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The Moderating Role of Worldwide Governance Indicators on ESG–Firm Performance Relationship: Evidence from Europe

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  • Rezart Demiraj

    (College of Business Administration, American University of the Middle East, Egaila 54200, Kuwait)

  • Enida Demiraj

    (College of Business Administration, American University of the Middle East, Egaila 54200, Kuwait
    Department of Business Administration, American College of the Middle East, Egaila 54200, Kuwait)

  • Suzan Dsouza

    (College of Business Administration, American University of the Middle East, Egaila 54200, Kuwait)

Abstract

Engaging in Environmental, Social, and Governance (ESG) activities entails costs that influence a firm’s financial and market performance. However, it is expected that the long-term benefits of ESG engagement outweigh these costs, leading to superior performance. Despite extensive research on the ESG–performance relationship, findings remain mixed. This study examines the moderating effect of country governance, measured by the Worldwide Governance Indicators (WGIs), on the relationship between firms’ ESG scores and their financial and market performance in the European context. Using a two-stage least squares (2SLS) regression model and a dataset spanning 12 years (2011–2022) for 2083 listed European firms, we find that WGI significantly moderates the ESG–performance relationship. Our results indicate that ESG engagement alone has a negative impact on financial performance (ROA), suggesting that the costs associated with ESG investments often outweigh their short-term benefits. However, strong governance structures mitigate these costs, transforming ESG investments into value-enhancing activities. Conversely, ESG engagement positively influences market performance (Tobin’s Q), signaling long-term value to investors. Yet, in jurisdictions with strong governance frameworks, this effect diminishes, as ESG compliance becomes a baseline expectation rather than a differentiating factor.

Suggested Citation

  • Rezart Demiraj & Enida Demiraj & Suzan Dsouza, 2025. "The Moderating Role of Worldwide Governance Indicators on ESG–Firm Performance Relationship: Evidence from Europe," JRFM, MDPI, vol. 18(4), pages 1-19, April.
    • Handle: RePEc:gam:jjrfmx:v:18:y:2025:i:4:p:213-:d:1634437
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    References listed on IDEAS

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    1. Zhonghuan Luo & Yujia Li & Luu Thi Nguyen & Irfan Jo & Jing Zhao, 2024. "The Moderating Role of Country Governance in the Link between ESG and Financial Performance: A Study of Listed Companies in 58 Countries," Sustainability, MDPI, vol. 16(13), pages 1-18, June.
    2. Houshang Habibniya & Suzan Dsouza & Mustafa Raza Rabbani & Nishad Nawaz & Rezart Demiraj, 2022. "Impact of Capital Structure on Profitability: Panel Data Evidence of the Telecom Industry in the United States," Risks, MDPI, vol. 10(8), pages 1-19, August.
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    5. Sadok El Ghoul & Omrane Guedhami & Yongtae Kim, 2017. "Country-level institutions, firm value, and the role of corporate social responsibility initiatives," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 48(3), pages 360-385, April.
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