Journal of Global Responsibility

Does ESG performance have an impact on financial performance? Evidence from

Germany
Patrick Velte,
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Patrick Velte, (2017) "Does ESG performance have an impact on financial performance? Evidence
from Germany", Journal of Global Responsibility, https://doi.org/10.1108/JGR-11-2016-0029
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Impact on
Does ESG performance have an financial
impact on financial performance? performance

Evidence from Germany

Patrick Velte
Institute of Finance and Accounting, Leuphana University of Lueneburg,
Lueneberg, Germany

Abstract
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Purpose – The purpose of this paper is to concentrate on environmental, social and governance
performance (ESGP) in total and divided in each component and evaluate their impact on financial
performance (FINP).
Design/methodology/approach – The study covers a sample selection of companies listed on the
German Prime Standard (DAX30, TecDAX, MDAX) for the business years 2010-2014 (412 firm-year
observations). A correlation and regression analysis was carried out to evaluate possible links between ESGP
as determined by the Asset4 database of Thomson Reuters and accounting and market-based measures of
FINP (Return on Assets [ROA] and Tobin’s Q).
Findings – ESGP has a positive impact on ROA but no impact on Tobin’s Q. Furthermore, by analyzing the
three different components of ESGP, governance performance has the strongest impact on FINP in
comparison to environmental and social performance.
Originality/value – The analysis makes a key contribution to the empirical corporate social responsibility
(CSR) research as the author breaks down ESGP into their three components and include both accounting-based
and market-based FINP measures for the German setting for the first time. Not only companies but also regulators
and researchers are affected by the notion that CSR and FINP are close together and should be lead to a successful
stakeholder management.
Keywords ESG performance, Corporate social responsibility, Financial performance,
Stakeholder theory, Corporate governance, Stakeholder management
Paper type Research paper

