Forward‐Looking ESG Relevance and Corporate Performance: Evidence From Credit Ratings

ABSTRACT

How does the relevance of ESG issues relate to firm performance, and does ESG relevance moderate the relationship between ESG engagement and firm financial outcomes? Using a novel indicator introduced by Fitch Ratings, we provide new empirical evidence to answer these questions. The forward‐looking indicator measures the relevance of ESG issues to firms' credit ratings. It captures firms' financial sensitivity to ESG‐related issues from a credit‐rating perspective. Utilising a sample of 663 firms from 55 countries, we examine the relationship between ESG relevance, its subcategories and firm performance. We find that environmental relevance has a significant negative association with firm performance. The results are economically meaningful as a one‐standard‐deviation increase in the environmental relevance score associated with decreases in Tobin's Q and return on assets ( ROA ) by 5.7% and 11.9%, respectively. Furthermore, we investigate how ESG relevance interacts with ESG performance in explaining firm performance. We find that environmental relevance significantly weakens the positive association between environmental performance and firm financial performance. The association between ESG relevance and firm performance is primarily concentrated in environmental relevance, while the moderating effect is concentrated in Tobin's Q . The findings remain broadly robust to instrumental variable regressions, propensity score matching and alternative measures of firm performance. Further analysis of the disaggregated components of environmental relevance indicates that the negative association is primarily concentrated in the relevance of greenhouse gas emissions. Our findings provide important insights into why ESG relevance matters for investors and firm performance, an issue that is often neglected in the literature.