The Moderating Role of Country Governance in the Link between ESG and Financial Performance: A Study of Listed Companies in 58 Countries

Abstract

Corporate environmental, social, and governance (ESG) performance is expected to positively affect financial performance because it helps firms gain sociopolitical legitimacy from receiving positive stakeholder awareness and gaining key resources. However, the research on the relationship between corporate ESG performance and financial performance has yielded mixed results. This paper explores the impact of the country governance environment on the ESG–financial performance link. We propose that the positive ESG–financial performance relationship is stronger for firms in countries with better governance. Empirical analyses using a large panel dataset covering 11 years and 58 countries support our arguments. We found that countries with more effective governance in political stability, regulatory quality, and control of corruption strengthen the positive ESG–financial performance relationship. The implications of our findings are significant for firms that face different governance environments and develop sustainable business strategies.

1. Introduction

Established studies highlight the important roles of corporate environmental, social, and governance in today’s businesses [1,2,3]. As an integrated concept, corporate environmental, social, and governance (ESG) represents “how corporations and investors integrate environmental, social, and governance concerns into their business models” [2,4]. Some studies argue that ESG is becoming a “business imperative” for business firms [1], which may contribute to the financial performance of focal firms [5]. Other scholars take a broader perspective and argue that focal firms have to adhere to sound corporate governance principles and environmental practices in order to address corporate financial performance as well as corporate social performance [3,6].

Although previous research highlights the importance of ESG on a firm’s financial performance and social performance, more recent studies call for more investigation into the potential correlation between corporate ESG performance and financial performance [7,8], which has failed to reach a consensus. For instance, some scholars have argued that ESG efforts fulfill stakeholders’ expectations and help firms obtain stakeholder support, which improves firms’ performance [5,9,10]. Moreover, ESG efforts may also boost efficiency, strengthen a company’s reputation, and attract new customers [10,11].

However, in the meantime, the existing literature also finds the potential negative influences of ESG behaviors on firm performance. For example, some studies have suggested that conducting ESG activities increases unavoidable costs and diminishes business and shareholder profitability. Thus, firms that participate in ESG activities may face a financial disadvantage compared to those that do not [7,12]. Additionally, ESG efforts may result from an agency conflict between shareholders and managers. Managers may participate in self-serving behavior by pursuing ESG activities to meet their social preferences or developing relationships with certain stakeholders to maximize personal profits [13].

In addition to the above-mentioned theoretical divergence, empirical results on the ESG performance and financial performance correlation are also mixed. While some research indicates that ESG practices improve corporate financial performance [14,15], others have found contrary results [13,16]. At the same time, other scholars have concluded that there is no association between corporate ESG performance and financial performance [17,18]. Finally, a curvilinear relationship between corporate ESG performance and financial performance has been posed by some scholars [19,20].

From both the theoretical perspective and the empirical aspect, the potential correlation between corporate ESG performance and financial performance demands further theoretical clarification as well as empirical examinations. Recent studies indicate that firms do not equally benefit from ESG practices [21]. To better understand the contingencies that may contribute to elaborating the divergent outcomes of ESG performance, other key factors, such as macro-level factors, may need to be considered [22,23,24], as business firms’ ESG practices are largely subject to the contexts in which they operate [25]. Some studies show that firms’ performance may vary across countries even if similar resources are allocated to the ESG activities of these firms [26,27], but the country-level contingencies are often underestimated when examining ESG practices [12,28].

However, little research has been conducted to investigate the influence of country-level factors on the correlation between corporate ESG performance and financial performance [29,30,31]. For instance, Ghoul et al. [32] discovered that the value of corporate social responsibility initiatives, as a form of ESG activities, is higher in countries with weaker market-supporting institutions. Rivera-Santos et al. [33] presented evidence that ESG activities can reduce transaction costs for firms operating in underdeveloped institutions, thereby enhancing firm performance. Shin et al. [34] demonstrated that national culture can significantly affect the relationship between ESG performance and financial performance as a contingency factor. These studies highlight the key role of macro-level factors in influencing corporate financial performance through ESG performance but largely ignore the potential role of governance.

To address the research gap, this study considers three key country-level factors to better understand the correlation between corporate ESG performance and firm financial performance. To be specific, political stability, regulatory quality, and control of corruption were selected, as they represent the selection, design, and enforcement of efficient rules [35]. Following the legitimacy perspective and the resource-based view [36,37], we investigated the potential mechanisms between corporate ESG performance and financial performance. Based on a large panel dataset of 3993 firms in 58 countries from 2010 to 2020, we conducted empirical analyses and tested our hypotheses.

Our results indicate a positive correlation between corporate ESG performance and financial performance. Moreover, we found that countries with better governance in political stability, regulatory quality, and control of corruption significantly and positively moderate these main effects. These results remain robust to alternative measures and country sensitivity tests. Our findings suggest that differences in country governance play a crucial and significant role in determining the impact of ESG activities on corporate financial performance.

This study contributes to the literature on ESG in three ways. First, we delve into the controversial relationship between ESG performance and financial performance. By analyzing the country governance data of a large panel of 58 countries from 2010 to 2020, we identified how ESG activities contribute to firm performance. This result provides new insights into why some corporate ESG performance benefits more in specific countries than others. Second, our study provides a new understanding of how country governance influences corporate ESG performance. To be specific, we found the moderating role of political stability, regulatory quality, and control of corruption. This finding largely extends and complements the previous research focusing on macro-level factors, such as national culture. Third, our study carries important value for empirical contexts. With a large panel dataset covering 11 years and 58 countries, our study provides robust empirical evidence to examine the ESG–financial performance link. Moreover, our analysis of 3993 firms over a decade elaborates on the long-term influence of ESG performance on financial outcomes. This result benefits policymakers and business practitioners aiming for sustainable development.