Introduction
As a reaction of the financial crisis in 2008/2009 and the decreased trust of
stakeholders, the European Commission initiated several reform activities to enhance
the quality of corporate governance. The motivation was a change from a short-term
shareholder value policy to a more sustainable management strategy that includes the
interests of heterogeneous stakeholder groups (e.g. customers, employees). A successful
stakeholder management strategy should lead to better environmental, social and
governance performance (ESGP) and may be also connected with future financial
performance (FINP). ESGP represents:
[. . .] a business organization’s configuration of principles of [environmental,] social [and
governance] responsibility, processes of [environmental], social [and governance] responsiveness,
and politics, programs and observable outcomes as they relate to the firm’s societal relationships.
(Wood, 1991, p. 693)
Journal of Global Responsibility
FINP can be classified as “financial visibility, or the extent to which a company achieves its © Emerald Publishing Limited
2041-2568
economic goals”. (Price and Mueller, 1986, quoted by Orlitzky et al., 2003, p. 411). DOI 10.1108/JGR-11-2016-0029
 JGR From a research perspective, a great amount of empirical studies has analyzed the link
between ESGP and FINP (Allouche and Laroche, 2005; Ambec and Lanoie, 2008; Margolis
and Walsh, 2003; Orlitzky et al., 2003; Griffin and Mahon, 1997). Despite a majority of
studies indicating a positive link, some findings are contradictory, i.e. reporting negative or
non-significant results and different causal impacts (Margolis and Walsh, 2003; Orlitzky
et al., 2003). These heterogeneous results can be mainly explained by different variables of
ESGP and FINP (Wu, 2006). ESGP can be measured by a variety of different indicators, like
corporate social responsibility (CSR) reporting, CSR ratings or charitable givings. FINP
measures are divided into accounting-based variables (e.g. Return on Assets [ROA], Return
on Equity or market-based items [e.g. Tobin’s Q]). By estimating the mainly used regression
models, it is important to include time lags of at least one year between ESGP and FINP
(Scholtens, 2008). The impact of ESGP on FINP will not occur at once. Furthermore, the
models should include a cause-and-effect analysis because it is not clear whether ESGP is
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the determinant of FINP or vice versa (Scholtens, 2008). Finally, ESGP is an aggregate
measure that arises from many CSR activities. It is not clear whether some aspects will
mainly contribute to the CSR–FINP relationship.
Keeping this in mind, the aim of our analysis is to focus on the relationship between
ESGP in total and divided in their three main components on different measures of FINP for
a sample of German listing firms. To our best knowledge, the empirical study by Fischer
and Sawczyn (2013) is the only similar analysis in this research field. Our paper makes a
clear contribution to the existing literature in two ways. First, different from Fischer and
Sawczyn (2013), we are not only interested in the effect of ESGP on FINP in total. We will
reveal a deeper analysis on how the three components, the environmental, social and
governance (ESG) scores, will contribute to the ESGP–FINP link. Second, we integrated both
accounted-based (ROA) and market-based FINP variables (Tobin’s Q) in our model.
We choose Germany as the main representative of the two-tier system (management
board and supervisory board) which is special in the international corporate governance
context. Since the financial crisis 2008/2009, German-listed corporations are forced in many
regulatory ways to implement CSR aspects in their management strategy and their
reporting process, e.g. sustainable management compensation systems or sustainable
information in their management report. Furthermore, German-listed companies are very
active in voluntary CSR reporting in line with the German Sustainability Code or the
Guidelines of the Global Reporting Initiative (GRI). Finally, the integrated reporting
framework of the International Integrated Reporting Council (IIRC) has gained huge interest
by German group companies (Eccles and Krzus, 2010; Eccles and Serafeim, 2011; for a
current literature review, Velte and Stawinoga, 2016).
We include 412 firm-years observations for the business years 2010-2014 and
information from sustainability reports, integrated reports, status reports and annual
reports. These sample companies represent the biggest companies on the German Prime
standard of the Frankfurt Stock Exchange (DAX30, TecDAX, MDAX). We control for
company variables (e.g. firm size, firm risk, industry). According to multiple regressions, the
total ESGP score has a positive and significant impact on accounting-based FINP (ROA),
but not on market-based performance (Tobin’s Q). Furthermore, our findings indicate that
the governance score (GS) as one of the three items of ESGP has the strongest impact on
FINP.
Our paper is structured as follows. To begin with, we present the main theoretical
explanatory approach to the economic relevance of sustainable management, ESGP and
financial outcomes. This will be the starting point for deducting our hypothesis. The data
and methodology of the empirical analysis will imply the sample selection, the main
 variables and the regression model. The research results of the correlation and regression Impact on
analysis are focused then. A summary and the limitations of the study will follow. financial
performance
Theoretical foundation and hypothesis development
A number of theories substantiate the link between CSR management, performance and
financial outcomes, while most studies have a clear focus on the stakeholder theory
(Freeman, 1984). Stakeholder theory assumes that satisfying the interests of different
coalition partners with which the company (stakeholders) is tied up through a network of
various joint ventures will ultimately determine the success of products and services
(Freeman, 1984). As an opposite approach to the classical principal agent theory (Ross, 1973;
Jensen and Meckling, 1976), a company constitutes a subset of society which means that
generating value is in principle measured by the fulfillment of specific societal expectations.
It is crucial that management succeeds in reconciling a multitude of interests, so that the
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corporate goals of stakeholders regarding their (partly) conflicting demands have to be

prioritized. For these expectations on the part of stakeholders to be fulfilled constantly, a
sustainability management is required. Sustainability management activities also represent
an effective tool of stakeholder communication implying a positive connection between
stakeholder power, sustainable achievement as well as sustainability reporting (Roberts,
1992). As stakeholders are interested in sustainable strategies of the company, better ESG
reporting will lead to better CSR performance measures, like CSR ratings or reputational
aspects (Clarkson et al., 2008). As the final consequence, the company can also gain
increased FINP (e.g. on the stock market), as the increased stakeholder trust leads to better
(non) financial circumstances.
In total, the empirical studies that analyze the ESGP-FINP link indicate mixed and
contradictory results (Orlitzky et al., 2003). But the majority of these studies found a positive
relationship (Godfrey et al., 2009; Barnett and Salomon, 2006) in line with stakeholder (agent)
theory. Also, the results of meta-analyses (Wu, 2006) or literature reviews (Beurden and
Goessling, 2008; Margolis and Walsh, 2003) come to this positive result. According to
stakeholder (agent) theory and former empirical research results, we assume that ESGP is
positively related with FINP. Splitting the ESGP into its three components, the
environmental, social and the governance performance scores, both theory and former
studies do not stress so far that one ESG component has a stronger contribution to the
positive impact on FINP. Insofar our hypothesis states:
H1. ESGP will lead to better FINP.

