Does Company Information Environment Affect ESG–Financial Performance Relationship? Evidence from European Markets

Abstract

This study investigates the relationship between ESG and financial performance and explores the influence of firms’ information environment on this relationship. To do this, we construct an information environment index from several proxy measures, evaluate ESG performance using Refinitiv’s ESG scores, and evaluate financial performance using return on assets and Tobin’s Q. We find that the information environment index has a positive relationship with both return on assets and Tobin’s Q ratio. On the contrary, ESG has a negative association with return on assets but a statistically insignificant relationship with Tobin’s Q. The negative relationship of ESG with return on assets is convex and weaker in companies with better information environments. We also show that in firms with high asset turnover ratios, ESG does not harm profitability. Separately examining the ESG components reveals that each similarly relates to profitability but that governance has a less negative impact. Our study reveals non-linearities in the relationship between ESG and financial performance that can help companies set better targets and implement better practices about ESG. The moderating effect of the information environment reveals the importance of information dissemination in preventing ESG practices from creating unfavorable consequences. This study may shed light on a more effective ESG policy by showing ways to reduce the adverse financial effects of ESG practices.