Esg Factor On Firm Risk

J Bus Econ (2016) 86:867–904
DOI 10.1007/s11573-016-0819-3
ORIGINAL PAPER
Impact of ESG factors on firm risk in Europe
Remmer Sassen1 • Anne-Kathrin Hinze1 •
Inga Hardeck2
Published online: 23 April 2016

Springer-Verlag Berlin Heidelberg 2016
Abstract A huge body of research has addressed the impact of corporate social
performance (CSP) on corporate financial performance. However, prior literature
provides only limited evidence of the impact of CSP on firm risk. The aim of this
paper is to investigate the impact of CSP operationalized by environmental, social,
and governance factors on market-based firm risk in Europe. Three risk measures
are analyzed: systematic, idiosyncratic, and total risk. On the basis of a large
European panel dataset of 8752 firm-year observations covering the period
2002–2014, we find that a higher CSP decreases total and idiosyncratic risk.
Looking at the three dimensions of CSP, we show that social performance has a
significantly negative effect on all three risk measures. Environmental performance
generally decreases idiosyncratic risk, whereas total risk and systematic risk are
only affected in environmentally sensitive industries. In contrast, we cannot detect a
significant effect of corporate governance performance on firm risk. Our findings
suggest that a higher CSP and a higher performance regarding the social dimension
in particular have the potential to increase firm value through lower firm risk.
Overall, our evidence fosters the assumption that there is a business case to be made
for corporate social responsibility.
& Remmer Sassen

remmer.sassen@wiso.uni-hamburg.de
Anne-Kathrin Hinze
anne-kathrin.hinze@wiso.uni-hamburg.de
Inga Hardeck
hardeck@europa-uni.de
1
HBS Hamburg Business School, University of Hamburg, Max-Brauer-Allee 60,
22765 Hamburg, Germany
2
Ernst & Young Endowed Assistant Professorship for Accounting and Taxation,
Große Scharrnstr. 59, 15230 Frankfurt (Oder), Germany
123
868 R. Sassen et al.
Keywords Corporate social performance Corporate social responsibility

ESG factors Firm risk Idiosyncratic risk Systematic risk
JEL Classification G32 M14
1 Introduction
Non-financial performance and corporate social responsibility (CSR) in particular

have gained increasing importance and attention among firms and their stakeholder
groups (e.g., Gramlich and Finster 2013). The corporate social performance (CSP) of
organizations is often operationalized and evaluated by the so-called environmental,
social, and governance factors (ESG factors) (Bassen and Senkl 2011; PRI 2015). It is
assumed that a high CSP has the potential to increase a company’s value by means of
both an increase in corporate financial performance (CFP), i.e., cash flows and/or a
reduction in the cost of capital (Plumlee et al. 2015). Thus, if one considers that firm
risk is an important determinant of the cost of capital, CSP has an impact on
shareholder value if it affects firm risk (Bouslah et al. 2013). Against this background,
integrating ESG factors into a firm’s strategy fits into the overall concept of risk
governance. This concept incorporates risk management at a macro and micro level,
with the macro level focusing on society’s CSR requirements and the micro level on
operational and financial risks (IRGC 2012; Renn 2008; Renn et al. 2011; Stein 2013).
This research focuses on the impact of CSP on firm risk as an important
determinant of the cost of capital. Whereas a huge body of literature has examined
the relationship between CSP and CFP (van Beurden and Gössling 2008; Margolis
and Walsh 2003; Margolis et al. 2009; Orlitzky et al. 2003), only a small amount of
literature has addressed the relationship between CSP and the cost of capital (equity
costs and/or debt costs). For instance, El Ghoul et al. (2011) found a negative
correlation between CSP and a company’s equity costs. Bauer et al. (2009)
examined the impact of employee relations on the costs of debt financing in the
United States and showed that strong employee relations decrease these costs.
Turning to firm risk in particular, Orlitzky and Benjamin (2001) performed a meta-
analytic review and investigated CSP and firm risk. They provide support for the
argument that a higher CSP decreases a company’s financial risk. However, their
review covered only 18 US-based primary studies with relatively small samples
(mostly n \ 100) and a differing operationalization of CSP. In addition, most of
these studies date back to the period from 1978 to 1995. The differing
measurements of CSP across different timeframes make it difficult to compare
the studies. More recent research on the association between CSP and firm risk
offers limited and ambiguous evidence. At the aggregate CSP level, prior studies
provide more or less consistent results and state a negative association between their
CSP measure and firm risk. At the disaggregate level, the picture of the individual
CSP measures is less clear. Recent studies show ambiguous results when it comes to
different subcategories of CSP. Although, for instance, some studies suggest a
negative relationship between environmental performance and firm risk (Salama
et al. 2011; Sharfman and Fernando 2008), other findings even show a positive
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Impact of ESG factors on firm risk in Europe 869
relationship for particular subsamples (Bouslah et al. 2013). Moreover, this recently
published research has several further limitations. Despite the increasing relevance
of CSP over time, the data employed in these studies were generally outdated. With
only a few exceptions (Lee and Faff 2009; Luo and Bhattacharya 2009; Salama
et al. 2011), prior studies focused on Northern American firms and used a limited set
of ESG and risk measures. Most studies employed US samples and CSR measures
provided by Kinder, Lydenberg, and Domini (KLD) (e.g., Oikonomou et al. 2012;
Jo and Na 2012). Additionally, recent research lacks comparability. Some studies
used aggregated CSP measures (e.g., Boutin-Dufresne and Savaria 2004; Bassen
et al. 2006), whereas others used individual CSP measures (Bouslah et al. 2013;
Sharfman and Fernando 2008; Salama et al. 2011) as explanatory variables.
Furthermore, different market-based risk measures were employed.
To fill this research gap, we aimed to investigate the impact of CSP measured by
ESG factors on firm risk in Europe. By using a large panel dataset of 8752 firm-year
observations over the period 2002–2014, we have examined the effect of CSP on
three different risk measures: total, systematic, and idiosyncratic risk. Total risk
reflects the firm’s stock volatility and is driven by the two components systematic
and idiosyncratic risk. While systematic risk depends on a company’s sensitivity to
general market movements, idiosyncratic risk is caused by firm-specific character-
istics and is associated with the residual risk that cannot be explained by changes in
average market portfolio returns (Sharpe 1964). The risk ratios were calculated
based on the Thomson Reuters Datastream database. ESG factors have been
obtained from the Thomson Reuters Asset4 database. This independent database is
often used for research purposes (e.g., Cheng et al. 2014; Eccles et al. 2014; Ioannou
and Serafeim 2012; Mackenzie et al. 2013). By using more than 750 individual data
points, Asset4 measures a company‘s CSP on the basis of the three pillars of
environmental, social, and corporate governance performance. We chose Europe as
the locus of our research for two reasons. First, there is limited research linking CSP
to risk measures within a European context. Second, CSP is particularly important
in Europe as prior literature suggests that European companies are leaders in CSP
compared to companies from other geographical areas (Ho et al. 2012). In addition,
the European Union passed several directives that foster CSR among European
firms, such as the recent directive on non-financial information disclosure in the
management report (European Commission 2013). By performing fixed effects
regressions with clustered standard errors at the firm level, we provide evidence that
social performance lowers firm risk. In addition, environmental performance
generally decreases idiosyncratic risk, whereas it has a negative effect on total and
systematic risk in environmentally sensitive industries only. However, we have been
unable to detect significant results for corporate governance performance. These
results hold under several robustness checks.
The remainder of this paper is organized as follows. Section 2 presents a brief
review of the relevant literature. In Sect. 3, we develop hypotheses on the impact of
CSP on firm risk. Next, the research design (Sect. 4) and the empirical results
(Sect. 5) are explained. The article concludes with a summary of the findings, a
discussion of their implications, and a description of the limitations and directions
for further research (Sect. 6).
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2 Literature review
A huge body of literature has examined the relationship between CSP and CFP.
These studies provide contentious results (Salzmann 2013). However, existing
meta-studies indicate unequivocal evidence for a rather positive association between
CSP and CFP. Orlitzky et al. (2003) conducted a meta-analysis of 52 studies on CSP
and CFP and found that social performance and environmental performance are
likely to have a positive impact on CFP, with the extent of the impact being
somewhat lower for environmental performance. Margolis and Walsh (2003)
investigated 127 studies on the association of corporate social conduct and CFP and
found that most evidence supports a positive impact and little a negative impact of
CSP on CFP. Van Beurden and Gössling (2008) performed a systematic literature
review of 34 studies. They also found clear empirical evidence for a positive
association between CSP and CFP and stated that studies arguing the opposite relied
on outdated material because societies have changed since the beginnings of the
CSR debate. Margolis et al. (2009) investigated the relationship between CSP and
CFP by using a meta-analytical approach (251 studies) and found an overall small
positive effect. Recently, Eccles et al. (2014) showed that ‘‘high sustainability
companies’’, i.e., companies that adopted high social and environmental standards
early on beyond what is legally required, outperformed ‘‘low sustainability
companies’’ over an observation period of 18 years.
As for the cost of capital, investor preferences for socially responsible
investments (SRI) as well as firm risk might mediate the effect of CSP on the
cost of capital. SRI is an investment strategy that pursues both financial goals and
social objectives (Renneboog et al. 2008). El Ghoul et al. (2011) have argued that
firms with low CSP tend to have a smaller investor base due to investor preferences.
A growing number of investors, especially large institutional investors, show a
preference for investing in firms that pursue specific CSR activities (Guenster et al.
2011). For instance, 41 % (6.9 trillion euros) of European professionally managed
assets exclude those that engage in certain controversial activities such as weapons,
alcohol, or tobacco products (Eurosif 2014). Institutional investors such as the
Norwegian pension fund, which has been divesting from carbon intensive industries,
are role models in this regard (Eurosif 2014; Sievänen et al. 2013). However, we
aim to focus on the impact of CSP on firm risk as a determinant of the cost of
capital. Prior studies have investigated equity costs and/or debt costs in particular
and often used accounting-based risk measures or credit ratings. Bassen et al. (2006)
and El Ghoul et al. (2011) found a negative relationship between CSP and equity
costs of a company. Bauer et al. (2009) focused on credit risks and showed that
firms with stronger employee relations have lower costs of debt financing and higher
credit ratings. Goss and Roberts (2011) examined the impact of CSP on the cost of
US bank loans and found that more responsible firms have lower costs. Stellner
et al. (2015) confirmed for a European sample that higher CSP results in lower
credit risks. Gramlich and Finster (2013) measured CSP by the inclusion of firms
into sustainability indices and firm risk by accounting-based risk measures
123
(profitability and liquidity ratios) in a European setting. They did not find clear
evidence that sustainable firms have lower risk ratios.
Overall, there has been very little research on the relationship between CSP and
firm risk. In a meta-analytic review on the association between CSP and firm risk
covering 18 US-based primary studies with relatively small samples (mostly
n \ 100) from the period 1978–1995, Orlitzky and Benjamin (2001) found evidence
that higher CSP leads to lower financial risk. Furthermore, the authors indicate that
the overall negative impact of CSP on market risk measures is stronger than on
accounting risk measures. However, differing measurements of CSP make it
difficult to compare existing studies. Primary studies have used several CSP
measures, yet these are somewhat limited measures that focus only on special
aspects of CSP. Table 1 provides an overview of more recent research, i.e., research
that was published after the meta-analysis of Orlitzky and Benjamin (2001), on the
impact of CSP on firm risk and shows that there are only few studies that have
focused on market-based risk measures. These studies investigated different aspects
related to the correlation between CSP and firm risk within different research
contexts such as marketing (e.g., Luo and Bhattacharya 2009), analyst coverage
(e.g., Jo and Harjoto 2014), investor utility (e.g., Oikonomou et al. 2012), or
customer loyalty (e.g., Albuquerque et al. 2014). Most studies focus on Northern
American companies. Two rather small sample size studies (Lee and Faff 2009; Luo
and Bhattacharya 2009) used an international sample, whereas Salama et al. (2011)
conducted their research in the United Kingdom. Most of the studies do not
emphasize special industries. Only Jo and Na (2012) restricted their analysis to
‘‘sinful industries’’ and Bassen et al. (2006) to utilities. Company-years covered in
these studies are often relatively outdated, with few exceptions using more recent
firm data. If one looks at the explanatory variables that measure firms’ CSP, existing
studies employ mostly aggregated CSP measures and rarely individual CSP
measures such as social scores or environmental scores or a combination of both.
Turning to risk measures, we see that different market-based risk measures are
employed. Whereas systematic risk is often used, only a few studies cover
idiosyncratic risk or total risk. At the aggregate CSP level, studies find generally
consistent results and state a negative association between their CSP measures and
firm risk. At the disaggregate level, the picture of the individual CSP measures is
less clear. Depending on the samples and subsamples, databases employed, CSP
measurements, and risk measures, recent research provides mixed results. For
instance, Salama et al. (2011) and Sharfman and Fernando (2008) found a negative
relationship between environmental performance and the risk measure they
employed, whereas Bouslah et al. (2013) found both negative and positive
relationships for different subsamples. Similar ambiguities can be stated for
diversity and corporate governance (Bouslah et al. 2013; Oikonomou et al. 2012).
The relationship between community or employee relations and firm risk seems to
be negative (Bouslah et al. 2013; Oikonomou et al. 2012). In contrast, the product
dimension tends to have no influence (Bouslah et al. 2013) or a negative impact
(Oikonomou et al. 2012).
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Table 1 Prior empirical research
872
Authors, year Sample Firms (firm-year Time CSP aggregate CSP disaggregate measures Systematic Idiosyn- Total
(industry) observations) frame measure risk (Beta) cratic risk risk
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Boutin-Dufresne and Canada 400 1995–1999 Canadian Social X
Savaria (2004) Investment Database
Bassen et al. (2006) World 44 2004 Scoring based on 38 Social score, X
(utilities) criteria environmental score
Sharfman and USA 270 2002 Environmental score based X
Fernando (2008) on TRI and KLD
Luo and Bhattacharya World 541 (1082) 2002–2003 Fortune’s Most X
(2009) Admired Companies
Lee and Faff (2009) World 400 1998–2002 Dow Jones X
Sustainability Index
Salama et al. (2011) UK (1625) 1994–2006 Environmental X
performance
Oikonomou et al. USA 769 (6986) 1991–2008 KLD Qualitative screens KLD X
(2012)
Jo and Na (2012) USA (‘‘sinful 513 (2719) 1991–2010 KLD X
industries’’)
Goss (2012) USA 3269 (15,034) 1991–2007 KLD X
Albuquerque et al. USA 4462 (23,803) 2003–2011 MSCI ESG database X
(2014) (formerly KLD)
Bouslah et al. (2013) USA 3100 (16,599) 1991–2007 KLD Qualitative screens KLD X X
Chang et al. (2014) USA 583 (5289) 1995–2009 KLD X X
Jo and Harjoto (2014) USA 3079 (14,482) 1991–2009 KLD X
Harjoto and Jo (2015) USA 2034 (9259) 1993–2009 KLD X
This study Europe 921 (8751) 2002–2014 Asset4 Asset4 pillar and category X X X
scores
R. Sassen et al.
3 Theoretical background and development of hypotheses
The European Commission defines CSR as ‘‘the responsibility of enterprises for