Data and methodology

Sample selection
We chose companies listed on the German Prime Standard (DAX30, TecDAX, MDAX) as
the sample for our empirical analysis. The intention was to evaluate the reaction of these
companies to the decreased trust after the financial crisis 2008/2009 with regard to the
implementation of a stakeholder management approach and a CSR strategy. The German
legislator introduced mandatory CSR management board compensation for listed
companies as from the business year 2010, insofar the management incentives for
stipulating a CSR management tool are increased. Furthermore, during the last years, the
awareness of an external CSR reporting is extremely high in Germany. Insofar, our research
focus are the business years 2010-2014. The companies in the sample are connected with the
strictest transparency and disclosure rules on the German capital market, so that we expect
an adequate CSR communication. Analyzing these aspects could have a signaling effect for
 JGR other listed companies in Germany because CSR management and performance is also
relevant for them. Insofar, our analysis is contributable for researchers, regulators and
practice. We left out companies from the financial industry due to their specific regulations
in comparison to other sectors and companies. Table I provides an overview of the final
sample of 412 firm years-observations.

Main variables
Data on corporate governance and CSR were hand collected from sustainability reports,
integrated reports, status reports and annual reports. Our independent variable ESGP is a
proxy for ESGP performance. ESGP was collected by the Thomson Reuters Datastream
database in the category ESG – Asset4 for the business years 2010, 2011, 2012, 2013 and 2014.
ESGP measures from Asset4 are updated every two weeks. We used Datastream ESG data
collected in May 2016. The total ESG score can be classified as an aggregated value of CSR
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performance in many environmental, social and governmental items, e.g. employment quality,
health and safety, training and development, human rights, community. Each item is divided
into a set of key performance indicators (KPIs), for example, work-life balance or training hours.
The overall ESG score implies an equal weighting of all relevant data points, z-scoring and
comparing them with the data points of all other companies to obtain a relative measure of
performance expressed as a percentage ranging from 0 to 100 per cent (a z-score is a relative
measure indicating the value in numbers of standard deviation of a given observation from the
mean value of all other observations) (Asset4 ESG data glossary, 2015). As we also analyze the
impact of the three components of the ESGP score separately, we define the environmental
score (ENS) as environmental performance, the social score (SOS) as social performance and
the GS as governance performance, all obtained from Asset4.
Our dependent variables ROA and Tobin’s Q are proxies for FINP. We decided to integrate
both accounting (ROA) and market-based measures (Tobin’s Q) of FINP in line with the
suggestions in current literature (Choi and Wang, 2009). In this connection, we make a fruitful
contribution to the first German study by Fischer and Sawczyn (2013), who concentrates on
accounting-based measurements (ROA). ROA is a most famous accounting-based variable of
FINP, representing the profitability of the company in relation to its total assets. As the
accounting-based variables are often influenced by earnings management decisions, market
based-items are necessary and are additionally included in many empirical studies (Choi and
Wang, 2009). Tobin’s Q is the ratio between a physical asset’s market value and its replacement
value. It has become common practice in the finance and accounting literature to measure the
ratio by comparing the market value of the firm’s equity and liabilities with its corresponding
book values, as the replacement values of a company’s assets are hard to evaluate (Choi and
Wang, 2009). To evaluate the impact of ESGP on FINP, we use the one-year lagged variables of
ROA and Tobin’s Q in line with the statements in the literature, that ESGP will not
immediately lead to better FINP (Choi and Wang, 2009). Insofar, we compare the ESGP scores
of the year t with the FINP variables of the year t þ 1, starting from 2011 to 2015. Firm-level
data on ROA and Tobin’s Q and additional variables (as controls) for the years 2010-2015 were
collected from Thomson Financial Datastream.

