Embedding sustainability in risk management: The impact of environmental, social, and governance ratings on corporate financial risk

Abstract

This study investigates the effect of corporate social and environmental evaluation on investors' risk perception to explore the potential market risk for public companies that adopt a sustainable and responsible corporate strategy. We referred to the triple corporate assessment according to environmental, social, and governance (ESG) criteria to check whether ESG factors-meant to direct firms toward social and environmental needs-improve corporate market performance or trigger, among investors, a perception of "window dressing." In doing so, we tested the impact of corporate social performance-proxied by an ESG assessment-on corporate financial risk using double risk measurement. We conducted a five-year longitudinal study (fiscal years 2014-2018) of 222 companies listed on the Standard & Poor's index. The empirical findings show higher investor uncertainty regarding corporate sustainability performance, probably due to the misalignment of objectives between investors and investees. Indeed, an overall ESG assessment corresponds to higher systematic risk for firms, and a corporate environmental rating has an upward effect on the same risk dimension.

ESG – A New Global Trend. Examples for Austria, Poland, and Romania

“…Non-financial reporting and ESG are considered fundamental to foster the transition to a sustainable global economy as they combine long-term profitability with environmental protection and social justice (Landi et al, 2022). Whether or not companies decide to incorporate it into their business model may influence, i.e.…”

“…It promotes the principles of sustainable development in the business environment. Nevertheless, due to growing environmental challenges, like for instance the climate crisis, CSR proved not to be effective enough (Landi et al, 2022). It was also observed that some enterprises, instead of making real use of its potential to stimulate a transition towards a more sustainable business, used CSR as a pure strategy to improve the company's image among their clients and potential investors (PwC, 2021).…”

“…Years later, this development proved to be insufficient, so nowadays a broader term called ESG is gaining importance (Landi et al, 2022). Environmental, social and corporate governance are the new criteria, which stand for a range of aspects that modern businesses should pay attention to.…”

impact of ESG strategies integration on the operational and reputational risks

“…The importance of the data stems from its being necessary and from its contribution in supporting management in general, as the management of companies needs extensive, appropriate and timely data for its operations around the world. This data can also contribute to making appropriate adjustments to business plans so that companies are able to know the surrounding environment and improve the process of responding to it proactively (Landi et al, 2022). Furthermore, this data leads to developing more accurate and realistic estimates for management and allows it to obtain more accurate information to deal with the results to meet or to exceed the desire of customers in the markets naturally (Zumente & Bistrova, 2021).…”

Leverage Structure Dynamics and Firm Value

“…To thrive in this competitive and global economy, a firm must design an optimal leverage structure that generates a positive change in firm value. The leverage structure affects the cost of financing, thereby impacting the stock's market price (Landi et al, 2022). The comprehensive relationship between leverage structure and firm value has been recognized, but the relationship may vary in signs and traits depending on the development of financial system and corporate governance practices in a country (Uddin et al, 2019).…”