their impacts on society […] to integrate social, environmental, ethical, human
rights and consumer concerns into their business operations and core strategy in
close collaboration with their stakeholders’’ (European Commission 2011, p. 6).
There are several ways to measure CSP. For instance, Elkington (1997) has
established the triple bottom line approach, which suggests that firms should
consider their economic, environmental, and social impacts on society in general
and on stakeholders in particular (Dyllick and Hockerts 2002). Corporate
governance performance as a further dimension of CSP is frequently employed
(Murphy and McGrath 2015). The use of ESG factors to capture CSP is widely
accepted both by research (e.g., Chang et al. 2014; Eccles et al. 2014) and by the
capital market (Bassen and Senkl 2011). For instance, rating agencies and the
members of the United Nations-supported Principles for Responsible Investment
(UN PRI) initiative use ESG factors to assess the social responsibility of
investments (PRI 2015).
From a theoretical perspective, stakeholder theory in particular (Clarkson 1995;
Donaldson and Preston 1995; Freeman 2010) is often used to explain a positive
impact of CSP on firm value. It claims that the needs of stakeholders, not just
shareholders, have to be integrated into corporate management, because meeting the
needs of these stakeholders directly creates value for shareholders (Freeman 2010).
Freeman (2010, p. 25) defines a stakeholder as ‘‘any group or individual who can
affect or is affected by the achievement of the firm’s objectives.’’ Stakeholders of
the firm include shareholders, for example, along with creditors, employees,
customers, suppliers, public interest groups, and governmental bodies.
We are specifically interested in the link between CSP and firm risk. In general,
firm risk can be explained as the potential of losing firm value as a result of
uncertainty concerning future outcomes or events (Chang et al. 2014; Orlitzky and
Benjamin 2001). Risk can be measured by the fluctuation of financial performance
over time with regard to share prices (market risk) or internal accounting returns
(accounting risk) (Orlitzky and Benjamin 2001). Consequently, typical risk
measures are subdivided into measures of accounting risk and market risk, although
both types of measures operationalize the same underlying constructs in two
different ways rather than being two different conceptual components of risk
(Orlitzky and Benjamin 2001). Examples of accounting risk measures are the
coefficient of variation of return on invested capital (ROIC), the percentage of a
firm’s total or long-term debt relative to assets, or the standard deviation of a firm’s
long-term return on assets (ROA) or return on equity (ROE) (Orlitzky and Benjamin
2001).
We have chosen to focus on market-based risk measures. The total market risk
can be explained as the degree to which stock returns for a particular company vary
over time (total stock volatility) and can be measured by the variance or the standard
deviation of the stock returns over the previous year (Bouslah et al. 2013; Jo and Na
2012; Orlitzky and Benjamin 2001). Financial theory subdivides total (market) risk
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into idiosyncratic risk and systematic risk (Jo and Na 2012; Luo and Bhattacharya
2009). The idiosyncratic risk (unsystematic risk) is specific to the firm (Luo and
Bhattacharya 2009) and cannot be explained by broad market movements.
Systematic risk represents a firm’s sensitivity to broad market movements or
changes that are relevant to all stocks (Luo and Bhattacharya 2009).
On the basis of stakeholder theory, an argument can be made that high levels of
CSP are associated with lower financial risk. Whereas low levels of CSP are likely
to entail higher probabilities of law suits and legal fines, a high degree of CSP can
foster more stable relations with the government and the financial community
(McGuire et al. 1988). Furthermore, market participants are more willing to allocate
capital to companies with higher levels of CSP so that CSR engagement can lower
capital constraints for companies (Cheng et al. 2014). Better CSP can enhance a
company‘s reputation (Cornell and Shapiro 1987), increase its brand value, as well
as improve the image of its products among consumers (Brown and Dacin 1997).
Moreover, CSR might increase a firm’s appeal as an employer and help attract and
retain a high-quality workforce (Turban and Greening 1997; Greening and Turban
2000). A good CSP might also be considered as a signal for superior management
skills (Waddock and Graves 1997). Taken together, these research findings suggest
that better CSP leads to less financial risks and therefore to a lower degree of stock
market risk and a lower likelihood of company crisis (Oikonomou et al. 2012).
Risk management theory (Godfrey 2005) further suggests that even in times of
crisis a company’s CSP can generate positive moral capital among various
stakeholders that can provide ‘‘insurance-like’’ protection for the firm. Godfrey
(2005) claims that this moral capital induced by a positive assessment of a
company’s CSP leads stakeholders to hold on to positive attributions to a company,
and this positively affects the attitude and loyalty toward a company (Luo and
Bhattacharya 2009). This in turn alleviates stakeholders’ sanctions against a
company in the event of a crisis and therefore leads to less volatile future cash flows
and thereby reduced risk (Chang et al. 2014). In this context, CSR engagement,
respectively the resulting moral capital, creates a mechanism that preserves
economic value (Godfrey et al. 2009). Godfrey et al. (2009) underpin this theory
and show empirically that the loss of shareholder value in the context of a negative
event is smaller for firms that engage in CSR activities. In line with this argument,
SRI investors are less sensitive to negative returns than conventional fund investors
(Bollen 2007; Renneboog et al. 2011), which suggests that investors with a CSP
focus might be more reluctant to withdraw money in response to negative financial
performance.
Although stakeholder theory and risk management theory suggest a negative link
between a company‘s CSP and firm risk, managerial opportunism theory implies a
positive relationship of CSR performance measures and firm risk (Bouslah et al.
2013). According to managerial opportunism theory, management predominantly
pursues private goals (Preston and O’Bannon 1997). Managers are incentivized by
short-term profit objectives. In times of high CFP, they will underinvest in CSP to
cash in, thereby condoning risks that occur in the long run. By contrast, they tend to
overinvest in CSP when CFP is low to justify their results. Cespa and Cestone
(2007) confirm that managers utilize investments in CSP in pursuit of their private
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interest. The authors suppose that managers follow a so-called entrenchment