The remainder of this paper is organized as follows: Section 2 presents the theoretical background and hypotheses development. Section 3 reports the data, variables, and method. Section 4 shows the results. Section 5 contains the discussions and conclusions.

2. Theoretical Background and Hypothesis Development

2.1. Corporate Financial Performance, ESG, and Legitimacy

Corporations are concerned not solely with their financial performance but also with the social and environmental implications of their operations [38], such as environmental performance and social performance. ESG integrates three different concepts for evaluating companies, including corporate environmental, social, and governance [1]. Environmental performance represents how corporations address environmental challenges, such as reducing emissions and incorporating environmental innovation into their policies and procedures [21,39]. Social performance takes into account a company’s practices and policies towards diverse stakeholders such as workers, vendors, consumers, and communities, dealing with pertinent social concerns [21]. Governance performance encompasses internal controls and ownership issues, such as top management team diversity, executive compensation, and the protection of shareholders’ rights [40]. Enterprises engage in ESG activities due to their potential impact on financial performance, particularly from a long-term perspective [41,42].

Due to the importance of ESG activities in the financial, environmental, and social areas of business firms, stakeholders become more interested in the social consequences of firms’ actions [3,43,44]. Previous studies on the ESG activities of business firms mainly follow two broad perspectives: their legitimacy and their resource-based view. Legitimacy is defined as “a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions” [36] (p. 574). That means firms can gain legitimacy by meeting societal expectations. The level of legitimacy is influenced by stakeholders’ dominant social values and beliefs and their awareness of them [23]. Corporate ESG performance can enhance a company’s sociopolitical legitimacy when perceived as appropriate and legitimate by the general public, key stakeholders, and government officials [45]. High stakeholder awareness and compliance with stakeholder expectations can result in more legitimacy, support, and respect for enterprises, ultimately benefiting the company’s financial performance [34]. From this perspective, legitimacy may partially explain why firms engage in ESG practices.

Different from the legitimacy perspective, some other studies examine the ESG activities and ESG performance of firms from the resource-based view (RBV). The RBV posits that a firm is a “unique collection of resources” [37]. This perspective suggests that a firm with key resources can attain and sustain a competitive advantage [46]. However, the needed resources for a firm are determined by both the focal firm and some of its key stakeholders, including government officials [47]. In this case, a firm’s high ESG performance that fulfills stakeholders’ expectations can help the focal firm build and maintain its reputation, increasing stakeholders’ willingness to cooperate and providing resources essential to success [48]. As such, gaining sociopolitical legitimacy from stakeholders and government officials can improve access to key resources and achieve competitiveness.

In summary, corporate ESG performance can address the concerns of a firm’s key stakeholders and the government, enhance sociopolitical legitimacy through stakeholder awareness, and improve corporate financial performance by obtaining more key resources. This perspective aligns with some developments in the stakeholder theory, which proposes that stakeholders are important for a company’s growth, financial performance, and success [49]. Therefore, companies can strategically engage with stakeholders to achieve their overall goals [10,50]. From this perspective, corporate ESG efforts can be considered a long-term strategy for firms to build better relationships with their primary stakeholders, resulting in positive responses and financial success [6,51]. Thus, we formulate our baseline hypothesis as the following:

Hypothesis 1.

Corporate ESG performance positively influences corporate financial performance.

2.2. The Moderating Role of Country Governance

The relationship between corporate ESG performance and financial performance is expected to vary significantly based on the focal firm’s political environment [52]. Early studies already highlight the importance of governments in firms’ activities [46]. Government policies and regulations determine trade norms, market structure, and permitted commodities and services depending on government subsidies and acquisitions [53]. As a result, government policy and enforcement are an important external source of unpredictability and have a substantial impact on a company’s operations.

In the case of ESG practices, the strength of governance will play a role in the effectiveness of corporate ESG practices. For instance, numerous environmental restrictions require corporations to execute environmental policies and proactive strategies, especially if they want to achieve a competitive edge [54]. In developed countries like European countries and the US, there are strict environmental requirements that enable effective communication of ESG information to stakeholders, which ensures that stakeholders have the necessary information about a firm’s ESG activities to make meaningful responses like cooperation and support [12]. Furthermore, individuals can acquire information about a company either directly from the company or through alternative channels, such as the media or the stock market [55]. Countries with superior governance not only provide firms with more effective policies but also offer greater media exposure, which facilitates the dissemination of information from the firms to their stakeholders [56]. Therefore, stakeholders of firms located in countries with better governance are more likely to be aware of the firms’ ESG contributions in a timely and accurate manner. Consequently, stakeholders will be better positioned to respond to ESG activities by providing more collaboration and support, which tends to improve firm financial performance. Increased stakeholder awareness should enhance the benefits that a firm may obtain from corporate ESG practices.

In cases of low stakeholder awareness, firms will receive less recognition for their ESG efforts due to less developed institutions and inefficient communication of information [56]. Thus, a firm will not benefit as much from engaging in ESG practices as its counterparts in contexts with high stakeholder awareness. Following this logic, ESG activities are expected to have a greater impact in countries with better governance, where ESG information is effectively communicated to stakeholders and firms gain more legitimacy and financial rewards. This supports the theory proposed by Rodriguez et al. [57] that institutional differences across countries result in varying expectations and returns to ESG.