Sample selection 2010 2011 2012 2013 2014

Listed companies on the German prime standard (DAX30, TecDAX, MDAX) 110 110 110 110 110
Table I. Financial institutions and missing company data 25 29 30 27 21
Survey sample Final sample 85 81 80 83 83
 We include several control variables commonly used in this research area (Fischer and Impact on
Sawczyn, 2013; Choi and Wang, 2009). R&D represents the technological knowledge as the financial
research and development (R&D) intensity. The data were generated from the R&D
expenses in the financial statements. In line with former studies, we expect a positive result
performance
(Kogut and Zander, 1992). We also include firm risk in our analysis with a systematic and an
unsystematic risk measure. We use the beta factor (BETA) as a proxy measure for
systematic risk and the ratio of total debt to total assets (DEBT) as a proxy for unsystematic
risk (Fischer and Sawczyn, 2013). Literature states that firm risk is associated with
stakeholder relations and FINP (Waddock and Graves, 1997). Firms with an increased level
of ESGP are perceived as less risky with regard to “insurance effects” and will be connected
with lower costs of debt capital (Orlitzky and Benjamin, 2001; Godfrey et al., 2009). In
addition, we include firm size (SIZE), measured by the natural logarithm of total assets,
because large size often brings economies of scale or scope, which may be difficult to imitate
(Roberts and Dowling, 2002). Prior studies found that firm size can be related to the extent to
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stakeholders’ interests about the CSR activities of the firm. The direction of the relationship
between firm size, CSR performance and FINP can be both negative or positive. Finally, we
integrate the branch of industry as control variable because the extent of stakeholder
management and performance may be different in several industries. The variable IND was
determined by a four-digit numeric standard industrial classification code as a dummy for
manufacturing and services (Fischer and Sawczyn, 2013).
We hypothesize a positive impact of ESGP on accounting-based and market-based
variables of FINP. Furthermore, we analyze which of the three components of ESGP
separately better contributes to FINP. A summary of the respected variables is included in
Table II.

Dependent variables Explanation

ROA Return on Assets ¼ Net income before preferred dividends þ

ðinterest expense on debt – interest capitalizedÞ  ð1  tax rateÞ
average of last year’s and current year’s total assets
Tobin’s Q Market value of equity and liabilities
Book value of equity and liabilities
Independent variables Explanation
ESGP Environmental, social and governance performance score collected by the Asset4
database by Thomson Reuters
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
GS 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
Control variables Explanation
R&D R&D expenses reported in the financial statement (R&D intensity)
Beta Beta factor (systematic firm risk)
Debt Total debt/total assets (unsystematic firm risk) Table II.
SIZE Natural logarithm of total assets (firm size) Variables of the
IND Dummy variable for (1) manufacturing and (2) services (branch of industry) study
 JGR Regression model
The study evaluates whether ESGP has a positive impact on FINP. FINP was separated into
ROA and Tobin’s Q. The assumptions of regression (linearity, homoscedasticity of residue,
normal distribution of error term, multicollinearity) in accordance with the approach of Hair
et al. (2009) were tested. We apply regression statistics in STATA 13. The following
regression equation applies for the total ESGP:
FINP ð ROA; Tobin’s QÞ ¼ a þ b 1 ESGP þ b 2 R&D þ b 3 BETA þ b 4 DEBT þ b 5 SIZE
þ b 6 IND þ «

Research results
Descriptive statistics
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Table III provides an overview of the descriptive statistics for the ESGP measures (panel A),
the FINP variables (panel B) and the control variables (panel C).
The ESGP scores in panel A range from 0 to 1. The mean (median) scores in our sample are
0.566 (0.606) for total ESGP, 0.498 (0.510) for GS, 0.589 (0.689) for ENS and 0.612 (0.621) for SOS.
Insofar, SOS and ENS scores are higher in comparison to GS. Furthermore, FINP measures
indicate a mean (median) of 0.057 (0.051) for ROA and 2.121 (1.879) for Tobin’s Q. Descriptive
statistics for our control variables are presented in panel C with a mean (median) of 0.736 (0.719)
for BETA, 0.423 (0.652) for DEBT, 329 (310) for R&D and 15.121 (15.534) for SIZE.