strategy. The latter strategically commit themselves to CSR to gain stakeholders’
support, thereby reducing the likelihood of being replaced in takeovers. Given
certain conditions, managers who pursue their private goals in this way thus tend to
overinvest in CSP to improve their reputation as ‘‘good global citizens’’ (Barnea and
Rubin 2010) and, in so doing, increase firm risk.
Given the predominance of arguments underpinning a negative relationship, we
assume that ESG factors have a negative impact on all market-based risk measures
(total, idiosyncratic, and systematic risk). However, considering the limited
empirical results and the conceivably ambiguous theoretical predictions, we do
not phrase our hypotheses so as to assume a clear direction of influence. This leads
us to our first hypothesis:
H1: Overall CSP measured by an aggregated ESG score affects a company’s
total, systematic, and idiosyncratic risk.
We argue that the different ESG dimensions consolidated in the overall ESG score
might have different impacts on firm risk (Bouslah et al. 2013). For instance, social
performance in terms of customer and employee needs might have a more direct
influence on company success than aspects of environmental protection. Moreover,
the three dimensions of ESG concern different kinds of stakeholders, which could
lead to different impacts on companies’ financial or risk metrics (Godfrey et al. 2009;
Girerd-Potin et al. 2014). Furthermore, investors might assess the relevance of the
three ESG dimensions to business activity differently. These distinctions could lead to
different market interests (Eccles et al. 2011), which in turn might cause different
market reactions to ESG activities. The differing relevance of the ESG aspects within
the investment community could also be due to different levels of measurability and
therefore reliability of information (Derwall and Verwijmeren 2007). Recent research
does not show clear correlations between the individual CSP measures and firm risk.
Therefore, we do not a priori assume a significantly negative impact of the individual
CSP measures (i.e., ESG dimensions) on firm risk; however, we assume that there is a
significant impact. Since the aggregated ESG score comprises the performance in
three different ESG dimensions, it does not allow for distinct inferences about a
potential differing impact of environmental, social, and governance aspects on firm
risk. Two companies with the same overall ESG score might therefore have different
relationships to firm risk because of different subscores in the three dimensions
(Bouslah et al. 2013). To shed light on the impact of the three pillars of ESG
performance, we state our second—once again non-directional—hypothesis as
follows.
H2: Environmental, social, and corporate governance performance affect a
company’s total, systematic, and idiosyncratic risk.
Since the relevance of ESG factors to business activity might differ depending on
the sector the respective company belongs to, Eccles et al. (2012) argue that in
determining the materiality of ESG information one has to consider that materiality
has to be defined on a sector-specific basis in terms of its importance within the
company’s value-creation process. In line with this argumentation, we assume the
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impact of the ESG dimensions on company risk to differ owing to industry-specific

requirements. Among other industry-specific coherences, we especially expect a
sector-specific peculiarity in the form of a higher relevance of environmental
performance to industries that can be classified as environmentally sensitive. We
consider industries to be ‘‘environmentally sensitive’’ if they are listed among the
‘‘NAICS Codes of Environmentally Sensitive Industries’’ published by the US Small
Business Administration.1 In this context, environmentally sensitive industries
comprise, for instance, mining, engineering, textile production, and transportation.
Since we expect environmental concerns or even environmentally related incidents to
have a considerable influence on a company’s stock market performance in these
industries, we hypothesize that a high environmental performance reduces risk metrics
for companies engaged in environmentally sensitive industries.
H3: Environmental performance has a negative effect on a company’s total,
systematic, and idiosyncratic risk in environmentally sensitive industries.
4 Research design
4.1 Sample selection
Table 2 presents data on the sample selection. We chose Europe as the locus of our
research for two reasons. To the best of our knowledge, there is only little
comprehensive research linking CSP to different firm-risk measures within a
European context. Stellner et al. (2015) show that a higher CSP lowers the credit
risk among 872 companies from twelve European countries. Salama et al. (2011)
provide evidence for the impact of environmental performance on systematic risk in
the United Kingdom. Some small sample studies have addressed the impact of CSP
on idiosyncratic risk on an international basis including Europe (Lee and Faff 2009;
Luo and Bhattacharya 2009). In addition, CSP is particularly important in Europe as
prior literature suggests that European companies are leaders in CSP compared to
companies in other geographical areas (Ho et al. 2012).
The initial sample consisted of all large-, medium-, and small-capitalized
companies from European countries that are part of the Thomson Reuters Asset4
database from 2002 to 2014. This database provides information on ESG factors
since 2002. We used Asset4 because it has the best coverage of European
companies over a long-term period compared to other providers.2 About 350 firms
1
This list was developed in conjunction with the Standard Operating Procedure 50 10 5(F), effective
date: 1 January 2014 (US Small Business Administration Office of Financial Assistance 2014).
2
Except for the most recent years, the KLD database does not offer data on European companies. The
KLD database provides strength and concern ratings for a number of indicators in seven qualitative issue
areas (community, diversity, employee relations, environment, product, human rights, and corporate
governance) and concern ratings for a number of indicators in six exclusionary areas (alcohol, gambling,
firearms, military, nuclear power, and tobacco). Since the data are based on information on strength and
concern indicators, the methodological approach for measuring ESG performance is different from that of
Asset4. The intangible value assessment (IVA) by an independent evaluation agency also has a US focus
except for the most recent years.
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Table 2 Final sample distribution by year and industry according to the Fama and French 12 industry classification (French 2015b)
Year Consumer Consumer Manufact. Oil, gas Chemicals Business Telephone Utilities Wholesale Healthcare Finance Other Total
2002 26 11 56 7 13 12 19 11 28 20 62 54 319
2003 26 11 57 8 14 14 20 11 30 20 64 56 331
2004 36 12 82 18 19 22 22 15 44 26 110 104 510
2005 46 16 93 23 23 30 28 20 54 29 127 120 609
2006 48 16 96 25 24 31 30 23 56 30 133 123 635

2007 49 16 99 25 27 37 32 26 61 34 145 137 688
2008 49 19 105 28 27 43 34 29 66 35 163 149 747
2009 53 20 108 30 29 50 38 29 71 39 170 153 790
2010 57 23 110 32 31 51 40 31 73 39 180 163 830
2011 63 24 112 33 34 54 43 33 78 39 190 169 872
2012 64 23 117 38 35 55 45 33 81 39 195 177 902
2013 64 21 116 39 33 53 46 31 82 39 187 174 885
2014 48 14 91 24 27 37 31 17 65 34 125 121 634
Total 629 226 1242 330 336 489 428 309 789 423 1851 1700 8752
877
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were part of the initial Asset4 Europe database in 2002. Their number gradually
increased up to 928 in 2013. Our initial sample thus comprised 9375 firm-year
observations. Missing risk measures and control variables have reduced the final
sample to an unbalanced panel of 8752 firm-year observations over the period
2002–2014 (Table 2).
Asset4 Europe broadly covers firms from all industries listed in the STOXX
Europe 600 index. Firms from STOXX Europe 600 are capitalized companies from
18 Western European countries. They are considered a benchmark for European
stock markets (Horvath and Petrovski 2013, p. 84). The remaining third of the
database is spread over various capitalized European firms. Overall, our remaining
sample covers companies from Austria, Belgium, the Czech Republic, Denmark,
Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway,
Poland, Portugal, Spain, Sweden, Switzerland, Turkey, and the United Kingdom
(including the Virgin Islands, Isle of Man, Gibraltar, and Bermuda).3
4.2 Dependent variables: risk measures
We have estimated a company’s risk by using three different risk measures: total
risk (RSTD), systematic risk (BETA), and idiosyncratic risk (IR). Total risk reflects
the firm’s stock volatility and is measured by using the annualized standard
deviation of daily stock returns over the previous 12 months (Bouslah et al. 2013; Jo
and Na 2012; Orlitzky and Benjamin 2001). Two components contribute to a
company’s total risk: systematic and idiosyncratic (unsystematic) risk (Sharpe
1964). Although traditional portfolio theory argues that idiosyncratic risk can be
eliminated by diversification in a well-constructed portfolio and investors only get
compensated for—and are therefore interested in—systematic risk, research has
recently shown that financial markets price in idiosyncratic risk as well (Ang et al.
2009). Goyal and Santa-Clara (2003) point out that average stock variance is mostly
driven by idiosyncratic risk. Furthermore, in practice investors generally lack a
well-diversified portfolio (Goyal and Santa-Clara 2003; Jo and Na 2012). It is
against this background that we examine idiosyncratic and systematic risk.
Systematic risk depends on a company’s sensitivity to changes in market returns
and accounts for the part of the risk, which is explained by how a stock’s return
responds to general market movements that affect the entire universe of securities
(Sharpe 1964; Oikonomou et al. 2012). We measured systematic risk by calculating
a firm’s Beta based on the standard CAPM model using the monthly excess returns
of the previous 60 months in a 5-year moving window because a firm’s systematic
risk is only subject to slow changes over time (Fama and French 2004; McAlister
et al. 2007).
Idiosyncratic risk is caused by firm-specific characteristics and is associated with
the residual risk that cannot be explained by changes in average market portfolio
returns (Luo and Bhattacharya 2009). In line with previous literature, we estimated
idiosyncratic risk by calculating the annualized standard deviation of the residuals
from the four-factor model (Carhart 1997) by using the previous year’s daily excess
3
Full Code LA4RGNEU in Asset4.
123
returns (Bouslah et al. 2013; Luo and Bhattacharya 2009). The four-factor model is
characterized by the following equation:
Rit Rft ¼ ai þ biM ðRMt Rft Þ þ biS SMBt þ biH HMLt þ biW WMLt þ eit
(Rit - Rft) is the daily excess return of company i for day t, where Rit is the
return of company i and Rft is the risk-free rate of return on day t. According to the
model, stock return is influenced by four different return factors and the
idiosyncratic residual eit. The term (Rmt - Rft) accounts for the excess return of a
value-weighted market portfolio of European stocks, SMBt for the difference of
return between small and big stocks, HMLt for the return difference between high
and low book-to-market-ratio stocks, and WMLt for the difference of returns
between previous winner and loser stocks on day t. The variable eit is the stochastic
error term, which results from our time series regressions of the four factors on a
company’s daily excess returns in a single year. We have run a separate regression
with daily data for every company year in the sample to obtain the annual standard
deviation of the respective company’s residual. The factors (Rmt - Rft), SMBt,
HMLt, and WMLt, as well as the risk-free rate of return for Europe were obtained
from Kenneth French’s website (French 2015a).4
4.3 Independent variables: ESG measures
In line with previous CSR research, we measured CSP by ESG factors, which were
obtained from the Thomson Reuters Asset4 database (e.g., Cheng et al. 2014; Eccles
et al. 2014; Eccles et al. 2015; Ioannou and Serafeim 2012; Mackenzie et al. 2013).
Using more than 750 individual data points, Asset4 measures the non-financial
performance of a company based on the three pillars environmental, social, and
corporate governance performance. Asset4 covers more than 4000 companies
worldwide, including all major indices. Specialized research analysts source
publicly available information from CSR reports, company websites, annual reports,
non-governmental organizations, major news providers, and elsewhere. The
integrated ESG score calculated within Asset4 also includes an economic pillar
addressing financial performance measures. As we are interested in the impact of
CSP on a company’s risk, we sought to neglect financial performance in order to
avoid the influence of financial characteristics on firm risk. Consequently, we
calculated an ESG score (ESG), which consists of an equally weighted average of
the three ESG pillar scores.
The environmental pillar score (ENS) measures a company’s impact on its
natural living and non-living environment (including air, land, and water). It
represents a company’s commitment and effectiveness towards reducing environ-
mental emissions, supporting the research and development of eco-efficient
products or services, and achieving an efficient use of natural resources in its
4
For the European market the values of the four factors are only provided on a monthly basis. To be able
pffiffiffiffiffiffiffiffiffiffiffiffiffi
to run our regression on excess daily returns, we calculated daily factors by fd ¼ 21 fm þ 1 1 with fd for
daily factor and fm for monthly factor on the basis of an average of 21 trading days (Ritter 1991; Spiess
and Affleck-Graves 1995).
123
production process (Thomson Reuters 2015a). Thus it encompasses issues like CO2
emissions, total amount of waste, use of nuclear energy, amount of environmental
R&D expenditures, total water withdrawal, and environmental supply chain
monitoring.
The social pillar score (SOS) represents ‘‘a company’s capacity to generate trust
and loyalty with its workforce, customers, and society […]. It’s a reflection of the
company’s reputation and the health of its license to operate’’ (Thomson Reuters
2015a). SOS measures a company’s management commitment and effectiveness
towards creating value-added products and services that uphold the customer’s
security, maintaining its reputation within the general community, safeguard human
rights, maintaining diversity and equal opportunities in its workforce, providing
high-quality job conditions and a healthy and safe workplace, as well as offering
training and development opportunities. For instance, performance aspects covered
include engagement in ‘‘sinful’’ industries (e.g., tobacco), fair-trade policies,
amount of donations, human rights/child labor controversies, flexible working
schemes, injury rate, and trade union representation.
The corporate governance pillar score (CGS) captures a company’s systems and
processes that aim to ensure that its board members and executives act in the best
interests of a company’s long-term shareholders. It measures a company’s
management commitment and effectiveness towards following best-practice
corporate governance principles (Thomson Reuters 2015a). CGS thus takes into
account the effectiveness of board activities and functions (e.g., the establishment of
necessary board committees, balance in the board structure, compensation policies,
the integration of financial and non-financial aspects into an overarching vision and
strategy, and shareholder rights).
4.4 Control variables
In line with previous studies examining aspects of CSR and firm risk, we have
included several firm characteristics as control variables (Bouslah et al. 2013;
Chang et al. 2014; Luo and Bhattacharya 2009; Oikonomou et al. 2012). We
retrieved all financial data used to calculate our control variables from the Thomson
Reuters Worldscope and Datastream databases.
Firm size (SIZE) measured as natural log of total assets in US$ accounts for size
effects on firm risk. We used return on assets (ROA) to measure a firm’s
profitability, calculated as the ratio of pretax income to total assets. We also
included the volatility of ROA (SDROA_5), calculated as the standard deviation of
ROA over the previous 5 years, to capture profit volatility as a sign of uncertainty
(Luo and Bhattacharya 2009). Leverage (LEV) controlled for the impact of a
company’s capital structure on firm risk and was calculated as long-term debt to
total assets. We controlled for market-to-book ratio (MTB) as the ratio of market
value of equity to book value of equity to capture different risk characteristics for
growth and value companies (Oikonomou et al. 2012). Furthermore, we included a
company’s stock market liquidity (LIQ) as a possible influencing factor on market
risk, measured as the number of shares traded over the previous year divided by
number of shares outstanding at the company’s year-end. Finally, we controlled for
123
dividend payment (DIV_1) as it could be interpreted as a signal for managements

