Stuart L. Gillan, Jay C. Hartzell, Andrew Koch, and ... - Pitt Business

model is consistent with the contention that firms caught cheating on CSR promises will earn
lower profits, while more responsible firms will earn higher profits as a reputational premium to
support good behavior. In contrast, the third Benabou and Tirole (2010) hypothesis is that CSR
develops because corporate executives and boards are engaged in these policies for their own
benefits. This implies a negative association between firm performance and CSR policies.
Of course, as noted by Benabou and Tirole (2010), empirical analyses of such issues are
subject to the problems of endogeneity, reverse causation, and non-mutual exclusivity of the
hypotheses. Keeping these caveats in mind, as a first step in this line of inquiry, we focus on the
associations between ESG and firm performance.
In Table II we report the results of tests examining the association between a firm’s
operating performance and its net KLD scores based on the individual components, E, S, and G.
Our proxy for firm performance is return on assets, measured as the ratio of Earnings Before
Interest and Taxes (EBIT) to Total Assets. We also include indicators for each Fama-French
(1993) 48-industry classification, so the estimated effects are industry-adjusted. The primary
focus is on the firm’s net KLD scores for environmental policies in Model (1), social
responsibility policies in Model (2), and governance policies in Model (3). In all specifications,
we control for firm size and the book-to-market ratio, include fixed year effects, and cluster
standard errors by firm. Specifically, we test the following model:
(1) EBIT/Assetst = + 1(ESG score)it + 2 ln(Market Value of Equityit-1) +ln(Market-to-
Book)it-1 +i,t + i,t
The results indicate a significant positive association between operating performance and
both the net environmental and governance scores. That is, firms that have stronger
environmental and governance polices in place tend to have better operating performance –
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