Correlation results
Table IV presents the Pearson correlation matrix for the dependent, independent and the
control variables. It is not surprising, that GS, ENS and SOS as components of ESGP are
positively significantly linked to each other. As supposed, BETA and DEBT are negatively
significantly correlated with ROA and Tobin’s Q. In opposite to this, the correlations
between the firm risk variables and ESGP are not significant. Giving the correlation of some
of the variables, we calculated variance inflation factors (VIF) to test for multicollinearity. If
the VIF is higher than 10, severe multicollinearity problems might occur. However, in our
data, no VIF exceeds 3.12; insofar multicollinearity should not affect our results.

Variable Mean Median SD Minimum Maximum

Panel A: ESG performance

ESGP 0.566 0.606 0.231 0.041 0.968
GS 0.498 0.510 0.212 0.032 0.921
ENS 0.589 0.689 0.256 0.048 0.954
SOS 0.612 0.621 0.281 0.032 0.983
Panel B: Financial performance
ROA 0.057 0.051 0.079 0.164 0.343
Tobin’s Q 2.121 1.879 2.121 0.432 9.233
Panel C: control variables
BETA 0.736 0.719 0.328 0.321 2.978
DEBT 0.423 0.652 0.298 0.213 0.869
IND 0 0 0.5 0 1
Table III. R&D (in mio. e) 329 310 46.98 32 601
Descriptive statistics SIZE 15.121 15.534 1.121 11.545 20.012
 Variables ROA Tobin’s Q ESGP GS ENS SOS BETA DEBT IND R&D SIZE
Impact on
financial
ROA 1 performance
Tobin’s Q 0.323* 1
ESGP 0.079 0.101 1
GS 0.021 0.048 0.656* 1
ENS 0.096 0.088 0.729* 0.414* 1
SOS 0.195 0.154 0.549* 0.392* 0.311* 1
BETA 0.182* 0.242* 0.365 0.241 0.264 0.219 1
DEBT 0.212* 0.455* 0.221 0.224 0.171 0.222 0.350 1
IND 0.260 0.082 0.223 0.122 0.371 0.153 0.0323 0.191 1
R&D 0.254* 0.222 0.314 0.129 0.212* 0.190 0.410 0.222 0.312 1
SIZE 0.212 0.433 0.214 0.123 0.298 0.032 0.212 0.021 0.211 0.242 1

Note: This table represents the correlation coefficients between the ESGP, FINP and control variables Table IV.
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for the whole sample. The variables are defined in Table III. * indicate significance at the 5% level (p < Pearson correlation
0.05) matrix

Regression results
Table V provides the results of the multivariate regression analysis. Both the total ESGP
and the three components GS, ENS and SOS are positively and significantly related to ROA
as accounting-based variable of FINP. Further analysis indicates that the impact of GS on
ROA is stronger than the other two components of ESGP. With regard to Tobin’s Q as the
market-based measure of FINP, we postulate a nonsignificant positive link. Insofar, our
results only partly support our main hypothesis. Interestingly, there is a strong negative and
significant relationship between the two measures of firm risk (BETA and DEBT) and
ESGP, GS, ENS and SOS. Insofar an increased (un)systematic firm risk will lead to lower
sustainability performance scores. Furthermore, we find that SIZE is positively related to

Variables ESGP GS ENS SOS

ROA 0.049* (0.012) 0.032** (0.010) 0.030* (0.010) 0.042* (0.013)

Tobin’s Q 0.104 (0.015) 0.078 (0.042) 0.063 (0.086) 0.121 (0.016)
BETA 0.007** (0.003) 0.008** (0.003) 0.005** (0.001) 0.010** (0.005)
DEBT 0.014** (0.004) 0.015** (0.005) 0.010** (0.001) 0.010** (0.001)
IND 0.000 (0.027) 0.000 (0.027) 0.010 (0.056) 0.009 (0.046)
R&D 0.101 (0.014) 0.151 (0.019) 0.144 (0.013) 0.129 (0.012)
SIZE 0.013** (0.003) 0.010** (0.006) 0.015** (0.009) 0.020** (0.012)
R2 (adj.) 0.217 0.191 0.183 0.189
Observations 412 412 412 412