perception of certainty of future earnings. Furthermore, high expected dividend cash
flows are likely to reduce stock volatility (Oikonomou et al. 2012). DIV_1 was
measured as the ratio of dividends per share to price per share. Owing to the fact that
dividend cash flows are time-lagged (dividends for t are decided on and paid in
t ? 1), we included dividend payment with a time lag of 1 year. For all other control
variables current values were employed. Table 3 contains a description of all
variables used.
Table 3 Definition of variables

Variables Explanation
BETA Systematic risk (i.e., sensitivity to changes in market returns) measured based on CAPM
model using the monthly excess returns of previous 60 months in a 5-year moving
window
RSTD Total risk (i.e., total stock volatility) measured by annualized standard deviation of daily
stock returns over the previous year
IR Idiosyncratic risk—unsystematic risk that cannot be explained by broad market movements,
measured by annualized standard deviation of the residuals from the Carhart four-factor
model using the previous year’s daily excess returns
ESG CSP score obtained from Asset4, measured as the equally weighted average of pillar scores
CGS, SOS, and ENS
CGS Corporate governance performance obtained from Asset4. Pillar score measuring a
company’s systems and processes that ensure that its board members and executives act in
the best interests of its long-term shareholders
ENS Environmental performance obtained from Asset4. Pillar score measuring a company’s
impact on living and non-living natural systems, including the air, land, and water, as well
as complete ecosystems
SOS Social performance obtained from Asset4. Pillar score measuring a company’s capacity to
generate trust and loyalty with its workforce, customers, and society
SOSO Social performance score in regard to society obtained from Asset4
SOCU Social performance score in regard to customers obtained from Asset4
SOWO Social performance score in regard to workforce obtained from Asset4
SOCO Social category score in regard to society/community obtained from Asset4
SOHR Social category score in regard to society/human rights obtained from Asset4
SIZE Company size measured as natural logarithm of total assets in US$
ROA Return on assets measured as pretax income/total assets
SDROA_5 Volatility of ROA measured as standard deviation of ROA over previous 5 years
LEV Leverage measured as long term debt/total assets
MTB Market to book ratio measured as market value/book value of common equity
LIQ Stock liquidity measured as turnover by volume/common shares outstanding
DIV_1 Dividend payment—dividends per share scaled by average share price paid for the previous
year
CURA Current ratio measured as current total assets to current total liabilities
YEAR Year dummies
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4.5 Methodology
We have tested the following relationship:

FIRMRISKit ¼ b0 þ b1 ESGit þ b2 SIZEit þ b3 ROAit þ b4 LEVit þ b5 MTBit
X12
þ b6 DIV 1it þ b7 SDROA 5it þ b8 LIQit þ bd YEARqi þ eit
q¼1
Our starting point was to estimate panel data regression models of firm risk as a
function of ESG factors and various control measures. We ran the Lagrange
multiplier test by Breusch and Pagan (1980) for the existence of individual
heterogeneity. This test examines whether pooled ordinary least squares (OLS) is an
appropriate model or not. Significant test statistics suggest unobserved heterogene-
ity and pooled OLS regression would therefore lead to biased estimates. A
significant value for the Hausman test statistic suggests correlation between the
unobserved firm fixed effects and the explanatory variables. Consequently, the
random effects estimator would lead to inconsistent results. Against this
background, the fixed effects estimator seemed to be most appropriate for our
data. Furthermore, our explanatory variables of interest are time-variant and are
therefore not affected by the common drawback of the fixed effects model, which is
the impossibility of including time-constant explanatory variables. The fixed effects
model involves estimating a parameter for each cross-sectional unit (i.e., each firm).
Fixed effects control for all time-invariant effects between firms (e.g., management,
industry, diversification, country, and listing). In addition to firm fixed effects, we
used year fixed effects to control for changing economic conditions that might affect
firm risk. For instance, we aimed to capture the impact of the financial crisis in 2008
and 2009 on firm risk.
We ran some further tests to check for serial autocorrelation and heteroscedas-
ticity. First, we tested for serial autocorrelation (the xtserial command in Stata)
according to Wooldridge (2010) and Drukker (2003). A significant test statistic
indicated the presence of serial correlation in our data. Second, we used the
modified Wald test for groupwise heteroscedasticity and found that heteroscedas-
ticity also affected our data. To alleviate concern about cross-sectional and time-
series dependence and heteroscedasticity, we calculated t-values on an adjusted
basis by using clustered standard errors by firm.
To test H2, instead of the integrated ESG score, we added the three pillar scores
ENS, CGS, and SOS to assess the impact of the different ESG factors. Additionally,
instead of SOS, we used social performance sub-scores differentiated by the targeted
stakeholder groups SOSO (society), SOCU (customer), and SOWO (workforce) to
deepen our insights into the impact of social performance.5 Third, to examine
possible interactions between environmental sensitivity and environmental perfor-
mance (H3), we included an interaction term of environmentally sensitive industry
5
Our later regressions suggest that, except for a few exceptions, SOS is the only one of our three pillar
scores that seems to affect risk measures. We therefore concentrated on social category scores.
123
and environmental performance. We classified companies as engaged in an

environmentally sensitive industry if the company’s standard industrial classifica-
tion (SIC) code matched the list found in the ‘‘NAICS Codes of Environmentally
Sensitive Industries’’ published by the US Small Business Administration. To
determine the industry, we used the SIC code 1 assigned by Datastream based on the
business segment that generates the most revenue. For the sake of consistency, we
recoded all relevant NAICS codes to SIC codes.
5 Results
5.1 Descriptive statistics
Table 4 reports the descriptive statistics for our risk measures (panel A),
explanatory variables (panel B), and control variables (panel C). Panel A of
Table 4 shows that the mean (median) total risk (RSTD) is 0.33 (0.29). The mean
(median) idiosyncratic risk (IR) is 0.33 (0.29), whereas the mean (median)
systematic risk (BETA) is 0.80 (0.73). Mean and median values of our risk measures
are comparable to prior research on firm risk (e.g., Bouslah et al. 2013). Mean firm
risk is higher among non-STOXX firms (BETA: 0.83, RSTD: 0.38, IR: 0.37)
compared to STOXX firms (BETA: 0.78, RSTD: 0.32, IR: 0.30).
ESG scores range between 0 and 1, with high scores indicating strong
performance in the category. The mean (median) scores in our sample are 0.61
(0.67) for ESG, 0.56 (0.60) for CGS, 0.64 (0.73) for ENS, and 0.68 (0.73) for SOS.
Again, the scores are higher among STOXX firms (ESG: 0.67, CGS: 0.59, ENS:
0.70, SOS: 0.72) compared to non-STOXX firms (ESG: 0.50, CGS: 0.48, ENS: 0.51,
SOS: 0.52), which indicates that STOXX firms have a higher corporate governance,
environmental, and social performance. Lower (higher) mean risk (mean ESG
scores) among STOXX firms might be attributable to their larger size (13.134
billion for STOXX firms vs. 2.728 billion for non-STOXX firms).
Table 5 reports that the total risk is significantly negatively correlated with ESG
and the pillar scores ENS and SOS at the 5 % level. Correlation coefficients suggest
that firms with a better CSP have a lower firm risk. Correlation between
idiosyncratic risk and CGS is significantly positive. A detailed inspection of social
category scores shows that all social scores are negatively correlated with the risk
measures; some of the correlations are significant at the 5 % level. We tested ESG,
the pillar scores, and the category scores in separate regression models. Given the
correlation of some of the variables, we calculated variance inflation factors (VIF)
to test for multicollinearity. A VIF of higher than 10 suggests severe multi-
collinearity problems. However, in our data, no VIF exceeds 2.83, which suggests
that multicollinearity should not affect the results.
123
Table 4 Descriptive statistics

