This brief is part of the Insights @ Center for Emerging Markets, a publication focused on cutting edge ideas and advice for global leaders about emerging markets.

By Alvaro Cuervo-Cazurra (Northeastern University), Saptarshi Purkayastha (Indian Institute of Management Calcutta) and Kannan Ramaswamy (Arizona State University)

Identifying the Impact of ESG on Company Performance in Emerging Markets

Companies wonder if their environmental, social, and governance (ESG) investments really help financial performance. New research shows that they do, but that in emerging markets, corporate social investments have a larger positive impact on financial performance than governance or environmental investments. The reason is that social investments help create capabilities that more directly compensate for government failures in the provision of public goods and services needed by firms to operate efficiently. On their part, governance investments require complementary regulations and environmental investments that may not be observed easily or appreciated by customers, resulting in a limited impact on performance. In contrast, in advanced economies in which the government has a higher capability to provide supportive infrastructure and markets are more efficient, environmental investments are more likely to result in higher performance than social or governance ones because of their more direct connection to reputation.

This research also shows that ESG can not only help reduce the effect of market failures in emerging markets, but that this beneficial impact can also be accentuated when used together with other mechanisms that address market failures. The authors discuss two of them, business group affiliation and government policy nudges. First, affiliation to a business group (a collection of legally independent firms connected through common ownership and strategy) enhances the impact of ESG on performance. The reason is that business groups' capabilities and expertise not only help improve performance, but also the creation of economies of scale in ESG that reinforce their efficacy. Second, government policy nudges, or policies that encourage but do not mandate desired behavior, also strengthen the impact of ESG on profitability. Nudges lead managers to reevaluate their ESG investments and focus on those that are more likely to support firms' reputation and eventual performance.

The authors illustrate these ideas with an analysis of ESG programs for a sample of 89 publicly traded Indian companies from 2007 to 2017. They find that social initiatives have a larger positive impact on return on assets than governance or environmental ones. They also find that business group affiliation and the policy nudge, in the form of the passage of the Companies Act of 2013 (which encouraged but not mandated that companies set aside two percent of their profits for ESG programs), reinforce the impact of social initiatives on performance more than the other investments.  

Taken together, these findings suggest that the financial implications of ESG initiatives depend on the institutional conditions of the country. In an emerging market, market and government failures tend to be common. Thus, ESG is not just a tool to improve responsiveness to stakeholders concerns but also a mechanism for addressing these failures. Social investments are a more direct solution to government failures, helping not only improve the quality of life of local communities but also firms' bottom lines.

Managerial Implications: How Emerging Market Firms Benefit from Social Programs
  • An important managerial implication from this work is that companies' social initiatives in emerging markets are particularly well suited to help them address market and government imperfections and failures in a manner that improves the quality of life of their communities and has many positive spillovers for their bottom line. Creating healthcare facilities on-site, founding and operating technical training schools, and providing access to clean drinking water and safe housing improve the quality of life for local communities, while also helping companies access a healthier, better trained, and motivated labor force. By improving their community standing and reputation as positive corporate citizens and contributors to local communities, companies can recruit better workers, sell more products, and win preferential treatment from local officials.

Original Article

Cuervo-Cazurra, A., Purkayastha S. & Ramaswamy, K. Variations in the Corporate Social Responsibility-Performance Relationship in Emerging Markets. Organization Science, Forthcoming. 


If you are interested in learning more about this work, contact Professor Cuervo-Cazurra.