As above, research on corporate ESG performance has attracted attention in both developed economies and emerging markets. However, the exploration of country governance differences as moderators has been limited [58]. Governance refers to the traditions and institutions that exert authority in a country [59]. According to Borrmann et al. [35], governance is especially crucial for the selection and construction of efficient rules, as well as their diffusion and enforcement, which includes monitoring, dispute resolution, and sanctions for infractions. All of these country governance dimensions, collectively and individually, would influence corporate strategies for long-term and large investments, such as ESG practices [60]. Therefore, based on the establishment, efficiency, and enforcement of rules [35], and due to ESG’s connections to country governance and corporate financial performance [61], country governance plays an important role in the correlation between corporate ESG performance and financial performance. More specifically, political stability, regulatory quality, and control of corruption will moderate the above-mentioned correlation.

2.3. Country Governance Dimensions

Political stability. Governance and the rules of governance originate from the process of selecting, monitoring, and replacing governments [62]. The selection and design of rules are considered consistent in politically stable countries. According to Fatemi et al. [14], firms often rely on third-party support and politically influential intermediaries to access resources that may be difficult to obtain [63]. Stakeholders in politically stable countries are more likely to prioritize long-term sustainability and consider ESG actions when making decisions [64], as ESG strategy actions are considered long-term investments that require a stable external environment [60].

In politically stable countries, there is often greater participation and engagement from various stakeholders, including the government and society, in promoting sustainable practices [59]. Companies with strong ESG performance are considered more resilient and better equipped to navigate changing market conditions, making them attractive to stakeholders and potentially boosting their financial performance [65]. This collaboration promotes transparency, accountability, and trust between companies and their stakeholders, thereby enhancing corporate sociopolitical legitimacy.

However, in politically unstable environments, governments are more vulnerable to being destabilized or overthrown through unconstitutional or violent means, including politically motivated violence and terrorism [32]. Political involvement is common in corporate operations, and corporations are expected to engage in corrupt practices [63]. Legitimacy for companies operating in volatile nations is precarious and challenging to convey to stakeholders amidst violence and terrorism [57]. Therefore, we argue that effective stakeholder engagement in politically stable countries can help companies better understand and respond to societal and environmental needs, leading to improved ESG performance and, eventually, enhanced financial performance.

Hypothesis 2.

The relationship between corporate ESG performance and financial performance is stronger in countries that are more politically stable.

Regulatory quality. Governance includes the capacity of the government to effectively formulate and implement sound regulations [62]. Regulatory quality, in line with this concept of governance, assesses the government’s engagement in private sector regulation, executive investigation, and enforcement [66]. In countries with strong regulatory standards, governments incorporate minimal public expectations regarding how companies should act concerning the environment and society into laws and regulations, including mandatory corporate social responsibility (CSR) reporting policies [67].

Corporate ESG practices mandated through regulation create a framework that encourages companies to disclose their ESG practices clearly and adequately [60]. This transparency enables stakeholders, including investors, employees, and customers, to make informed decisions based on credible information. As a result, the quality and efficiency of economic regulations determine institutional strength [56]. Following this logic, if the government formulates and implements sound policies effectively, corporate ESG practices are more likely to come under public scrutiny, and stakeholders can then assess corporate sustainability efforts and align their values with those of the company. This, in turn, helps firms obtain cooperation and support from stakeholders, which will further improve the financial performance of the focal firms. This leads to the following:

Hypothesis 3.

The relationship between corporate ESG performance and financial performance is stronger in countries with higher regulatory quality.

Control of corruption. Another critical governance characteristic that can moderate the influence of firms’ ESG performance on financial performance is the prevalence of corruption within a country. Corruption refers to the exploitation of public positions and power for personal gain in violation of established rules [46]. Previous studies have shown that companies in nations with high levels of corruption frequently underperform in terms of ESG performance, as such an institutional environment discourages socially responsible behavior by eroding the foundations of institutional trust [65,68].

Different from the negative impacts, some other studies found the positive influence of country corruption on firms’ ESG performance. For instance, when confronted with a corruption challenge, firms that adopt strong ESG standards are more likely to achieve growth and profitability [69]. However, in a corrupt environment, rent-seeking opportunities increase, allowing corrupt officials to easily influence firms through various policies, including ESG practices [70]. Therefore, firms may choose to rely on informal network ties rather than formal ones or engage in non-market strategic actions such as bribery and corruption rather than market-oriented activities like meeting the demands of customers and employee training [60]. Based on the foregoing, we argue that the corruption level in a country affects a firm’s ESG performance and consequently affects its financial performance.

Hypothesis 4.

The relationship between corporate ESG performance and financial performance is stronger in countries with stronger control of corruption.

The above hypotheses can be summarized as shown in Figure 1.

3. Methodology

3.1. Data and Sample

We used several data sources to construct our sample. The Thomson Reuters ASSET4 database offers extensive ESG scores with 250 key performance indicators for over 5000 listed companies from more than 50 countries, utilizing only publicly available information from almost 900 sources. ASSET4 data have been utilized in many ESG studies of global companies [32,34,66]. We collected the ESG scores from this database and matched them with corporate financial data obtained from Compustat North America. We then combined these with country-level governance data from the World Bank. We excluded firms in the financial industry due to their different regulatory settings. We also excluded firms with missing values. The procedure described above resulted in an unbalanced panel of 22,099 observations, which included 3993 firms from 58 countries over an 11-year period from 2010 to 2020. This specific period was selected due to the availability of data. At present, data for the period following 2020 are not available for all 58 countries. The availability of ESG data for companies around the world has increased since 2010. Therefore, the data from the period between 2010 and 2020 are readily accessible, ensuring the consistency of the statistical scope of our sample. We conducted the analysis using STATA 17 software.

