Environmental, Social, and Governance (ESG) Scores and Firm Profitability Across Countries and Sectors: An Empirical Analysis

Abstract

This paper explores the relationship between a firm's Environmental, Social, and Governance (ESG) score, and its profitability across sectors and countries. More specifically, this work aims to understand if European and Asian firms see a greater or lesser effect of ESG Score on profits relative to firms in the United States. This work also explores whether certain componentsof the ESG scores (environmental, social, or governance) have a more significant impact on profitability inspecific sectors. Using ESG score and firm financial data from Thomson Reuter's Eikon and control variables for firm size, risk, and industry, a three-part analysis was run. An initial analysis of the ESG combined score and the individual pillar scores and gross profit relationship is conducted using OLS regression and time and firm fixed effects regression analysis. Next, to understand how geographic region plays a role in the correlation between firm ESG score and financial performance, OLS regressions are run using regional dummy variables and interaction terms between regional dummy variables and ESG score. Lastly, this thesis explores how the ESG score-gross profit relationship varies across industries using interaction terms between the industry dummy variable for each industry with the ESG score variable. The results suggest a positive relationship between ESG score and gross profit, with varying effects for different pillars. The most significant effect was on the environmental pillar. The results also show that European firms see a greater correlation between financial performance and higher ESG scores than United States firms. The analysis of Asian firms did not show a more significant relationship between financial performance and higher ESG scores compared to the United States. Across sectors, results varied. This suggests a clear direction for future research in understanding the relationship between more disaggregated industrial categories and different components of the ESG score. This thesis offers new insights into regional and cross-sector differences in the effect of both combined ESG score and the individual ESG pillar scores.