Variable Mean Median SD Min. Max. Skewness Kurtosis N
Panel A: risk measures

BETA 0.8030 0.7373 0.4351 -0.4058 3.0885 0.8135 4.0147 7959
RSTD 0.3377 0.2934 0.1734 0.0000 3.3010 3.0964 26.4128 8547
IR 0.3313 0.2958 0.1824 0.0001 2.4260 2.0410 12.8634 8752
Panel B: ESG scores
ESG 0.6131 0.6689 0.2333 0.0494 0.9700 -0.5907 2.2854 8752
CGS 0.5566 0.6038 0.2671 0.0148 0.9726 -0.3850 1.9578 8752
ENS 0.6354 0.7346 0.2921 0.0827 0.9734 -0.5597 1.8085 8752
SOS 0.6473 0.7274 0.2820 0.0346 0.9896 -0.6117 2.0675 8752
SOCU 0.5666 0.6029 0.3072 0.0305 0.9922 -0.2319 1.6426 8752
SOSO 0.5825 0.6007 0.2657 0.0816 0.9852 -0.2173 1.7375 8752
SOWO 0.6245 0.6557 0.2207 0.0670 0.9800 -0.4914 2.3439 8752
Panel C: control variables
SIZE 15.8380 15.5648 1.8139 11.9890 20.1576 0.4857 2.7576 8752
ROA 0.0686 0.0578 0.0830 -0.1549 0.3220 0.6271 4.6849 8752
LEV 0.1895 0.1666 0.1520 0.0000 0.6094 0.7740 3.0262 8752
MTB 2.6361 1.9054 2.3703 0.2523 12.5925 2.3523 9.2772 8752
DIV_1 0.0303 0.0284 0.0222 0.0000 0.5522 2.1807 38.3915 8752
SDROA_5 0.0336 0.0202 0.0388 0.0008 0.1970 2.2986 8.7738 8752
LIQ 3.8873 3.0834 3.2342 0.0205 14.7222 1.3146 4.7147 8752
CURA 1.4788 1.2800 0.8415 0.4000 4.8700 1.9168 7.4445 6981
5.2 Regressions results
Table 6 presents the multivariate regressions results of the risk measures BETA,
RSTD, and IR as a function of ESG.6 In the case of RSTD and IR, the coefficients of
ESG are significant with a negative sign, which is in line with H1. Obviously a
firm’s higher CSP is associated with lower total and idiosyncratic risk. Contrary to
H1, the relationship between ESG and BETA is not significant.
To understand which ESG factors affect firm risk, we regressed our risk measures
on the three pillar scores CGS, ENS, and SOS instead of using the aggregated ESG
score. Table 6 shows that there is a negative and significant relationship between
SOS and all three risk measures, whereas ENS has only a significantly negative
association with IR. CGS is non-significant for all risk measures. Accordingly, we
can only support H2 for SOS and partially for ENS. A higher social performance is
6
In our hypotheses, we assume a causal relationship between the ESG score or its category scores and
firm risk, with the former having an impact on the latter. Although our regression analysis is not able to
reveal a causal relationship we confirm our hypotheses in case we find a significant relationship between
the ESG score or its category scores and firm risk. However, we challenge this causal relationship in the
following Sect. 5.3.
123
Table 5 Correlation table
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
BETA (1) 1
RSTD (2) 0.4311* 1
IR (3) 0.2170* 0.2017* 1
ESG (4) –0.0014 –0.0527* 0.0153 1
CGS (5) 0.0137 –0.0034 0.0807* 0.7212* 1
ENS (6) 0.0005 –0.0573* –0.0175 0.8766* 0.3918* 1
SOS (7) –0.017 –0.0682* –0.0203 0.8904* 0.4368* 0.7685* 1
SOCU (8) –0.0003 –0.0345* –0.0106 0.5394* 0.1805* 0.5051* 0.6444* 1

SOSO (9) –0.0242* –0.0735* –0.0035 0.7883* 0.4384* 0.6593* 0.8580* 0.4646* 1
SOWO (10) –0.0207 –0.0556* –0.0146 0.8366* 0.4145* 0.7242* 0.9335* 0.4917* 0.7063* 1
SIZE (11) 0.0062 –0.0525* –0.0324* 0.3947* 0.1165* 0.4143* 0.4398* 0.2587* 0.3947* 0.4449* 1
ROA (12) –0.1294* –0.1630* –0.0785* –0.0406* –0.0072 –0.0632* –0.0285* –0.0479* –0.0113 –0.0241* –0.3000* 1
LEV (13) –0.0444* 0.0184 –0.0176 0.0386* 0.0460* 0.0299* 0.0213* 0.0272* –0.0027 0.0328* 0.0131 –0.2038* 1
MTB (14) –0.1101* –0.0938* –0.0474* –0.0270* 0.0330* –0.0777* –0.0177 –0.0079 –0.0004 –0.0283* –0.3097* 0.4954* –0.0608* 1
DIV_1 (15) –0.1368* –0.1495* –0.0764* 0.1354* 0.1040* 0.1116* 0.1219* 0.0484* 0.1223* 0.1284* 0.1197* 0.0685* 0.0697* –0.0455* 1
SDROA_5 (16) 0.1435* 0.1183* 0.0706* –0.1121* 0.0261* –0.1335* –0.1647* –0.1631* –0.1447* –0.1443* –0.3312* 0.0783* –0.0249* 0.1087* –0.1479* 1
LIQ (17) 0.1300* 0.1709* –0.0124 0.1597* 0.2278* 0.0599* 0.1186* 0.0658* 0.1264* 0.0904* 0.0178 –0.0785* 0.1001* 0.013 –0.0022 0.0914*
This table presents the correlation coefficients between the risk, ESG, and control variables for the whole sample. All variables are defined in Table 3.
Stars indicate significance at the 5 % level (p \ 0.05)
885
123
Table 6 Impact of ESG and pillar scores on all risk measures
886
Variables (1) BETA (2) BETA (3) BETA (1) RSTD (2) RSTD (3) RSTD (1) IR (2) IR (3) IR
123
ESG 0.005 -0.032* -0.041***
(0.068) (0.017) (0.012)
CGS 0.069 0.073 0.004 0.004 0.003 0.003
(0.046) (0.046) (0.014) (0.014) (0.012) (0.012)
ENS 0.046 0.118 0.015 0.031 -0.020* -0.018
(0.054) (0.073) (0.015) (0.020) (0.011) (0.014)
ENV_SEN#ENS -0.155* -0.033* -0.003
(0.092) (0.023) (0.016)
SOS -0.103* -0.101* -0.050*** -0.049*** -0.021** -0.021**
(0.054) (0.054) (0.015) (0.015) (0.011) (0.011)
SIZE 0.026 0.026 0.026 -0.028*** -0.028*** -0.028*** -0.016*** -0.016*** -0.016***
(0.022) (0.022) (0.022) (0.008) (0.008) (0.008) (0.006) (0.006) (0.006)
ROA -0.059 -0.056 -0.056 -0.231*** -0.230*** -0.230*** 0.066* 0.066* 0.066*
(0.104) (0.105) (0.105) (0.040) (0.039) (0.039) (0.034) (0.034) (0.034)
LEV 0.063 0.065 0.063 0.046 0.047 0.046 -0.000 -0.000 -0.000
(0.086) (0.086) (0.086) (0.033) (0.033) (0.033) (0.026) (0.026) (0.026)
MTB 0.008** 0.008** 0.008** -0.001 -0.001 -0.001 -0.002 -0.002 -0.002
(0.003) (0.003) (0.003) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
DIV_1 -2.061*** -2.056*** -2.084*** -0.687*** -0.685*** -0.691*** -0.042 -0.042 -0.043
(0.455) (0.457) (0.453) (0.149) (0.150) (0.149) (0.100) (0.100) (0.100)
SDROA_5 0.965*** 0.969*** 0.954*** 0.147** 0.147** 0.145** -0.035 -0.034 -0.034
(0.285) (0.283) (0.284) (0.066) (0.066) (0.065) (0.056) (0.056) (0.056)
LIQ 0.015*** 0.015*** 0.015*** 0.010*** 0.010*** 0.010*** -0.001 -0.001 -0.001
(0.004) (0.004) (0.004) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
Constant 0.452 0.459 0.475 0.838*** 0.838*** 0.838*** 0.538*** 0.538*** 0.538***
R. Sassen et al.
Table 6 continued
(0.333) (0.334) (0.335) (0.124) (0.124) (0.124) (0.084) (0.083) (0.083)

Observations 7959 7959 7959 8547 8547 8547 8752 8752 8752
R-squared 0.126 0.128 0.129 0.459 0.460 0.461 0.358 0.358 0.358
ID number 884 884 884 921 921 921 921 921 921
Firm FE Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes Yes Yes Yes
This table presents results from fixed effects regressions of the risk measures on the ESG score, three pillar scores, respectively, and controls over the period 2002–2014 for
the whole sample. BETA is the firm’s systematic risk. Firm’s total risk (RSTD) is the annualized standard deviation from the daily stock returns over the past year.
Idiosyncratic risk (IR) is the standard deviation of the residuals derived from the four-factor Carhart (1997) model. ESG is the average score of the three pillar scores
corporate governance performance (CGS), environmental performance (ENS), and social performance (SOS). All variables are defined in Table 3. Year fixed effects are
unreported. Robust and clustered (by firm) standard errors are reported in parentheses. The p values are two-tailed except for ENV_SEN#ENS. The symbols ***, **, and *
indicate significance at the 1, 5, and 10 % level, respectively
887
123
related to lower total, systematic, and idiosyncratic risk. By contrast, a higher

environmental performance is only associated with lower idiosyncratic risk. The
SOS coefficient of 0.103 on BETA indicates that an increase in a firm’s social
performance by one standard deviation (0.28) is linked to a relative decrease in
systematic risk by 3.6 % in relation to the mean risk (0.80). An increase in a firm’s
social performance by one standard deviation is associated with a reduction of total
risk by 4.2 %. With regard to idiosyncratic risk, a simultaneous increase in social
and environmental performance by one standard deviation is related to a reduction
of risk by 3.6 %.
Given the relevance of the social performance score, we aimed to obtain a clearer
picture of the impact of social performance on risk measures. Asset4 differentiates
firms’ social performance in terms of three stakeholder groups: customers (SOCU),
society as a whole (SOSO), and workforce (SOWO). We therefore replaced SOS
with these three scores. Table 7 shows that social performance in terms of society as
a whole (SOSO) is significantly negatively associated with systematic and total risk,
whereas there is a significantly negative relationship between social performance
toward customers (SOCU) and idiosyncratic risk. Social performance as it relates to
the firms’ workforce (SOWO) does not affect any of the three risk measures.
Since SOWO concerns employment aspects like guaranteeing health and safety or
providing opportunities for training and development and thereby meeting the needs
of the firm’s workforce (as internal stakeholders), it can be considered as a comparably
‘‘company-internal’’ factor of social performance, which has less of a direct impact on
market risk. In line with our results, we assume a much higher public visibility and a
more pronounced relationship with market risk for SOCU and SOSO, which concern
customers and society and thereby external stakeholders. SOCU represents the product
responsibility category score that measures a company’s management commitment
and effectiveness towards creating high-quality products and services that protect
customer health and safety (Thomson Reuters 2015a). By covering issues like
avoiding health hazardous ingredients, product recalls, and engagement in socially
undesirable industries, we expect SOCU to have a large potential impact on market
risk owing to a direct link between customer satisfaction and financial performance
and a high public awareness. Social performance toward society as a whole (SOSO)
consists of the two category scores SOCO and SOHR. SOCO measures a company’s
management commitment and effectiveness towards maintaining the company’s
reputation within the general community by being a good citizen, protecting public
health, and respecting business ethics (Thomson Reuters 2015a). It reflects a
company’s social performance regarding donations, employee engagement in
voluntary community work, tax fraud/anti-trust controversies, involvement in the
local community, or bribery and corruption policies. SOHR measures a company’s
management commitment and effectiveness towards honoring fundamental human
rights throughout its supply chain (Thomson Reuters 2015a). It represents a
company’s implementation of human rights policies, human rights monitoring in its
own or its suppliers’ facilities, or human rights/child labor controversies covered in the
media. In line with our results, we assume that SOSO is significantly linked to company
risk owing to its high public visibility and the direct impact of social reputation
engagement on market perception. Given the significance of SOSO, we replicated our
123
Table 7 Impact of two pillar and social category scores on risk measures
Variables (1) BETA (2) BETA (1) RSTD (2) RSTD (1) IR (2) IR
CGS 0.072 0.073 0.006 0.006 0.003 0.003

