Impact of ESG Ratings on Brown Sector Firms’ Financial Performance

As we are witnessing a shift of paradigm from traditional economic growth towards sustainable development, backed by United Nation’s Sustainable Development Goals call to action, the concept of Environmental, Social and Governance (ESG) has been integrated in almost all aspects of the economy. Firms are probably the category of stakeholders towards the most expectations have been made for them to do better in terms of ESG. Significant scrutiny is being put on firms activating in traditionally emission-intensive sectors however, one cannot deny the aspect that the polluting sectors of economy have been the main pillar of economic growth since the industrial revolution. The current research aims at studying in what way the ESG performance of polluting firms is backed by improved financial performance and whether greening these firms leads to a trade-off or a win-win situation. By doing so, the paper aims at filling a gap in the existing literature as there is significant evidence concerning the relationship between ESG and financial performance in general, while a limited number of studies focus on firms activating in emission-intensive sectors. We perform the analysis using panel data regression models for a set of 138 firms registered across the European Union and over a period of 14 years. We look at financial performance from both a profitability and as well as market value perspective and the findings indicate that improvements in governance and social performance positively influence return on assets (ROA) and return on equity (ROE), while environmental performance, as well as the aggregated ESG score, has a limited impact, particularly in the case of Tobin’s Q. The study brings valuable insights to both business actors and policymakers by highlighting that the social and governance goals can be attained without sacrificing financial performance, while greening polluting firms may be perceived as burdensome and could imply financial trade-offs.