Competition and ESG practices in emerging markets

Henrique C. Martins

2021-04-05

Motivation

Over the last few years, there is a massive interest in corporate ESG decisions (disclosure and performance) from academia and practitioners.

To invest more in ESG practices, corporations are facing pressure from:

Investors (Matos, 2020),
Public opinion (Baldini, Dal Maso, Liberatore, Mazzi, & Terzani, 2018),
And peers (Cao, Liang, & Zhan, 2019)

However, antecedents and consequences of ESG practices are not well defined in the literature.

There is still a debate whether such practices increase or decrease firm value, for instance.

Motivation

The literature has two main hypotheses to explain why managers invest in ESG practices

1) The altruist/agency conflict argument

It says that ESG practices are value-decreasing decisions and, thus, a form of agency conflict.
The main reason managers invest in such practices is altruism.
- I.e., they pursue some form of personal reputation.

Motivation

2) The strategic argument

It says that ESG practices are value-increasing decisions and, thus, a way to differentiate from competitors. “Escape from competition” effect.
The main reason managers invest in such practices is to find value in ‘non-traditional’ ways.

Literature shows conflicting evidences: Barnea and Rubin (2010), Borghesi et al. (2014); Fernández-Kranz and Santaló (2010), Flammer (2015a), and Vural-Yavaç (2020).

But in Emerging Markets

The ‘Escape from competition argument’ is less likely to hold, because:

Worse Investor protection, higher agency problems
Poor institutions, high corruption
Corporate practices are more opaque

Thus, stakeholders are less likely to evaluate correctly the returns of strategies based on ESG practices, even profitable ones.

Hypothesis 1: Competition is negatively associated with corporate ESG practices.

Hypothesis 2: An increase in competition decreases corporate investment in ESG practices.

Shock in Competition: Brazil 2015

Beginning of a presidential impeachment
Negative GDP growth of about 3.5%
Skyrocketing inflation of about 10.5%
Decrease in exports and imports of goods and services of around 14% and 24%, respectively.

Shock in Competition: Brazil 2015

Source: World Economic Forum.

Sample

Sample of 5.971 firm-year observations for 22 emerging economies (Kearney, 2012)
Period: 2011-2019
Database: Thomson Reuters Eikon
- Financial and ESG data
Two types of models:
- Either Firm FE or Country & Industry FE
- DiD: Brazil (treatment), 21 emerging markets (control), shock in 2015.
- Yearly propensity-score matching over the observables, with and without replacement.
Ind. Var.: Competition is the Herfindahl-Hirschman index

Countries

Brazil is not different than sample average

Models

Model 1:

\(ESG_{i,t} = β_1 + β_2 × Competition_{i,t-1} + β_3 × Size_{i,t-1} + β_4 × MtB_{i,t-1} + \\ β_5 × Leverage_{i,t-1} + β_6 × Capex + RD_{i,t-1} + β_7 × ROA_{i,t-1} + \\ β_8 × Cash_{i,t-1} + ϕ_{time} + ϵ_{i,t}\)

Model 2:

\(ESG_{i,t} = β_1 + β_2 × Treated (Brazil) + β_3 × After (2015) + \\ β_4×Treated (Brazil) × After (2015) + β_5 × Size_{i,t-1} + β_6 × MtB_{i,t-1} + \\ β_7 × Leverage_{i,t-1} + β_8 × Capex + RD_{i,t-1} + β_9 × ROA_{i,t-1} + \\ β_{10} × Cash_{i,t-1} + ϕ_{time} + ϵ_{i,t}\)

Main Results (Model 1)

Main Results (Model 2 - pre-matching)

Main Results (Model 2 - post-matching)

Main Results (Robustness and Falsification)

Robustness: Excluding China

Falsification: “Shock” in Latin America Countries, instead of Brazil

Placebo tests (alternative Y’s)

Conclusions

Product market competition leads to worse ESG practices in emerging markets.

When competition increases, firms make trade-offs between alternative investment strategies.

Which penalizes those assumed as less profitable in the short-term, such as ESG-related practices.
- Especially, E and S. Findings of G are more ambiguous.

Results contradict US-based findings: Fernández-Kranz and Santaló (2010), Flammer (2015b), and Leong and Yang (2020).
- This is the interesting part of this article.

Managers from emerging markets decrease ESG performance to face more challenging and uncertain times, supporting the view that they invest in these practices for altruistic purposes.

THANK YOU!

Henrique Castro Martins