(0.045) (0.045) (0.014) (0.014) (0.012) (0.012)
ENS 0.045 0.045 0.015 0.015 -0.019* -0.019*
(0.053) (0.053) (0.014) (0.014) (0.011) (0.011)
SOCU 0.001 0.001 -0.004 -0.004 -0.022*** -0.022***
(0.027) (0.027) (0.008) (0.008) (0.008) (0.008)
SOSO -0.083** -0.054*** -0.014
(0.040) (0.012) (0.011)
SOCO -0.051* -0.029*** -0.008
(0.027) (0.008) (0.007)
SOHR -0.030 -0.024** -0.007
(0.034) (0.010) (0.008)
SOWO -0.059 -0.058 -0.011 -0.010 0.006 0.006
(0.061) (0.061) (0.019) (0.019) (0.014) (0.014)
SIZE 0.027 0.026 -0.028*** -0.028*** -0.016*** -0.016***
(0.022) (0.022) (0.008) (0.008) (0.006) (0.006)
ROA -0.056 -0.055 -0.231*** -0.231*** 0.065* 0.065*
(0.104) (0.104) (0.039) (0.039) (0.034) (0.034)
LEV 0.066 0.066 0.046 0.046 -0.001 -0.001
(0.086) (0.086) (0.033) (0.033) (0.026) (0.026)
MTB 0.008** 0.008** -0.001 -0.001 -0.001 -0.001
(0.003) (0.003) (0.001) (0.001) (0.001) (0.001)
DIV_1 -2.048*** -2.046*** -0.685*** -0.685*** -0.045 -0.045
(0.455) (0.455) (0.149) (0.148) (0.099) (0.099)
SDROA_5 0.954*** 0.955*** 0.137** 0.137** -0.038 -0.038
(0.284) (0.284) (0.066) (0.066) (0.056) (0.056)
LIQ 0.015*** 0.015*** 0.010*** 0.010*** -0.001 -0.001
(0.004) (0.004) (0.001) (0.001) (0.001) (0.001)
Constant 0.462 0.464 0.840*** 0.841*** 0.547*** 0.547***
(0.334) (0.334) (0.124) (0.124) (0.083) (0.083)
Observations 7959 7959 8547 8547 8752 8752
R-squared 0.129 0.129 0.461 0.461 0.359 0.359
ID number 884 884 921 921 921 921
Firm FE Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes
This table presents results from fixed effects regressions of the risk measures on the two pillar and seven
social category scores and controls over the period 2002–2014 for the whole sample. BETA is the firm’s
systematic risk. Firm’s total risk (RSTD) is the annualized standard deviation from the daily stock returns
over the past year. Idiosyncratic risk (IR) is the standard deviation of the residuals derived from the four-
factor Carhart (1997) model. All variables are defined in Table 3. Year fixed effects are unreported.
Robust and clustered (by firm) standard errors are reported in parentheses. The p values are two-tailed.
The symbols ***, **, and * indicate significance at the 1, 5, and 10 % level, respectively
123
model using SOCO and SOHR instead of SOSO. Table 7 indicates that SOCO is
significantly negatively associated with systematic and total risk, whereas SOHR only
has a significant link to total risk. There is still a significantly negative relationship
between SOCU and IR.
Next, we aimed to assess whether the effect of environmental performance
differs depending on the industry. In detail, we created an interaction effect between
environmentally sensitive industries and environmental performance. Our findings
mainly support H3 (Table 6). As expected, the link between environmental
performance and both total and systematic risk is significantly more negative in
environmentally sensitive industries. However, contrary to H3, the results are non-
significant with regard to idiosyncratic risk. In combination with the results for H2,
we can conclude that environmental performance is generally negatively associated
with idiosyncratic risk, whereas total and systematic risk are negatively linked to
ENS only in environmentally sensitive industries.
Among the control variables, we found that particularly ROA, DIV, and SIZE are
significantly negatively associated with firm risk, whereas there is a positive
relationship between the two variables STROA_5 and LIQ and risk. The coefficients
of the control variables are generally consistent with the findings of prior studies (Jo
and Na 2012; Bouslah et al. 2013; Oikonomou et al. 2012).
5.3 Endogeneity
Endogeneity can have different sources. It might result from omitted variables that
are correlated with explanatory variables and the disturbance term leading to biased
coefficients. We used a fixed effects model that controls for all time-invariant
characteristics and employed multiple time-variant control variables. We therefore
assume that an omitted variable bias should not be a problem in our data. Our model
presumes that CSP affects firm risk. However, reverse causality or simultaneity
might be another source of endogeneity, particularly with regard to CGS. Hermalin
and Weisbach (2003) suggest that a firm’s governance structure is endogenously
determined. For example, on the one hand, a higher CGS decreases firm risk; on the
other hand, firms that suffer from higher risk have incentives to strengthen their
corporate governance to avoid potential damage to the firm. Bouslah et al. (2013)
found a bidirectional causality between firm risk and some CSP measures for a US
sample. To challenge our expectations about the impact of CSP on firm risk, we
employed a Granger causality test (Granger 1969; Bouslah et al. 2013; Luo and
Bhattacharya 2009; Chang et al. 2014). Concretely, given our panel structure, we
performed a panel vector autoregression (VAR)-Granger causality Wald test and
estimated the following VAR model:
FIRMRISKit ¼ a0 þ a1 FIRMRISKit1 þ a2 FIRMRISKit2 þ b1 ESGit1
þ b2 ESGit2 þ eit
ESGit ¼ c0 þ c1 ESGit1 þ c2 ESGit2 þ d1 FIRMRISKit1 þ d2 FIRMRISKit2 þ eit
123
We tested H0 that b1 = 0 and b2 ¼ 0 (i.e., that ESG does not Granger-cause firm
risk). Similarly, we tested H0 that d1 ¼ 0 and d2 ¼ 0 (i.e., that firm risk does not
Granger-cause ESG). In each case, a rejection of H0 implies that there is Granger
causality. Three cases are possible. First, there can be bidirectional relationships in
which ESG impacts firm risk, whereas firm risk simultaneously affects ESG.
Second, unidirectional relationships in which ESG affects firm risk or vice versa.
Finally, missing causality is also conceivable.
In the first case, we estimated a panel VAR model by fitting a multivariate panel
regression of each dependent variable on lags of itself and lags of other dependent
variables using the generalized method of moments (GMM). Love and Zicchino
(2006) developed a methodology for panel data that removes fixed effects before
estimating VAR using forward orthogonal deviation or Helmert transformation.
Cluster-robust standard errors at the firm level were used to mitigate heteroscedas-
ticity and autocorrelation concerns. According to Wooldridge, two lags are typically
used in calculating the Granger test in annual data (Wooldridge 2010, p. 650). Then,
we performed Granger causality Wald tests for each equation of the underlying
panel VAR model (Table 8).
We looked at the pillar score level instead of ESG because causality might differ
between the three performance scores, and we separately tested the respective pillar
scores and risk measures. We found a bidirectional relationship between CGS and
all risk measures, as we assumed at the beginning (i.e., CGS Granger-causes all risk
measures, whereas all risk measures also simultaneously Granger-cause CGS). As
for ENS and SOS, Granger causality indicates only a unidirectional relationship
between the two variables and all risk measures. Firms with higher social (or
environmental) performance tend to have a lower firm risk, whereas firm risk does
not impact the level of a firm’s social (or environmental) performance. Because of
the relevance of SOS in our prior analysis, we replaced SOS with the disaggregated
measures SOCU, SOSO, and SOWO in our Granger causality test. In general, we
could confirm a unidirectional relationship for these measures. However, we found a
bidirectional relationship between SOWO and the risk measures BETA and IR.
According to these findings, firms with a higher social performance toward their
customers, society as a whole, and their workforce experience lower risks. In
addition, high risks induce companies to improve their social performance toward
their workforce. This seems intuitive as some industries such as the apparel industry
often face risk events in the form of crises or scandals as a result of poor and
unhealthy working conditions (i.e., low SOWO). These risk events then motivate
firms to invest in labor rights or workplace safety.7
To summarize, our findings are generally consistent for the different risk
measures. Whereas our findings with regard to SOS8 and ENS support our model
specification, the misspecification with regard to CGS causes the CGS parameter
estimates to be inconsistent for all risk measures. Econometrically, consistent
7
We thank one of the anonymous reviewers for this proposition.
8
Since the bidirectional relationship between SOWO and BETA or SOWO and IR might indicate
inconsistent results for SOWO, this would solely affect SOWO, which displays a non-significant
regression coefficient. Hence, this does not affect our (significant) findings for the SOSO and SOCU
category.
123
892
Table 8 Granger causality test
123
Equation BETA RSTD IR Relationship according to
Granger causality test
Chi2 (df) p value Chi2 (df) p value Chi2 (df) p value
CGS does not Granger-cause risk 4.848 (2) 0.089 7.803 (2) 0.020 13.616 (2) 0.001 Bidirectional
Risk does not Granger-cause CGS 14.210 (2) 0.001 14.375 (2) 0.001 13.570 (2) 0.001
ENS does not Granger-cause risk 7.628 (2) 0.022 19.760 (2) 0.000 45.960 (2) 0.000 Unidirectional
Risk does not Granger-cause ENS 2.962 (2) 0.227 2.263 (2) 0.323 2.365 (2) 0.306
SOS does not Granger-cause risk 29.464 (2) 0.000 32.257 (2) 0.000 55.193 (2) 0.000 Unidirectional
Risk does not Granger-cause SOS 0.520 (2) 0.771 0.472 (2) 0.790 1.202 (2) 0.548
Disaggregated SOS scores
SOCU does not Granger-cause risk 1.186 (2) 0.553 11.179 (2) 0.004 14.119 (2) 0.001 Unidirectional/independent
Risk does not Granger-cause SOCU 0.220 (2) 0.896 0.739 (2) 0.691 4.071 (2) 0.131
SOSO does not Granger-cause risk 11.355 (2) 0.003 22.831 (2) 0.000 10.337 (2) 0.006 Unidirectional
Risk does not Granger-cause SOSO 0.874 (2) 0.646 0.715 (2) 0.699 1.323 (2) 0.516
SOWO does not Granger-cause risk 20.865 (2) 0.000 20.470 (2) 0.000 92.223 (2) 0.000 Bi-/unidirectional
Risk does not Granger-cause SOWO 4.676 (2) 0.097 0.226 (2) 0.893 5.045 (2) 0.080
This table presents results from Granger causality Wald tests (Granger 1969) with two lags according to Wooldridge (2010) for each equation of the underlying panel VAR
model. The model was estimated by fitting a multivariate panel regression of each dependent variable on lags of itself and lags of other dependent variables using the
generalized method of moments (GMM). Love and Zicchino 2006) developed this methodology for panel data using forward orthogonal deviation or Helmert trans-
formation. Cluster-robust standard errors at the firm level were used. BETA is the firm’s systematic risk. Firm’s total risk (RSTD) is the annualized standard deviation from
the daily stock returns over the past year. Idiosyncratic risk (IR) is the standard deviation of the residuals derived from the four-factor Carhart (1997) model. ESG is the
average score of the three pillar scores corporate governance performance (CGS), environmental performance (ENS), and social performance (SOS). In addition to testing
the SOS pillar score, we did a separate test on the disaggregated social performance measures toward customers (SOCU), society (SOSO), and workforce (SOWO). All
variables are defined in Table 3
R. Sassen et al.
estimates could be obtained by means of two-stage procedures that rely on

