1. Introduction
It is widely known that corporate social responsibility (CSR) plays a vital role in enhancing corporate sustainability and improving reputation [
1]. More recently, huge amounts of attention have been paid, especially in emerging markets, to how a firm discloses CSR practices in its financial reports in a way that impresses the firm’s stakeholders [
2]. More importantly, it is a major interest of any firm to attract foreign investment, as this is a key indicator of enhanced competitive advantages amongst peer firms. Good CSR disclosure can also reflect good corporate governance practices, which may distinguish a firm from others. The fundamental concept of CSR is to enhance a firm’s concern of environmental, social, and even governance aspects, and these efforts are considered by top management departing from well-known financial actions motivated solely by achieving firm profitability [
3]. In Saudi Arabia, a key developing economy in a region that has improved rapidly in the last five years, most large firms reference CSR in their annual reports. This is not only to adhere to corporate governance policies but also to satisfy the various needs of stakeholders including shareholders, investors, employees, and the wider community.
The rising interest in CSR in Saudi firms follows the introduction of the Saudi Vision 2030 in 2016, which pays significant attention to social responsibility and its practices in the local community. Additionally, the improvement in corporate governance in the same vision plays a role in motivating Saudi firms to start publishing their CSR and other initiatives that help different parties in the Saudi community. The CSR strategy was launched in 2020 and aimed at promoting corporate social responsibility, which is a part of the national transformation program in the Ministry of Human Resources and Social Development. The strategy includes analyzing the reality of corporate social responsibility in the Kingdom and conducting a standard comparison of the international best practices in the field. Its vision was to establish a culture of social responsibility in all developing sectors to enhance corporate contributions to social responsibility programs, which have a vital impact on the development of the local society, environment, and whole economy. This strategy also aims to establish a social responsibility infrastructure by activating social responsibility capabilities represented by six pillars: partnerships and governance, laws and regulations, national planning, motivation and encouragement, awareness and capacity development, and monitoring and measurement.
The concentration on CSR in Saudi Arabia comes from its vision and reforms applied to various aspects of the economy to open it to the global economy and host foreign investment, which is believed to boost the local economy and sustainability [
4]. Even though the institutionalization of CSR in Saudi firms is still growing, most firms have followed these orientations since 2016 and confirm that they are willing to enhance CSR practices and show them in their annual reports. However, it is difficult to predict the determinants of CSR disclosure in Saudi firms. Additionally, foreign investment rules are also being modified to allow more foreign equity to enter the Saudi stock market, either in the form of individual investors or via direct investment by large foreign corporations. Hence, the rise of foreign investment witnessed recently could be explained by the disclosure of CSR by Saudi firms, which researchers have not yet examined in this field.
However, prior research discusses the difficulties for foreign investors when deciding to invest in a host country [
1,
5]. This is mainly due to uncertainty and information asymmetry that could be increased in the case of foreign investment. Hence, corporations that put more emphasis on enhancing ESG performance could reduce the level of uncertainty and improve trustworthiness [
6]. Accordingly, and based on the Stakeholder theory, a firm should facilitate all its stakeholders’ needs [
7]. This can be achieved by improving the level of disclosure and increasing its accountability towards those stakeholders. As a result, these actions will also build a solid and trustworthy relationship between the host firm and foreign investors [
8]. Legitimacy theory also provides a theoretical framework that could explain this relationship. That is, firms that improve their ESG performance in various ways following global CSR standards may seem more legitimate and trustworthy to foreign investors [
9]. Improving corporate governance is another benchmark for foreign investors who wish to see that their host firm is adopting good corporate governance schemes that alleviate its legitimacy and trustworthiness.
This research aims to examine whether ESG performance and CG can attract foreign investment as key indicators of good performance and sustainability. This research contributes to the existing literature on CSR. Although the empirical literature on CSR is rapidly growing, it still provides inconsistent findings when explaining the rationale of the relationship between CSR and foreign investment. This may be justified by the presence of too many proxies that could affect these types of relationships. This research adopts two critical theories that may clarify the association between improving ESG performance as a tool of CSR and the magnitude of foreign investment. Furthermore, most prior literature is limited to foreign direct investment (FDI) and its impact on CSR [
10,
11,
12,
13,
14]. However, regardless of the economic importance of FDI for corporations and countries, the literature neglects the importance of attracting individual foreign investors who can improve the governance practices of the stock market and increase liquidity [
15]. This research aims to provide empirical findings that justify why ESG performance is important for foreign investors.
Given the nature of Saudi Arabia and the recent global focus on the significant reform of its economy, which is one of the fastest-growing economies in the region, this research was conducted on Saudi firms for two reasons. First, the notable reforms in CSR that have been witnessed amongst Saudi firms in the last five years could be crucial and informative if they are investigated alongside the growth in foreign investment. Second, the parallel improvement in corporate governance in Saudi Arabia can be linked to the increase in foreign investment percentage, which jumped by 150% in 2021 compared to 2018. Taken together, theoretically and empirically, this research is expected to fill the gap in the literature on CSR, CG, and foreign investment, especially in emerging markets.
