Impact of ESG factors on firm risk in Europe

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.

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Notes

  1. 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. 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.

  3. 3.

    Full Code LA4RGNEU in Asset4.

  4. 4.

    For the European market the values of the four factors are only provided on a monthly basis. To be able to run our regression on excess daily returns, we calculated daily factors by \( f_{d} = \sqrt[{21}]{{f_{m} + 1}} - 1 \) with f d for daily factor and f m for monthly factor on the basis of an average of 21 trading days (Ritter 1991; Spiess and Affleck-Graves 1995).

  5. 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.

  6. 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.

  7. 7.

    We thank one of the anonymous reviewers for this proposition.

  8. 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.

  9. 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.

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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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Correspondence to Remmer Sassen.

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Sassen, R., Hinze, A. & Hardeck, I. Impact of ESG factors on firm risk in Europe. J Bus Econ 86, 867–904 (2016). https://doi.org/10.1007/s11573-016-0819-3

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Keywords

  • Corporate social performance
  • Corporate social responsibility
  • ESG factors
  • Firm risk
  • Idiosyncratic risk
  • Systematic risk

JEL Classification

  • G32
  • M14