ESG - Performance and Corporate Investment Efficiency: Evidence from European Firms

This thesis analyzes the link between Environmental, Social, and Governance (ESG) performance and the efficiency of European firms in investments. Although ESG activism has been considered a means to enhance long-term transparency and value creation, it is controversial whether and how it impacts the efficiency of firms in capital allocation. Having a panel dataset of European listed firms for the period 2012-2024, Refinitiv Eikon ESG scores are combined with firm-level financial data to construct investment inefficiency measures based on the Biggerstaff et al. (2021) residual model. Panel regressions are utilized to test if ESG performance lowers overall investment inefficiency and specifically the risks of over- and under-investment. The research also examines heterogeneity between firm size and the impacts of the COVID-19 crisis as an exogenous shock. The evidence provides strong and uniform results, suggesting that better ESG performance contributes to reduce underinvestment, increasing the availability of financing for firms and reducing information asymmetry. However, the study provides weaker evidence that ESG contributes to reduce overinvestment, suggesting that it’s much more difficult to limit excessive investments by the managers, who sometimes invest more than what it would be necessary. Given the fact that ESG factors seems to be context-dependent, the study focused even to test the trend under stressed conditions, discovering that the beneficial effect of ESG in reducing inefficiency is robust during the COVID-19 period, emphasizing the relevance of the ESG factors during times of high uncertainty. In general, the study demonstrates that ESG has effects on trying to reduce financing frictions, but they don’t contribute to reduce managerial opportunism. The thesis makes a contribution to the research on ESG in the European context in which the institutions have been working a lot in sustainability issues. The findings have broad implications for managers, investors, and regulators, and indicate that ESG is capable to increase the efficiency of capital allocation, in particular reducing underinvestment.