What is the effect of ESG on firm's performance? UK FTSE All-Share Index Evidence

Abstract

The purpose of this study is to identify whether investing in ESG practices is beneficial for a firm’s financial and market performance. The current paper will answer the questions: “Do environmentally friendly companies have better firm performance?” and “Do firms with higher ESG score and better corporate governance mechanisms, lead to better firm performance?”. Moreover, the study will implement the ideas developed in the agency and stakeholder theory. The dataset includes 2196 UK FTSE All-Share Index observations for the period 2009-2020. The companies are drawn from manufacturing, retail, and services industries. The data has been collected from Refinitiv and Thomson Reuters Asset4 Datastream. Three proxies have been used for representing a firm’s performance - ROA, MVBV and annual stock returns. As the expected relations on this topic are contradictory, the hypothesis used for this paper is in a non-directional form stating that ESG is associated with future firm performance. A negative significant relationship has been found between ESG and ROA which can be due to the increase of the additional environmental cost implemented which will decrease firm profitability. A negative significant relationship has been discovered between ESG score and MVBV and annual stock returns, explaining that investors are not so focused on ESG practices rather than pure profits as stated by the traditional economic theory. The results can be used to optimise management activities on the board of directors. The current study contributes to the overall literature by investigating the association between ESG score and firm performance of the UK FTSE All-Share Index corporations. Moreover, the paper compensates for the gap between the UK’s ESG and firm performance association analysis and thus, confirms the importance of ESG practices in today’s days. The conclusions of this study have placed a foundation for further and more in-depth examination in the future. Future research could consider a multi-national sample, focusing on a broader group of environmental attributes.