Notes: This table presents results from fixed-effects regressions of the ESGP measures on FINP (ROA and
Tobin’s Q) and controls over the period 2010-2014 for the whole sample. Return on Assets (ROA)
and Tobin’s Q are the dependent financial performance measures. ESG is the environmental, social and
governance performance score collected by the Asset4 database by Thomson Reuters. ENS is the
environmental performance score, SOS the social performance score and GS the governance performance
score as the three components of the ESG score. ESG, ENS, SOS and GS are the independent CSR
performance variables. R&D presents the R&D expenses, beta is the beta factor (systematic firm risk), debt
the ratio between total debt and total assets (unsystematic firm risk), SIZE the natural logarithm of total
assets (firm size) and IND a dummy variable for the branch of industry (manufacturing or services) as
control variables. Robust and clustered (by firm) standard errors are reported in parentheses. The p values Table V.
are two-tailed. The symbols ** and * indicate significance at the 5% and 10% level, respectively Regression analysis
 JGR ESGP in total and to all components. The results of the regression analysis are presented in
Table V.

Summary and limitations

Our empirical study concentrates on the impact of ESGP on one-year lagged FINP on the
German prime standard (DAX30, TecDAX and MDAX). To our best knowledge, it is the
first empirical study for the German capital market with a deeper analysis of ESGP scores
and different FINP measures. The analysis comprises 412 firm-years observations covering
the business years 2010-2014 and states that ESGP in total and the three components, the
environmental, social and the governance performance scores separately, have a positive
impact on accounting-based FINP (ROA). Further analysis indicates that governance
performance has the strongest impact on FINP in comparison to environmental and social
aspects. One possible explanation for this result could be the longer tradition of corporate
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governance reporting in Germany since the introduction of the Code 2002 or the increased
value relevance for the stakeholders. Surprisingly, there is no significant impact of ESGP on
market-based FINP (Tobin’s Q).
Our results are most relevant for researchers, regulators and practice to strengthen the
incentives for establishing and increasing the stakeholder management tools in CSR
activities. In this context, the connection between financial and non-financial KPIs becomes
extremely important as it is currently strengthened with the integrated reporting by the
IIRC and the implementation of sustainability balanced scorecards. We expect an increased
research activity for the European capital market in the following years as the last
regulations since the financial crisis 2008/2009 aim to increase the CSR awareness of public
interest entities. Consequently, CSR reporting can be classified as a key complement to
classical financial reporting and will be more and more standardized (e.g. by the GRI
Guidelines). A successful stakeholder management will only lead to better CSR performance
and afterward to increased FINP, if non-financial reporting is not any longer seen as a
marketing tool (“green washing”), but as an objective and reliable information tool. We
encourage researchers to connect corporate governance variables with the ESGP-FINP
relationship, e.g. the connection between sustainable management compensation on ESGP
and FINP.
Finally, we stress the limitations of our study. As we only cover a small period (2010-
2014), it offers limited insights as regulatory changes of increased stakeholder management
incentives after the financial crisis 2008/2009 are only likely to be apparent in the case of
long-term studies. In addition, the study is limited to the analysis of the ESGP of Asset4.
The assessment is not free of subjective influences, which decreases the validity of our
results. But this restriction can also be transferred to other common used variables, e.g. own
CSR disclosure scores by content analysis of CSR reports. Insofar, future research activities
should dwell on alternative and innovative measures of ESGP.

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Downloaded by Australian Catholic University At 06:45 13 June 2017 (PT)

Orlitzky, M., Siegel, D. and Waldman, D.A. (2011), “Strategic corporate social responsibility and
environmental sustainability”, Business & Society, Vol. 50 No. 1, pp. 6-27.

Corresponding author
Patrick Velte can be contacted at: velte@leuphana.de

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