3.2. Measurements

Dependent variable. Following established studies [24], we used return on assets (ROA) as a dependent variable, which is calculated as net income divided by total assets and reflects corporate financial performance [34].

Independent variable. Following Ghoul et al. [32], we used the ESG score to proxy ESG performance provided by the Thomson Reuters ASSET4 database. The original ESG scores each lie between 0 and 100. Since the variable is skewed, following previous studies [32], we computed its natural logarithm.

Moderating variables. We used the worldwide governance indicators (WGIs) from the World Bank as moderating variables. The WGIs use 35 different data sources from over 30 organizations globally to quantify various dimensions of country governance, allowing for meaningful cross-country and over-time comparisons [62]. The WGI has been employed as a governance measure in many studies [34,56,63]. In accordance with our emphasis on selecting, designing, and enforcing effective regulations, we gathered scores for political stability, regulatory quality, and control of corruption from the WGIs. These scores range from −2.5 (weak) to 2.5 (strong) and serve as an estimation of country governance.

Control variables. We used control variables typically used in corporate financial performance regressions to ensure that the coefficient on ESG did not pick up the influence of other correlated factors [23,32]. From established studies, our control variables included firm size, leverage, fixed asset intensity, market capitalization, R&D, financial volatility, economic development, and culture. According to Claessens et al. [71], larger enterprises are more diverse and therefore suffer more from the diversity discount. We calculated firm size using the logarithm of total assets [23]. A higher leverage ratio may indicate greater financial vulnerability and, hence, deterioration in financial performance [60]. Leverage is calculated by dividing total debt by total assets [14]. Firms that allocate a greater portion of their fixed capital to investment may experience higher growth rates, which could impact their profitability [60]. Following Tolmie et al. [56], we measured fixed asset intensity as fixed assets divided by total assets and new assets as the average net property, plant, and equipment (PP&E) scaled by gross PP&E. Companies with a high market capitalization generally exhibit strong financial performance [1]. We measured market capitalization using the natural logarithm of firm market capitalization [1]. Research and development expenses are normally expensed and not capitalized, but they are an investment in future revenue growth [32]. We included a control variable for R&D, which equals 1 if the firm’s R&D expenditure is above 0, and 0 otherwise [32]. Firms experiencing financial volatility may have an impact on profitability [60]. We measured financial volatility as the average of the sum of the changes in debt and equity scaled by total assets [67]. Companies in economically prosperous nations with individualistic cultures may have greater value [25]. We measured economic development using the natural logarithm of GDP per capita for each year, evaluated in constant US dollars [66]. We used Hofstede’s cultural dimensions to measure culture, calculated as the average of Hofstede’s six dimensions [34].

3.3. Estimation Method

One of the key issues in our studies examining the ESG–financial performance link is the exclusion of key variables, which is referred to as endogeneity in the model [60]. Endogeneity might also occur due to the reverse causality between dependent and independent variables [60]. We estimated the coefficients using the fixed effects regression model (1) that approximates randomization to address endogeneity, referring to Mooneeapen et al. [63]. The fixed effects design is well-suited for analyses with panel data [32], and the evidence of causal relations in firm fixed effects models can be compelling [32]. We included firm fixed effects and year fixed effects to mitigate endogeneity concerns arising from omitted variables correlated with corporate ESG performance and financial performance [32], and we lagged explanatory and control variables by one year to address concerns about reverse causality and simultaneity bias [60]. The Hausman test supports the use of the fixed effects regression model [23].

$${ROA}_{i,t}={\alpha }_0+{\alpha }_1{ESG}_{i,t-1}+{\alpha }_2{WGI}_{i,t-1}+{\alpha }_3{ESG}_{i,t-1}\times {WGI}_{i,t-1}+\Sigma \theta {Control}_{i,t-1}+{\mu }_i+{\mu }_t+{\epsilon }_{i,t}$$

(1)

where $i$ indexes firms, $t$ indexes years, $ESG$ is our proxy for ESG performance, $WGI$ is one of the three country governance dimensions discussed above, Control includes the firm-level and country-level control variables, ${\mu }_i$ denotes firm fixed effects, ${\mu }_t$ denotes year fixed effects, and $\epsilon$ is an error term.

4. Results

4.1. Descriptive Statistics and Correlations

Table 1. Sample composition by country/region, industry, and year.

Country/Region	N	%	Country/Region	N	%	Country/Region	N	%
Argentina	33	0.15	Hong Kong	60	0.27	Peru	5	0.02
Australia	480	2.17	India	95	0.43	Philippines	33	0.15
Austria	42	0.19	Indonesia	13	0.06	Poland	22	0.10
Bahamas	3	0.01	Ireland	218	0.99	Portugal	13	0.06
Bahrain	6	0.03	Israel	129	0.58	Puerto Rico	10	0.05
Belgium	17	0.08	Italy	86	0.39	Qatar	5	0.02
Bermuda	111	0.50	Japan	253	1.14	Russia	28	0.13
Brazil	120	0.54	Jordan	2	0.01	Singapore	51	0.23
Canada	2089	9.45	Korea	45	0.20	South Africa	71	0.32
Chile	74	0.33	Luxembourg	65	0.29	Spain	61	0.28
China	234	1.06	Malaysia	4	0.02	Sweden	101	0.46
Colombia	25	0.11	Mexico	48	0.22	Switzerland	136	0.62
Costa Rica	1	0.00	Monaco	19	0.09	Taiwan	15	0.07
Cyprus	5	0.02	Mongolia	1	0.00	Thailand	49	0.22
Denmark	28	0.13	Morocco	7	0.03	United Arab Emirates	3	0.01
Egypt	4	0.02	Netherlands	174	0.79	United Kingdom	649	2.93
Finland	32	0.14	New Zealand	49	0.22	United States	15,838	71.67
France	161	0.73	Norway	94	0.43	Uruguay	5	0.02
Germany	144	0.65	Oman	5	0.02
Greece	12	0.05	Panama	16	0.07
Total	22,099	100.00
Industry	N			%	Year	N	%
Energy	2059			9.32	2010	1180	5.34
Materials	2052			9.29	2011	1189	5.38
Industrials	3545			16.04	2012	1192	5.39
Consumer Discretionary	2922			13.22	2013	1215	5.50
Consumer Staples	1049			4.75	2014	1248	5.65
Health Care	3736			16.91	2015	1779	8.05
Information Technology	3131			14.17	2016	2320	10.50
Communication Services	1272			5.76	2017	2788	12.62
Utilities	864			3.91	2018	2928	13.25
Real Estate	1469			6.65	2019	3177	14.38
					2020	3083	13.95
Total	22,099			100.00	Total	22,099	100.00