instrumental variables. These instrumental variables allow one to generate predicted
values of the explanatory variable CGS that are uncorrelated with firm risk and thus
the error term in our model. However, prior literature (Ittner and Larcker 2001;
Ashbaugh-Skaife et al. 2006) points out that instrumental variables are very difficult
to identify in most accounting research settings, particularly with respect to
corporate governance characteristics because a well-developed theory of the
determinants of governance is missing (Hermalin and Weisbach 2003). In the
absence of adequate instrumental variables, we have to keep in mind that
simultaneity bias impedes the interpretation of results with regard to CGS.
Simultaneity might explain why CGS parameter estimates are positive and non-
significant in all estimations, which is in contrast to H2.
The use of lagged explanatory variables could at least partially address
simultaneity (Harjoto and Jo 2015; Luo and Bhattacharya 2009). Our analysis thus
far has examined the impact of current CSP on current firm risk. However, it might
be possible that the current CSP affects firm risk in the subsequent period. To assess
this relationship, we replicated our model using lagged CSP followed by lagged
pillar scores. Using lagged explanatory variables does not eliminate simultaneity
problems (Wintoki et al. 2012). However, it diminishes the impact of simultaneity
since past CGS and current firm risk are not determined in the same period. Table 9
shows that the results for BETA and RSTD remained unchanged. In contrast, all
explanatory variables became non-significant in the case of IR. The non-significant
effects on IR might be due to the fact that CSP immediately impacts excess returns
of a company that are not explained by broad market movements.
5.4 Additional tests and robustness checks
We conducted multiple checks to investigate the robustness of our findings. Prior

US-based research on firm risk often used the ratio of current total assets to current
total liabilities (CURA) to control for a firm’s funding liquidity (Oikonomou et al.
2012). We excluded this variable owing to limited data availability in our European
sample in which firm-year observations drop to 6981 when including CURA. To test
whether an inclusion of this control impacted our results, we replicated our
regressions including CURA. Our untabulated findings indicate that the results
depicted in Table 5 were unaffected by the inclusion of CURA (i.e., ESG still
significantly decreased total and idiosyncratic risk). Similarly, at the pillar score
level, ENS decreased idiosyncratic risk, whereas SOS decreased all risk measures.
Our sample consisted of members of the STOXX Europe 600 and various other
European capitalized companies. To assess potential characteristics of STOXX
firms in this context, we ran separate regressions for the STOXX firms only
(Table 10). The results remained mainly unchanged. However, the effect of SOS on
IR became non-significant and CGS then significantly affected BETA with a positive
sign. Given the bidirectional relationship between CGS and our risk measures, one
possible explanation for this result could be that the positive impact of risk on CGS
becomes more pronounced in STOXX companies than the negative effect of CGS
on risk. STOXX constituents are subject to higher transparency requirements and to
123
Table 9 Impact of lagged ESG and lagged pillar scores on risk measures
894
123
L.ESG -0.061 -0.029* -0.018
(0.063) (0.016) (0.013)
L.CGS 0.055 0.059 -0.004 -0.004 -0.003 -0.002
(0.043) (0.042) (0.012) (0.012) (0.011) (0.011)
L.ENS -0.007 0.074 0.008 0.019 -0.008 -0.000
(0.050) (0.069) (0.014) (0.020) (0.011) (0.014)
ENV_SEN#L.ENS -0.171** -0.022 -0.016
(0.086) (0.023) (0.017)
L.SOS -0.097* -0.095* -0.032** -0.032** -0.007 -0.007
(0.053) (0.053) (0.014) (0.014) (0.011) (0.011)
SIZE 0.014 0.014 0.015 -0.032*** -0.032*** -0.032*** -0.019*** -0.019*** -0.019***
(0.022) (0.022) (0.022) (0.008) (0.008) (0.008) (0.007) (0.007) (0.007)
ROA -0.073 -0.069 -0.071 -0.191*** -0.191*** -0.191*** 0.045 0.045 0.045
(0.104) (0.104) (0.104) (0.040) (0.040) (0.040) (0.036) (0.036) (0.036)
LEV 0.048 0.050 0.051 0.026 0.027 0.027 0.005 0.005 0.005
(0.084) (0.084) (0.083) (0.030) (0.030) (0.030) (0.030) (0.030) (0.030)
MTB 0.008** 0.008** 0.008** -0.001 -0.001 -0.001 -0.001 -0.001 -0.001
(0.003) (0.003) (0.003) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
DIV_1 -2.019*** -2.017*** -2.034*** -0.725*** -0.727*** -0.729*** -0.002 -0.002 -0.004
(0.459) (0.457) (0.457) (0.137) (0.137) (0.137) (0.114) (0.114) (0.115)
SDROA_5 0.880*** 0.885*** 0.867*** 0.097 0.095 0.093 -0.023 -0.023 -0.024
(0.284) (0.282) (0.283) (0.062) (0.062) (0.062) (0.062) (0.062) (0.062)
LIQ 0.015*** 0.015*** 0.015*** 0.011*** 0.011*** 0.011*** -0.001 -0.001 -0.001
(0.004) (0.004) (0.004) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
R. Sassen et al.
Table 9 continued
Constant 0.514 0.521 0.525 0.823*** 0.824*** 0.823*** 0.512*** 0.512*** 0.511***
(0.345) (0.345) (0.346) (0.129) (0.129) (0.129) (0.106) (0.106) (0.106)
Observations 7306 7306 7306 7803 7803 7803 7963 7963 7963
R-squared 0.136 0.138 0.140 0.477 0.478 0.478 0.362 0.362 0.362
ID number 880 880 880 916 916 916 916 916 916
Firm FE Yes Yes Yes Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes Yes Yes Yes
This table presents results from fixed effects regressions of the risk measures on the lagged ESG score, the lagged three pillar scores, respectively, and controls over the
period 2002–2014 for the whole sample. BETA is the firm’s systematic risk. Firm’s total risk (RSTD) is the annualized standard deviation from the daily stock returns over
the past year. Idiosyncratic risk (IR) is the standard deviation of the residuals derived from the four-factor Carhart (1997) model. ESG is the average score of the three pillar
scores corporate governance performance (CGS), environmental performance (ENS) and social performance (SOS). All variables are defined in Table 3. Year fixed effects
are unreported. Robust and clustered (by firm) standard errors are reported in parentheses. The p values are two-tailed except for ENV_SEN#ENS. The symbols ***, **,
and * indicate significance at the 1, 5, and 10 % level, respectively
895
123
Table 10 Impact of ESG and pillar scores on all risk measures (STOXX sample)
Variables (1) BETA (2) BETA (1) RSTD (2) RSTD (1) IR (2) IR
ESG 0.083 -0.039* -0.031**

(0.090) (0.021) (0.014)
CGS 0.109* 0.005 -0.005
(0.058) (0.014) (0.013)
ENS 0.096 0.008 -0.025**
(0.066) (0.015) (0.013)
SOS -0.117* -0.050** -0.000
(0.070) (0.021) (0.013)
SIZE 0.035 0.035 -0.013 -0.012 -0.014** -0.014**
(0.027) (0.027) (0.009) (0.009) (0.006) (0.006)
ROA -0.009 0.002 -0.173*** -0.169*** 0.077* 0.076*
(0.141) (0.142) (0.044) (0.043) (0.044) (0.045)
LEV 0.092 0.093 0.024 0.025 -0.008 -0.008
(0.112) (0.112) (0.039) (0.039) (0.025) (0.025)
MTB 0.007* 0.007* 0.000 0.000 -0.001 -0.001
(0.004) (0.004) (0.001) (0.001) (0.001) (0.001)
DIV_1 -2.749*** -2.749*** -0.655*** -0.654*** -0.080 -0.078
(0.616) (0.613) (0.183) (0.182) (0.156) (0.155)
SDROA_5 0.948** 0.931** 0.140** 0.134* -0.054 -0.051
(0.387) (0.384) (0.069) (0.069) (0.062) (0.063)
LIQ 0.015*** 0.015*** 0.011*** 0.011*** -0.001 -0.001
(0.005) (0.005) (0.002) (0.002) (0.001) (0.001)
Constant 0.256 0.256 0.597*** 0.596*** 0.486*** 0.487***
(0.423) (0.426) (0.148) (0.147) (0.092) (0.092)
Observations 5161 5161 5531 5531 5674 5674
R-squared 0.136 0.140 0.514 0.515 0.384 0.384
ID number 532 532 551 551 551 551
Firm FE Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes
This table presents results from fixed effects regressions of the risk measures on the ESG score, three
pillar scores, respectively, and controls over the period 2002–2014 for the STOXX sample. BETA is the
firm’s systematic risk. Firm’s total risk (RSTD) is the annualized standard deviation from the daily stock
returns over the past year. Idiosyncratic risk (IR) is the standard deviation of the residuals derived from
the four-factor Carhart (1997) model. ESG is the average score of the three pillar scores corporate
governance performance (CGS), environmental performance (ENS), and social performance (SOS). All
variables are defined in Table 3. Year fixed effects are unreported. Robust and clustered (by firm)
standard errors are reported in parentheses. The p values are two-tailed. The symbols ***, **, and *
indicate significance at the 1, 5, and 10 % level, respectively
higher visibility among the public. Therefore, we assume that, due to market
expectations and public pressure, the urge for STOXX firms to react to higher
volatility by means of an improved governance mechanism is stronger than for non-
STOXX companies.
123
We removed financial firms9 from our data set because their capital and risk
requirements are heavily regulated and atypical. We then replicated our model. Our
untabulated results suggest no changes to our results for ESG and the three pillar
scores. Similar findings without finance firms suggest that our results are not driven
by characteristics of the finance industry.
In a final step, we restricted our analysis to firms that were continuously part of
the sample beginning in 2002. This robustness check aims to eliminate a potential
impact of increasing firm coverage in the Asset4 database over time and problems
associated with unbalanced panels (Wooldridge 2010). A look at the firm coverage
in the Asset4 database shows that the number of firms increases from about 350 in
2002 to 928 in 2013. Owing to missing values, we end up with a balanced panel of
203 firms per year in our regression model for BETA, 231 firms for the total risk
regression, and 247 firms in the case of idiosyncratic risk, respectively. The
untabulated results suggest that our findings were mainly unchanged in this smaller
sample. In detail, the effect of ESG on RSTD became slightly non-significant
(p = 0.11). Additionally, the negative effect of ENS was no longer significant in the
case of IR. Again, we can support the relevance of SOS. Social performance still
significantly decreased all three risk measures. These slight changes in significance
levels could be attributed to the much smaller sample size.
Through the robustness checks our results underline the decreasing impact of
social performance on all risk measures. However, our findings on the negative
impact of SOS on IR do not hold for the STOXX sample. In general, environmental
performance decreases idiosyncratic risk, whereas it has a negative effect on total
and systematic risk only in environmentally sensitive industries.
6 Conclusion
6.1 Summary
Prior research provides limited evidence on the relationship between CSP and firm
risk. Against this background, this study employs a large European panel dataset of
8752 firm-year observations covering the period of 2002–2014 to assess the impact
of CSP measured by ESG factors on firm risk. Three risk measures have been
applied: systematic, idiosyncratic, and total risk. We performed fixed effects
regressions with cluster-robust standard errors at the firm level and used a large set
of control variables. We found that the higher the aggregated ESG score, the lower
the total and idiosyncratic risk. Although an effective ESG risk-management
strategy might increase a company’s flexibility to deal with broad economic
downturns (Sharfman and Fernando 2008) and thereby lower a company’s
systematic risk, we assume that BETA is driven more by industry-specific than by
firm-specific characteristics and is therefore less responsive to the individual ESG
performance than our other risk measures. Turning to the three pillar scores of
9
All firms that are classified as banking (no. 44) and insurance firms (no. 45) according to the Fama and
French (1997) 48 industry classification were excluded.
123
corporate governance, environmental, and social performance, our results indicate

