Research - 03.10.2023 - 08:00 

How does competitive pressure shape a firm’s ESG performance?

In the face of competitive pressure, is there a trade-off between a company’s financial performance and its commitment to environmental, social, and governance (ESG) activities? Is ESG a source of competitive advantage, or do firms simply spend other people’s money on sustainability to become “good”? A study by HSG Assistant Professor Vesa Pursiainen.
Source: HSG Newsroom

Do businesses operating in especially competitive environments have an incentive to invest more in ESG to set themselves apart from their peers? Or does the competitive pressure force management to focus on profits and cut back on sustainability?

A new paper by HSG Assistant Professor Vesa Pursiainen and Hanwen Sun and Yue Xiang at University of Bath, seeks to look at the relationship between market competition and a company’s ESG scores. Numerous academic studies suggest that environmental, social, and governance (ESG) activities can give firms a competitive advantage. This could be because customers, employees, and investors value ESG. There is also evidence that good ESG performance can enhance a firm’s access to capital markets. Yet, better ESG performance entails costs and could represent a trade-off against other potential uses of funds. Competitive pressures may exacerbate these constraints, compelling firms to prioritize the core needs of their operations instead of focusing on sustainability. 

A look at ESG scores

The researchers used ESG scores from Refinitiv Eikon to measure ESG performance and a product fluidity index, based on product text descriptions, to determine the similarity between a company’s products and their rivals’. A higher product fluidity rating suggests that a firm’s products are closer to its competitors’ products, indicating more competitive pressure. They also looked at firms’ exposure to rising Chinese imports to determine an increase in foreign competition.

More pressure leads to less sustainability

The main finding of the paper is that firms under greater domestic and foreign competitive pressure have lower ESG scores. The study also showed that an increase in import competition is associated with a reduction in ESG scores over time. The data indicated that heightened competition reduces ESG investment due to constraints on capital allocation. The more competition there is within an industry or sector, the less those companies focus on ESG performance, indicating that firms see a trade-off between ESG and other investment needs.

To see how changes in competitive pressure affect ESG investment, researchers looked at the economic shock that took place in 2001 when China joined the WTO and there was a surge in Chinese imports into the United States. In line with the domestic competition findings, data here also demonstrated that an escalation in export competition from China is associated with significant reductions in firms’ ESG scores. This suggests that firms with less exposure to competition may have more latitude to make ESG investments.

Overall, the findings suggest that businesses perceive a trade-off between profitability and ESG – at least in the short term. Increased competitive pressure does not lead to increased investment in ESG but instead appears to result in a decrease in ESG activities. Hence, while competition undoubtedly fosters positive outcomes such as lower prices and enhanced quality, it may also bear potentially negative societal consequences by diminishing a firm’s commitment to sustainability. These finding should also influence policymakers attempting to balance antitrust concerns with calls for more sustainable businesses. 

The study entitled “Competitive Pressure and ESG” can be found on the Social Science Research Network website.

Vesa Pursiainen is assistant professor at the University of St.Gallen and the Swiss Finance Institute (SFI-HSG).
Hanwen Sun is associate professor of Finance at School of Management, University of Bath.
Yue Xiang is PhD candidate in Management (Finance and Accounting) at University of Bath.

A similar post was first published on Columbia Law School's Blue Sky blog

Image: Adobe Stock / Parradee