presents a summary of our sample by country, year, and industry. Our sample comprises 22,099 observations; approximately 71.67% are firms from the US. The rest of the observations are widely spread across different countries and regions. The number of firm–years observations increased from 1180 in 2010 to 3083 in 2020. Our sample is distributed across industries according to the standard industrial classification (SIC), ranging from 3.9% in the utilities sector to 16% in the industrial sector.

Table 2. Descriptive statistics and correlations.

Variables		Mean	SD	1	2	3	4	5	6	7
1	ROA	0.02	3.44
2	ESG	4.63	0.6	0.08 ***
3	Political stability	0.49	0.39	−0.01 *	0.05 ***
4	Regulatory quality	1.42	0.36	−0.02 **	−0.03 ***	0.45 ***
5	Control of corruption	1.35	0.43	0.00	0.02 ***	0.48 ***	0.47 ***
6	Size	7.83	1.94	0.19 ***	0.56 ***	0.10 ***	−0.08 ***	0.01
7	Leverage	0.29	0.23	−0.06 ***	0.06 ***	−0.01 **	0.01	−0.02 **
8	R&D	0.48	0.5	−0.06 ***	0.05 ***	−0.09 ***	−0.04 ***	−0.05 ***	−0.19 ***	-0.19 ***
9	Fixed asset intensity	0.28	0.27	0.03 ***	0.09 ***	0.15 ***	0.03 ***	0.07 ***	0.18 ***	0.18 ***
10	Finance	0.71	0.21	0.16 ***	−0.10 ***	−0.01	0.04 ***	0.01	0.01	0.01
11	New assets	0.54	0.19	−0.01 *	−0.14 ***	−0.01	0.00	−0.01	0.05 ***	0.05 ***
12	Market capitalization	7.93	1.87	0.18 ***	0.51 ***	0.05 ***	−0.09 ***	−0.01	0.03 ***	0.03 ***
13	GDP	10.82	0.46	−0.01 *	−0.11 ***	0.41 ***	0.54 ***	0.46 ***	0.04 ***	0.04 ***
14	Culture	54.55	6.45	−0.01	0.02 ***	0.04 ***	0.15 ***	0.14 ***	−0.01	−0.01
Variables		Mean	SD	8	9	10	11	12	13
9	Fixed asset intensity	0.28	0.27	−0.47 ***
10	Finance	0.71	0.21	−0.04 ***	0.11 ***
11	New assets	0.54	0.19	−0.23 ***	0.38 ***	0.21 ***
12	Market capitalization	7.93	1.87	0.05 ***	0.00	−0.03 ***	−0.01 *
13	GDP	10.82	0.46	0.04 ***	−0.08 ***	0.01 *	−0.04 ***	−0.06 ***
14	Culture	54.55	6.45	0.07 ***	−0.07 ***	−0.04 ***	−0.05 ***	0.05 ***	0.18 ***

Notes: N = 22,099, * p < 0.1, ** p < 0.05, *** p < 0.01.

presents the basic descriptive statistics and correlation results for all variables used in the analysis. The samples have an average ROA of 0.02 and an average ESG score of 4.63. The average scores for each country’s governance dimension range from 0.49 to 1.50. The standard deviation (SD) results show wide fluctuations across observations. Furthermore, we assessed the issue of multicollinearity by calculating the variance inflation factors (VIFs) [60]. As the average VIF is 2.78 and all VIFs are below 10, we argue that multicollinearity is not a significant concern in our dataset.

4.2. Results of Regression

Table 3. Results with Tobin’s Q as the dependent variable.