that social performance decreases total, systematic, and idiosyncratic risk. Given its
relevance, we assessed the impact of social performance toward the three
stakeholder groups of customers, society as a whole, and workforce in detail. A
high social performance in terms of society as a whole lowers systematic and total
risk; that is to say, a company’s management commitment and effectiveness
towards maintaining the company’s reputation within the general community by
being a good citizen, protecting public health, and respecting business ethics seems
to be a relevant factor. Social performance in regard to customers has only a
negative effect on idiosyncratic risk. Environmental performance generally
decreases idiosyncratic risk, whereas total risk and systematic risk are only
negatively affected in environmentally sensitive industries. However, in contrast to
H2, we were unable to detect any impact of corporate governance performance on
firm value. Focusing on STOXX firms, we even show a significantly positive
relationship between corporate governance performance and systematic risk.
Performing a Granger-causality test suggested a bidirectional relationship between
corporate governance and all three risk measures, whereas we detected a
unidirectional effect of social and environmental performance on firm risk.
Simultaneity might explain why the association between corporate governance
performance and firm risk is generally non-significant. Our results remained mostly
unchanged through a battery of robustness checks.
6.2 Discussion
The present research has important theoretical and practical implications for
(potential) investors, analysts, firms, their managers, and for (national)
policymakers.
From the investor perspective, our results suggest that the integration of ESG
factors into the overall firm strategy and operations reduces firm risk. This bolsters
the assumption that there is a business case to be made for CSR activities.
Accordingly, a higher CSP has the potential to increase shareholder value by means
of lower company risk and thereby lower costs of capital (Plumlee et al. 2015).
Social performance and, more specifically, those scores that are related to external
stakeholders (community, customers) seem to be the most relevant factors when it
comes to firm risk. These findings imply that high public visibility and its
concomitant potential to affect corporate reputation influence the impact of ESG
factors on firm risk. Investing in environmental performance is particularly fruitful
for companies that are engaged in environmentally sensitive industries. This is
plausible as those firms suffer especially from stakeholder pressure as well as
regulatory and reputational environmental risks. We cannot detect a significant
impact for corporate governance performance. Our non-significant coefficient could
be due to simultaneity problems in the model specification. Companies that suffer
from high firm risk might be under pressure to improve their corporate governance
123
(Bouslah et al. 2013). This relationship could bias the corporate governance
performance coefficient.
Our findings support the assumptions made by stakeholder theory (Freeman
2010) and risk management theory (Godfrey 2005) that predict a negative
relationship between CSP and firm risk. Supporting stakeholder theory, the risk
reducing impact of CSP might result from meeting the needs of the various
stakeholders, which in turn leads to less financial risks and therefore to lower
volatility of a firm’s stock in the capital market. From the perspective of risk
management theory, a high CSP has the potential to build up moral capital, which
motivates stakeholders to be more loyal to the company. These loyal stakeholders
might be less inclined to react overly sensitive to negative news, which also leads to
less financial risks and thereby less volatility and lower market risk measures for the
respective company. While our findings support both theories, our study design does
not enable us to draw clear conclusions as to which effect drives our results. Yet our
findings do suggest that management, on average, does not use investments in CSP
to the detriment of the firm, as predicted by managerial opportunism theory (Preston
and O’Bannon 1997).
We were specifically interested in the impact of CSP on firm risk in Europe
because the literature suggests that European companies are leaders in CSP
compared to companies in other geographical areas (Ho et al. 2012). Whereas
Bouslah et al. (2013) found mixed evidence of the impact of CSP indicators on firm
risk in the US, our research provides unequivocal evidence of the risk-reducing
impact of CSP in Europe. Apparently, CSP is more relevant among European firms,
and their environment rewards their CSP to a greater extent. This is in line with
Stellner et al. (2015), who showed that companies benefit from lower credit risk if
their relative ESG performance (above vs. below average) matches those of the
corresponding country (above vs. below average). They suggest that high ESG
performing companies are particularly able to reduce their credit risk in an
environment that rewards investments in CSR.
In regard to managerial implications, our results suggest that investing in social
performance as well as environmental performance among environmentally
sensitive firms has the potential to decrease risk. This value-enhancing impact of
CSP should be taken into account in shaping a firm’s organizational structure. For
instance, ESG factors should be integrated into a firm’s strategical and operational
risk and compliance management strategy. The inclusion of ESG factors into
compensation schemes could support their consideration and align management and
shareholder interests. Shareholders are able to encourage this by exercising their
rights during the shareholder meeting to determine a sustainable compensation
policy.
Our results suggest that responsible investing should generally reduce stock
performance risk (Harjoto and Jo 2015; Orlitzky and Benjamin 2001). Against this
background, disclosure on ESG factors offers relevant information for (potential)
investors and is thereby able to lower costs of capital (Dhaliwal et al. 2011). To
provide (potential) investors with relevant and reliable information, national or
123
supranational policymakers could increase disclosure regulation (e.g., by means of

mandatory CSR disclosure). Moreover, mandatory disclosure could encourage firms
to integrate ESG factors into their firm strategy and operations and thus stabilize
capital markets by lowering market fluctuations. The EU directive on mandatory
disclosure of non-financial information (European Commission 2013) could be a
first positive step in this direction.
6.3 Limitations and further research
We relied on ESG factors offered by the Thomson Reuters Asset4 database to

measure CSP. Asset4 has been widely used in prior research as well as for
investment purposes by major investment houses (Cheng et al. 2014; Eccles et al.
2015). Thomson Reuters (2015b) states that the database is created by 100
experienced analysts and that ‘‘every data point goes through a verification process,
including a series of data entry checks, automated quality rules and historical
comparisons.’’ We therefore have sufficient trust in the quality of the database.
However, it would be worthwhile to challenge the reliability of our findings with
other datasets. As other providers of ESG information have just started to collect
data on European firms, we leave this reliability test to future research.
The Granger causality test suggests a bidirectional relationship between
corporate governance performance and firm risk, which makes it difficult to assess
the impact of corporate governance performance on firm risk. Future research could
address this simultaneity problem, for instance, by means of event studies.
The present study is restricted to European companies. It might be fruitful to
investigate the relationship between ESG factors and market-based risk measures
(idiosyncratic, systematic, and total risk) in other settings. Since prior research has a
strong focus on US companies, it might be interesting to extend our European
research to other regions such as emerging markets and developing countries.
Despite these limitations, this research provides a comprehensive analysis of the
impact of ESG factors on firm risk by using a large European panel dataset. Our
findings underpin the economic importance of CSP and thereby provide—beyond a
philanthropic rationale—further motivation for the effective management of ESG
factors.
Acknowledgments The authors thank two anonymous reviewers for their valuable comments, which
have greatly improved the paper. We are also grateful to the session participants at the 3rd Risk
Governance Conference hosted by the University of Siegen and at the 3rd European Responsible
Investment & Institutions Conference hosted by the University of Hamburg for their helpful comments
and suggestions.
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Esg Factor On Firm Risk

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J Bus Econ (2016) 86:867–904

Impact of ESG factors on firm risk in Europe

Remmer Sassen1 • Anne-Kathrin Hinze1 •

Published online: 23 April 2016

& Remmer Sassen

Keywords Corporate social performance Corporate social responsibility

JEL Classification G32 M14

Non-financial performance and corporate social responsibility (CSR) in particular

3 Theoretical background and development of hypotheses

The European Commission defines CSR as ‘‘the responsibility of enterprises for

interest. The authors suppose that managers follow a so-called entrenchment

impact of the ESG dimensions on company risk to differ owing to industry-specific

4.1 Sample selection

2006 48 16 96 25 24 31 30 23 56 30 133 123 635

4.2 Dependent variables: risk measures

4.3 Independent variables: ESG measures

4.4 Control variables

dividend payment (DIV_1) as it could be interpreted as a signal for managements

Table 3 Definition of variables

We have tested the following relationship:

and environmental performance. We classified companies as engaged in an

5.1 Descriptive statistics

Table 4 Descriptive statistics

Panel A: risk measures

5.2 Regressions results

SOCU (8) –0.0003 –0.0345* –0.0106 0.5394* 0.1805* 0.5051* 0.6444* 1

(0.333) (0.334) (0.335) (0.124) (0.124) (0.124) (0.084) (0.083) (0.083)

related to lower total, systematic, and idiosyncratic risk. By contrast, a higher

CGS 0.072 0.073 0.006 0.006 0.003 0.003

ESGit ¼ c0 þ c1 ESGit1 þ c2 ESGit2 þ d1 FIRMRISKit1 þ d2 FIRMRISKit2 þ eit

Table 8 Granger causality test

estimates could be obtained by means of two-stage procedures that rely on

5.4 Additional tests and robustness checks

We conducted multiple checks to investigate the robustness of our findings. Prior

ESG 0.083 -0.039* -0.031**

corporate governance, environmental, and social performance, our results indicate

supranational policymakers could increase disclosure regulation (e.g., by means of

6.3 Limitations and further research

We relied on ESG factors offered by the Thomson Reuters Asset4 database to

Freeman RE (2010) Strategic management: a stakeholder approach. Cambridge University Press,

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