The rest of the study is organized as follows. The next section illustrates the theoretical and empirical literature on the relationship between CSR, CG, corporate performance, and foreign investment. This also includes a discussion of hypotheses development.
Section 3 presents the sample and methodology, followed by regression results and a discussion in
Section 4. The final section summarizes the research conclusions, implications, and limitations.
3. Sample and Methodology
The initial sample included 184 listed firms in the Saudi stock market (Tadawul). Due to the exclusion of firms that suffer from insufficient data either in foreign ownership or CSR score, the final sample covered 110 firms from different industries, including financial firms from 2017 to 2021, with around 550 firm-year observations. With respect to data sources, financial data, corporate governance data, and foreign ownership data were collected from the Saudi stock market (Tadawul), the sample was built using the data of Alregab [
4], and we expanded the period to cover the latest years. Data for ESG performance were gathered from the CSRhub database, which has been ranked among the top five sustainability ratings in the world [
73,
74,
75].
To test the research hypotheses, a regression analysis was employed for all models using both OLS and System-GMM estimation, and the study uses pooled OLS to identify the initial relationship between the dependent variable and explanatory variables. However, it is known that OLS may present incorrect results, especially in the types of relationships that may show endogeneity [
76]. Hence, the use of the System-GMM estimator was mainly for accommodating the expected endogeneity in regression models by employing instruments and lagged variables. The main model was tested based on the following formula [
1]:
where:
: Foreign ownership of firm i for year t;
: The lag of FO for one period of time;
: The lag of corporate social responsibility score of firm i for year t;
: governance variables, including ownership structure (OS) of firm i for year t, board independence (BI) of firm i for year t, and executive pay (EP) of firm i for year t;
: The logarithm of return on equity (LogROE), firm age (AGE), firm size (Ln SIZE), and leverage (LEV).
The CSR variable is broken further into three variables to be tested individually, as shown in the hypotheses. The first is social CSR (Soc CSR). The second is environmental CSR (Env CSR). The third is governance CSR (Gov CSR). Additionally, the logarithm of some variables was applied because of the skewness of the variable. The definitions of all variables are presented in
Table 1.
5. Conclusions
Based on theories of CSR, this study aims to investigate the effect of ESG performance on foreign investors in conjunction with corporate governance indicators. It is argued that firms with more social and environmental action disclosure enjoy better performance and sustainability. Additionally, corporate governance is one of the corporate social responsibility pillars that could improve a firm’s performance and attract more foreign investment. Given that the existing literature does not provide consistent findings—especially in terms of CSR and foreign investment association, as well as emerging markets where investor protection is not well-regulated—this study provides new evidence from Saudi Arabia, which is one of the leading economies in the region and which has witnessed considerable reform in recent years. By undertaking an empirical examination of a sample of 110 firms from Saudi Arabia, this study analyses ESG performance as a total and breaks it down further to include three sub-scores according to the three main indicators of CSR: social, environmental, and governance. This study employs two tests to regress the effect of ESG performance and corporate governance on foreign ownership. Pooled OLS is used to present the initial relationship. Additionally, System-GMM is employed to test this relationship and solve for the expected endogeneity that could appear in these types of regression analyses.
The findings indicate that, in general, the ESG score can predict foreign investment; this includes all CSR variables. That is, on the one hand, superior ESG performance is noted by foreign investors who need to see trustworthy signals that help them to decide whether to invest or not. On the other hand, firms are required to pay more attention to their ESG performance and to satisfy their current or potential investors. This is supported by both stakeholder theory and legitimacy theory. Additionally, the governance score shows the highest positive association in terms of its significance level, indicating that corporate governance practices are more important for foreign investors. These results suggest that firms that show good governance scores may attract extra foreign equity. The findings also reveal that foreign investment positively correlates with ownership concentration and board independence. Additionally, the size of the firm and its profit are positively associated with the magnitude of foreign investors. This may indicate that large firms that show high profitability tend to pay more attention to CSR and CG, thus attracting foreign investors who trust these large corporations.
Research findings have several implications that could be considered by corporations, policymakers, and researchers in this field. First, in countries similar to Saudi Arabia (e.g., the Gulf area, the Middle East and North Africa, MENA), where CSR is still growing and improving, further policies and regulations are needed to follow the global schemes. Second, the consistency of CSR standards and disclosure is considered inevitable at this stage, especially in these emerging economies. Third, firms must concentrate on other non-financial activities, which are a priority in the new economy.
This research has several limitations that could inspire future research. First, this research is limited to one country. Further research could be conducted in the Gulf area and MENA region. Second, research data is relatively restricted by the availability of information for each firm in the sample. Expanding the dataset may provide more robust findings. Third, it is recommended to include additional proxy variables to the regression model testing these overlapping relationships. Finally, a comparative study between countries in the MENA region could provide additional information.