	(1)	(2)	(3)	(4)	(5)
Size	−0.074 ***	−0.0767 ***	−0.0777 ***	−0.0764 ***	−0.0772 ***
	(0.008)	(0.00804)	(0.00804)	(0.00804)	(0.00804)
Leverage	−0.338 ***	−0.338 ***	−0.338 ***	−0.338 ***	−0.338 ***
	(0.015)	(0.0147)	(0.0147)	(0.0147)	(0.0147)
Fixed asset intensity	−0.163 ***	−0.168 ***	−0.173 ***	−0.171 ***	−0.174 ***
	(0.039)	(0.0394)	(0.0394)	(0.0394)	(0.0395)
R&D	−0.022	−0.0230	−0.0244	−0.0229	−0.0235
	(0.023)	(0.0230)	(0.0230)	(0.0230)	(0.0230)
Finance	−0.286 ***	−0.286 ***	−0.287 ***	−0.286 ***	−0.286 ***
	(0.026)	(0.0256)	(0.0256)	(0.0256)	(0.0256)
New assets	−0.016	−0.0133	−0.0114	−0.0138	−0.0111
	(0.030)	(0.0298)	(0.0298)	(0.0298)	(0.0298)
Market capitalization	0.071 ***	0.0707 ***	0.0710 ***	0.0703 ***	0.0707 ***
	(0.005)	(0.00492)	(0.00493)	(0.00492)	(0.00493)
GDP	0.007	0.00855	0.0172	0.0248	−9.52 × 10−5
	(0.015)	(0.0147)	(0.0169)	(0.0186)	(0.0202)
Culture	−0.001	−0.000551	−0.000680	−0.000672	−0.000839
	(0.002)	(0.00181)	(0.00181)	(0.00182)	(0.00182)
ESG		0.0242 ***	0.0189 **	0.0225 **	0.0221 **
		(0.00881)	(0.00898)	(0.00883)	(0.00886)
Political stability			−0.0272
			(0.0176)
ESG×Political stability			0.0492 ***
			(0.0169)
Regulatory quality				−0.0384 *
				(0.0219)
ESG×Regulatory quality				0.0542 ***
				(0.0193)
Control of corruption					0.00640
					(0.0207)
ESG×Control of corruption					0.0409 **
					(0.0182)
Constant	0.324 *	0.218	0.175	0.115	0.332
	(0.176)	(0.180)	(0.195)	(0.207)	(0.219)
Observations	22,099	22,099	22,099	22,099	22,099
R-squared	0.074	0.074	0.075	0.075	0.074
Company effects	YES	YES	YES	YES	YES
Year effects	YES	YES	YES	YES	YES

Notes: Standard errors are in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01.

presents the regression results. Model 1 presents the results with firm-level and country-level control variables only. Model 2, our baseline model, shows the relationship between corporate ESG performance and financial performance. Models 3 through 5 demonstrate the moderating effects of each country governance dimension. As anticipated, models 2 to 5 demonstrate a positive and significant relationship between corporate ESG performance and financial performance, which is in line with the findings of previous studies [34,46]. Therefore, baseline hypothesis 1 is supported.

Regarding Hypothesis 2, political stability positively and significantly moderates the relationship between corporate ESG performance and financial performance in Model 3 (p < 0.01). Thus, Hypothesis 2 is supported, indicating that companies’ ESG activities enhance their financial performance more in politically stable countries.

Regarding Hypothesis 3, regulatory quality positively and significantly moderates the relationship between corporate ESG performance and financial performance in Model 4 (p < 0.01). Therefore, Hypothesis 3 is supported. indicating that the relationship between corporate ESG performance and financial performance is stronger in countries with higher regulatory quality.

Regarding Hypothesis 4, control of corruption also positively and significantly moderates the relationship between corporate ESG performance and financial performance in Model 5 (p < 0.05). Therefore, Hypothesis 4 is supported, indicating that the correlation between corporate ESG performance and financial performance is more pronounced in countries with better control of corruption.

In summary, we found supportive evidence that corporate ESG performance is positively related to financial performance and that corporate ESG performance is more positively related to financial performance in countries with better governance in political stability, regulatory quality, and control of corruption. The above analysis indicates that the three dimensions of country governance have a significant impact on the relationship between corporate ESG performance and financial performance. Corporations can manage their limited resources and implement their ESG strategies more effectively in countries with better governance, where corporate ESG performance is more positively correlated with financial performance.

To enhance the interpretation of our results, we utilized Wang and Qian’s [24] method to illustrate the significant interaction effects (Figure 2). The figures demonstrate that when political stability, regulatory quality, and control of corruption are high, the correlation between corporate ESG performance and firm performance is more positive.

Regarding the impact of each governance dimension on corporate financial performance, all country governance dimensions, except for control of corruption, have an adverse effect on the financial performance of the firm. Regarding the control variables, the coefficients on the control variables are generally consistent with those in previous studies [24,60]. Specifically, larger firms are associated with lower financial performance, while firms with more market capitalization have higher financial performance. Additionally, firms with greater leverage have lower financial performance. It is also worth noting that a country’s culture has a negative impact on a firm’s performance.

4.3. Robustness Tests

Two robustness tests were conducted to verify the findings. Tobin’s Q is used as an alternative measure of corporate financial performance [1,24]. Tobin’s Q is a metric used to evaluate a firm’s operational and financial performance from the perspective of external stakeholders [32]. Following Wang and Qian [24], we calculated Tobin’s Q by using the market valuation of equity plus net debt minus deferred tax cost, then scaled the result by average total assets.

Table 4. Results with Tobin’s Q as the dependent variable.

