Sustainability in Focus: Exploring ESG performance and Financial Performance in SMEs vs large firms in the United Kingdom

Abstract

This study analyzes the relationship between Environmental, Social, and Governance (ESG) performance and Corporate Financial Performance (CFP), focusing on Small-Medium Enterprises (SMEs) compared to large firms. The study contributes to existing knowledge on ESG and firm’s profitability by delving into sustainability in SMEs. Using panel regression analysis on a sample of 355 listed United Kingdom (UK) firms from 2018 to 2022, the study explores how ESG practices influenced accounting-based profitability measurement - Return on Assets (ROA). The study examined ESG combined scores and their disaggregated components for a dynamic analysis. Moreover, corrected standard errors are used to address the issue of cross-correlations according to panel data.

The empirical findings revealed that the association between ESG performance and CFP varies depending on the analysis periods and firms’ ownership structure. While no positive association was observed between ESG and CFP for all firms, a significant convex relationship was identified in the case of SMEs. The study attributes its findings to the volatility of the COVID-19 pandemic, emphasizing that firms prioritize cash flow towards maintaining business operations over investing in ESG activities. The nonlinear relationship suggests that SMEs face significant investment costs when implementing ESG practices. A straightforward implication for the study indicates that decision-making regarding ESG investment in the UK during uncertain times should be carefully planned to avoid potential profitability trade-offs. Furthermore, the fact that corporate governance is the critical driver in the ESG–CFP relationship suggests that investing in ESG activities should be directed to this component.