viewpoint, link between ESG performance and valuation of the company is not evident. There are several effects of ESG activity which may influence firm’s value in direct or indirect way. First and the most direct, ESG activity that exceeds minimal legal standards implies additional non-necessary costs for a company. Therefore, the early understanding of this relationship was uniformly negative [7].

Empirical findings by most researchers demonstrate positive relationship between ESG performance and financial performance [8]. Another example of paper is where also positive relationship is revealed; for this research the sample of nearly 17.000 firm-year observations over the 1995-2007 period was used. Other examples of positive association are [9]. Constructed model with structural equations within which economic performance is a function of environmental performance and controls. The authors found a positive influence of environmental performance on economic performance. They confirmed ESG performance to be positively related to firm value, especially in states with weaker institutions, explaining this difference by ESG mitigation effect for market failures related to institutional voids.

ESG disclosure is non-standardized, voluntary reporting that varies a lot in form and intensity. Nowadays, many firms stick to unified guidelines in this sphere, such as GRI [10]. More recently, Initiative for Intagrated Reporting (IIR) proposed a new set of standards in terms of ESG for international usage, first published in 2013 [11]. Additionally, apart from sustainability or combined reporting, firms more often use other non-traditional channels for ESG disclosure.

Most of the research on ESG reporting was based on manually constructed ratings and lists developed by individual researchers who collected data from annual reports and other publicly available data, on their own (for instance, [12]). The restricted access to ESG data and its non-systematic reporting put a constraint to many previous research studies. Currently, specialized commercial data providers collect and aggregate ESG data which provides new opportunities for analysis.

Before going further to consideration of ESG disclosure relationship with financial performance or company valuation, it is important to recognize there are different motives for ESG reporting in the first place. According to voluntary disclosure theory, developed by it is stated that companies with positive ESG performance would prefer to report extensively on their ESG activities, while firms with low ESG performance would choose to disclose minimum information. Under this framework, organizations signal about their good ESG performance because they want to be distinguished from poorer performers and thus avoid situations of adverse selection. Good ESG performance creates a favorable image in society and that firms with good ESG performance have a higher value (or lower cost of capital) only if they are widely covered in the media.

In contrast to this argument, there are more motives why firms may intensify or weaken ESG disclosure. It is possible that a company would disclose more information about ESG to manage public perception by explaining going changes in its ESG-related policies. For instance, it may intensify its transparency to prevent or mitigate negative consequences of significant environmental damages or similar critical for society events on its reputation and market value fluctuations, or to restore its legitimacy [13]. Firms could also use ESG disclosure to look more socially responsible, irrespective of their true performance – “greenwashing”. Furthermore, managers of the company may choose not to disclose their environmental, charitable or other socially responsible investments if they are worried that investors may not appreciate these actions finding them too costly and not coinciding with shareholders’ interests. Therefore, a company with a good ESG performance may deliberately choose not to publish too much about ESG activities or even understate them – this is called “brownwashing”.

In the baseline model, 3 instrumental variables have been chosen for the potential endogenous variable of ESG reporting. The first instrumental variable is the presence of CSR committee as a part of board of directors. [15-16] noticed that companies that have CSR committees are prone to disclose information on gas emission and have better quality of this information. Therefore, extant studies prove CSR committees to affect significantly the level and quality of ESG disclosure. Therefore, this instrumental variable should be significantly correlated with ESG reporting and suitable for 2-stage regression model.

The second instrumental variable used is analysts’ earnings forecast surprise and calculated by subtracting the consensus earnings estimate from the actual reported earnings and then dividing by the consensus earnings estimate. There is a wide range of studies providing evidence that extent of transparency and disclosure is negatively related to a dispersion of analysts’ earnings forecast It is clear that the more transparent a company is, the less information asymmetry arises, and the more precise forecasts are. Regarding ESG disclosure, [17] conclude that dispersion of analysts’ earnings forecasts is negatively associated with mandatory ESG standards (by law) and positively associated with voluntary ESG activities. All in all, earnings forecast surprise should suit the relevance condition in our model. As for independency criterion, there is no comprehensive evidence on a relationship between earnings forecast accuracy and firm value. Some researches show that analyst forecast dispersion is positively correlated with current stock prices and negatively related with future returns other papers conclude on quite the opposite relationship. Other part of studies found no relationship: [18-19]. Considering these mixed findings, it is implied that analysts’ earnings forecast surprise instrument satisfies exogeneity condition. However, postestimation exogeneity tests are needed to evaluate suitability of instruments.

Finally, ownership concentration is used as an instrument. Previous studies documented an adverse relationship between ownership concentration and the level of disclosure [20]. Companies with several large shareholders might have less motivation to be transparent because the demand for public disclosure is weaker comparing to companies with much more dispersed ownership and stronger community of minority shareholders. Moreover, large shareholders may have insider access to company information; for instance, they can be related to board of directors. Regarding CSR/ESG disclosure, it is widely concluded that firms with more concentrated ownership have on average more modest ESG reporting [21-22]. Specification of first-stage regression should account for potential endogeneity of the interaction terms between ESG performance and ESG disclosure. So, the first-stage regressions are as follows:

Disc = F (CSR_comm, Analyst_forecast, Own_conc)

Disc*Str = F (CSR_comm*Str, Analyst_forecast*Str, Own_conc*Str)

Disc*Con = F (CSR_comm*Con, Analyst_forecast*Con, Own_conc*Con)

All the instrumental variables must satisfy relevance and exogeneity conditions, and to check it the postestimation test statistics is examined. Firm value is proxied by Tobin’s Q; level of ESG disclosure is proxied by ESG disclosure percentile score from Bloomberg ESG database, and ESG strengths/concerns data is provided by respective scoring in Thomson Reuters ESG database.

To finalize regression models, several control variables are added in accordance with previous literature [23]. There are several metrics which are traditionally used as control variables for firm value. These variables comprise profitability proxy (ROA), ROA growth, firm size (natural logarithm of sales - lnsales), asset intensity (assets to sales ratio - assetsales), leverage (debt to equity), advertising intensity (advertising expenditures to sales - advert), research and development intensity (R&D spendings to sales - rd), asset age (net PPE to gross PPE - ppe_ntg). Also, dummy variables for absence of advertising and R&D expenditures are added (advert_missing, rd_missing), as well as industry and year effects.

All in all, 2SLS regression models used in this study are as follows:

First stage models with instrumental variables:

Disc = a + B1*CSR_comm + B2*Analyst_forecast + B3* Own_conc + B4* Str +B5* Con + controls + e,

Disc*Str = a + B1*CSR_comm*Str + B2*Analyst_forecast*Str + B3* Own_conc*Str + B4* Str + B5* Con + controls + e,

Disc*Con = a + B1*CSR_comm*Con + B2*Analyst_forecast*Con + B3* Own_conc*Con + B4* Str + B5* Con + controls + e,

Second stage model:

TobinQ = a + B1*Disc + B2*Str + B3*Str*Disc+ B4*Con+ B5*Con*Disc+ controls+ e,

where controls are: ROA, ROAgr, ln_sales, assetsales, leverage, advert, advert_missing, rd, rd_missing, ppe_ntg, year, industry.

Thus, the right strategy for a company is to keep balancing between too much ESG risk exposure on one side, and too much focusing on ESG activities and ESG transparency on the other side.

To conclude, all the tasks of the study are completed, as well as the goal: the relationship between ESG performance, ESG disclosure and value of a company was determined. The further study can address the issue of exploring the effects of ESG performance and disclosure in different markets, as well as breaking it down into 3 pillars of ESG.

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