	(1)	(2)	(3)	(4)	(5)
Size	−0.085 ***	−0.0821 ***	−0.0828 ***	−0.0826 ***	−0.0827 ***
	(0.053)	(0.00954)	(0.00956)	(0.00954)	(0.00956)
Leverage	−0.365 ***	−0.347 ***	−0.347 ***	−0.347 ***	−0.347 ***
	(0.079)	(0.0167)	(0.0167)	(0.0167)	(0.0167)
Fixed asset intensity	−0.251 ***	−0.268 ***	−0.271 ***	−0.272 ***	−0.274 ***
	(0.001)	(0.0451)	(0.0452)	(0.0451)	(0.0452)
R&D	−0.015	−0.0202	−0.0209	−0.0197	−0.0213
	(0.033)	(0.0260)	(0.0260)	(0.0260)	(0.0260)
Finance	−0.298 ***	0.00477	0.00395	0.00340	0.00494
	(0.003)	(0.0371)	(0.0371)	(0.0371)	(0.0371)
New assets	−0.025	−0.0784 **	−0.0762 **	−0.0787 **	−0.0761 **
	(0.032)	(0.0383)	(0.0385)	(0.0383)	(0.0383)
Market capitalization	0.080 ***	0.0834 ***	0.0835 ***	0.0830 ***	0.0831 ***
	(0.001)	(0.00582)	(0.00583)	(0.00582)	(0.00583)
GDP	0.009	0.0104	0.0126	0.0226	−0.00441
	(0.020)	(0.0167)	(0.0192)	(0.0207)	(0.0228)
Culture	−0.002	0.000277	0.000254	0.000099	0.000142
	(0.005)	(0.00226)	(0.00226)	(0.00226)	(0.00226)
ESG		0.00771 *	0.00702	0.00776 *	0.00776 *
		(0.00465)	(0.00469)	(0.00466)	(0.00466)
Political stability			−0.00996
			(0.0200)
ESG×Political stability			0.0282 *
			(0.0220)
Regulatory quality				−0.0332
				(0.0248)
ESG×Regulatory quality				0.0605 **
				(0.0257)
Control of corruption					0.0151
					(0.0235)
ESG×Control of corruption					0.0379 *
					(0.0228)
Constant	0.319 *	0.0989	0.0886	0.0344	0.0989
	(0.173)	(0.204)	(0.220)	(0.228)	(0.204)
Observations	22,099	22,099	22,099	22,099	22,099
R-squared	0.073	0.078	0.078	0.078	0.078
Company effects	YES	YES	YES	YES	YES
Year effects	YES	YES	YES	YES	YES

Notes: Standard errors are in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01.

presents the analysis results. We obtained similar results: all three country governance dimensions positively moderated the relationship between ESG performance and financial performance, and the moderating effect was all significant.

To confirm the robustness of the results, we conducted a country sensitivity test. The country sensitivity test aims to assess the impact of outlier countries on the results [66]. Following Cahan et al. [1], the regressions were rerun after excluding countries with less than 21 firms, which accounted for less than 0.1% of our sample. We implemented strict criteria to mitigate any potential bias from including data points that may not adequately represent the broader companies [66]. The results are consistent with the main findings presented in

Table 5. Results of the country sensitivity test.

	(1)	(2)	(3)	(4)	(5)
Size	−0.080 ***	−0.0828 ***	−0.0838 ***	−0.0825 ***	−0.0828 ***
	(0.008)	(0.00806)	(0.00807)	(0.00806)	(0.00806)
Leverage	−0.342 ***	−0.342 ***	−0.343 ***	−0.342 ***	−0.342 ***
	(0.015)	(0.0147)	(0.0147)	(0.0147)	(0.0147)
Fixed asset intensity	−0.185 ***	−0.191 ***	−0.196 ***	−0.194 ***	−0.191 ***
	(0.039)	(0.0395)	(0.0395)	(0.0395)	(0.0395)
R&D	−0.021	−0.0221	−0.0234	−0.0219	−0.0221
	(0.023)	(0.0229)	(0.0229)	(0.0229)	(0.0229)
Finance	−0.280 ***	−0.280 ***	−0.280 ***	−0.280 ***	−0.280 ***
	(0.026)	(0.0256)	(0.0256)	(0.0256)	(0.0256)
New assets	0.006	0.00926	0.0115	0.00895	0.00926
	(0.030)	(0.0299)	(0.0300)	(0.0299)	(0.0299)
Market capitalization	0.070 ***	0.0701 ***	0.0704 ***	0.0697 ***	0.0701 ***
	(0.005)	(0.00492)	(0.00493)	(0.00493)	(0.00492)
GDP	0.007	0.00889	0.0174	0.0251	0.00889
	(0.015)	(0.0149)	(0.0173)	(0.0188)	(0.0149)
Culture	−0.001	−0.000526	−0.000647	−0.000684	−0.000526
	(0.002)	(0.00182)	(0.00182)	(0.00183)	(0.00182)
ESG		0.0242 ***	0.0187 **	0.0222 **	0.0218 **
		(0.00882)	(0.00899)	(0.00884)	(0.00887)
Political stability			−0.0262
			(0.0178)
ESG×Political stability			0.0507 ***
			(0.0170)
Regulatory quality				−0.0376 *
				(0.0220)
ESG×Regulatory quality				0.0589 ***
				(0.0194)
Control of corruption					0.00464
					(0.0208)
ESG×Control of corruption					0.0444 **
					(0.0184)
Constant	0.359 **	0.254	0.212	0.154	0.358
	(0.179)	(0.183)	(0.199)	(0.209)	(0.222)
Observations	16,108	16,108	16,108	16,108	16,108
R-squared	0.075	0.075	0.076	0.076	0.075
Company effects	YES	YES	YES	YES	YES
Year effects	YES	YES	YES	YES	YES

Notes: Standard errors are in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01.

.

5. Discussions

We have argued that corporate ESG performance positively influences corporate financial performance by gaining sociopolitical legitimacy from receiving positive stakeholder awareness and gaining key resources. Moreover, we have suggested that this positive relationship between corporate ESG performance and financial performance is stronger in countries with higher levels of political stability, regulatory quality, and control of corruption. Our analyses support these hypotheses using a large panel dataset covering 3993 firms in 58 countries from 2010 to 2020. We found a positive relationship between corporate ESG performance and financial performance as measured by ROA. Further, we found that countries with better governance in political stability, regulatory quality, and control of corruption positively and significantly moderate the relationship between corporate ESG performance and financial performance. These results remained robust when using Tobin’s Q as an alternative measure of corporate financial performance and excluding countries with less than 21 firms as a country sensitivity test.

