Does Institutional Quality and Managerial Ability Drive the Association between ESG and Firm Performance: Evidence from Emerging Asian Markets

Abstract

This study aims to explore the role of managerial ability (MA) and institutional quality (IQ) in enhancing the
positive impact of Environmental, Social, and Governance (ESG) policies on financial performance (FP). Against
the backdrop of global climate change, socio-economic advancements, and evolving corporate governance
standards, organizations face increasing pressure to adopt ESG practices. However, the implementation of ESG
policies often entails substantial costs. By investigating the joint influence of MA and IQ, this research seeks to
identify supplementary factors that can amplify the beneficial effects of ESG initiatives on FP. The study is
quantitative exploratory and uses panel data of 750 publicly listed companies covering period from 2010 to 2020.
Data has been acquired from the reputed data provider like Thomson Reuters and OLS regression has been used
for panel data analysis. Two measures of financial performance, the Tobin’s Q and Return of Assets (ROA) have
been used as proxies of financial performance. The study reaffirms the positive impact of Environmental, Social,
and Governance (ESG) factors on the financial performance of firms. Each pillar of ESG – environmental, social,
and governance – is positively correlated with financial performance. Additionally, managerial ability and
institutional quality act as supplementary variables, moderating the relationship between ESG and firms’
financial performance. Notably, both proxies of financial performance, Tobin’s Q and Return on Assets (ROA),
yield nearly identical results in terms of their relationships with ESG and the moderating effects of managerial
ability and institutional quality. Data of only 750 firms used for the analysis. Latest data was not available,
therefore, data from 2010 to 2020 was used in the study. The study underscores the potential for inducing
Environmental, Social, and Governance (ESG) practices in emerging economies through a combination of
managerial ability and institutional pressures. It emphasizes the role of policymakers in addressing inefficiencies,
corrupt practices, and policy inconsistencies that impede the governance index and hinder the ease of doing
business. At the organizational level, policymakers should prioritize appointing managers with higher managerial
ability to responsible positions. For managers, understanding the long-term benefits associated with ESG
practices is crucial, despite potential short-term challenges. While previous research often focused on specific
countries, regions, or industries, this study stands out by examining the relationship between ESG and FP across
multiple emerging economies and industries, offering more generalizable findings. Building upon Stakeholders'
Theory, the study extends Upper Echelon Theory and Institutional Theory to incorporate the roles of managerial
ability and institutional quality in shaping this relationship."