5.1. Theoretical Contribution

This study contributes to the growing literature on ESG. First, we investigated the contentious relationship between corporate ESG performance and financial performance. Analyzing large panel data on country governance dimensions in various nations, we provide insights into why some corporate ESG performance benefits more in specific countries by identifying through which ESG activities can contribute to financial success. Cuervo-Cazurra et al. [29] note that previous research has mainly focused on the firm-level and industry-level context, with little attention paid to the impact of country-level factors. Our findings contribute to a stronger theoretical foundation for the ESG–financial performance link in the context of country governance, suggesting that better governance in political stability, regulatory quality, and control of corruption provides a more conducive environment for the implementation of ESG strategies. This is important as Candio [6] points out that future research should examine the ESG–financial performance link in the regulatory context, which is likely to significantly influence both the magnitude and direction of the estimated effect. Furthermore, investing in ESG activities for the long term can have a positive impact on a company’s financial performance. Companies with a long-term orientation can benefit from ESG strategies [72].

Second, our study adds to our understanding of how country governance influences corporate ESG performance by looking into the moderating roles of political stability, regulatory quality, and corruption control. According to Borrmann et al. [35], country governance is crucial for the selection, diffusion, and enforcement of efficient rules. We examined three country governance dimensions that are crucial to the multidimensional concept of country governance to understand the strength of a country’s governance environment. Our findings indicate that the three country governance dimensions of political stability, regulatory quality, and control of corruption have a substantial impact on the ESG–financial performance link by enabling firms to obtain positive stakeholder awareness and gain key resources. Therefore, the company’s political environment is critical in deciding how much benefit may be derived from corporate ESG efforts. Furthermore, the three national governance dimensions we analyzed complement the country-level factors investigated in previous research. For instance, Mooneeapen et al. [63] explored country-level governance factors across three distinct constructs: political system, political stability, and political quality. We conducted a detailed study from a rules-based perspective. Our findings help to broaden the present literature on the impact of country governance on corporate ESG performance while also offering a comprehensive understanding of the various functions of country governance.

Third, our study contributes to empirical research on the impact of country governance on firms in a global context using a large panel dataset. Our study tested arguments using a large panel dataset covering 11 years and 58 countries, providing empirical relevance in the context of the governance environment across countries and economies. The global governance environment provides a useful sociopolitical context in which to extend our general conceptual arguments. Tilt [73] points out that past research on ESG practices has primarily concentrated on developed economies, such as the United States and the United Kingdom, thus failing to investigate political differences in developing economies, which account for a larger number of countries. Moreover, our study examines the long-term impact of ESG performance on financial outcomes, providing valuable insights for the development of sustainable business strategies in different countries. According to Wang and Bansal [42], companies that have a long-term focus can make strategic decisions that more effectively realize the benefits of ESG activities. Conducting a longitudinal study would provide a clearer understanding of how ESG initiatives impact financial performance over extended periods in various countries, which is essential for comprehending the sustainability of these practices [74].

5.2. Managerial Implications

Our study presents important managerial implications for corporate managers. First, firms should engage in ESG activities as they help to receive positive stakeholder awareness and access to key resources. Our research shows that companies with strong ESG performance have better financial performance over an 11-year period. Enterprises should consider ESG efforts as part of a broader, sustainable business strategy that contributes to the long-term financial success of the enterprise [75]. Second, managers should take into account their company’s resources and competencies, as well as the country governance context where they operate, when selecting an ESG strategy. Our findings indicate that ESG activities can contribute more to corporate financial success when governance is improved, which is especially relevant for enterprises operating in various countries with varying levels of governance [64]. Furthermore, while there is a moderating effect on the ESG–financial performance link, corporate ESG performance and financial performance remain positively correlated, albeit to varying degrees.

Our study also offers valuable implications for policymakers. First, our findings suggest that the relationship between companies’ ESG performance and financial performance is more pronounced in countries with better regulatory quality and control of corruption, which is in line with current environmental, social, and corporate governance regulatory policies that are strictly enforced by law in many countries. Second, our findings show that businesses adopt a proactive approach to providing social and environmental value when governments foster greater stability. This is because incentives for businesses to justify their actions are more effective in politically secure countries, resulting in better ESG performance. Our findings add to the general understanding that a stable policy environment is more likely to result in sustainable growth [76].

5.3. Limitations and Future Research

Our study has several limitations. First, our study only examines whether a company’s ESG performance is influenced by country governance dimensions in the country where it is headquartered. However, since there are listed companies in the sample that operate in more than one country, the governance environments of those countries also have an impact on their ESG performance. Multinational enterprises that operate in multiple countries may face pressure from different institutional environments, which can affect their ESG performance. Therefore, it is crucial to consider the impact of the different countries in which they are located when investigating their ESG performance. Future studies should consider or examine these influences. Second, we have argued that corporate ESG performance influences financial performance by receiving positive stakeholder awareness and gaining key resources. However, due to data limitations, we were unable to directly measure some factors (e.g., governance and stakeholder awareness) that underlie these mechanisms. The arguments could be greatly strengthened if future studies could directly measure these factors. Third, firm fixed effects are used to address endogeneity between corporate ESG performance and financial performance. However, it is important to consider that unobserved factors may also influence the relationship between corporate ESG performance and financial performance, particularly in relation to country-level governance. To gain a better understanding of this relationship, it would be beneficial to investigate whether this changes after exogenous shocks to country governance caused by regulatory changes. While identifying a natural experimental setting can be challenging, future studies could explore the use of an exogenous shock in countries to re-examine our hypotheses.