1. Introduction
Green development and the idea of sustainability are the current trends in economic development. Sustainable development, as defined by the World Commission on Environment and Development (WCED), is “development that meets the needs of the present without compromising future generations’ ability to meet their own needs”. Demanding green development and sustainable development is essential for the ecological environment and social economy because unsustainable exploitation and the consumption of natural resources will lead to ecological damage and a loss of biodiversity, which will ultimately endanger human survival. The concept of ESG was first introduced by the United Nations Global Compact (UNGC) and 20 financial institutions in a report entitled “Who Cares Wins” published in 2004 to promote a more environmentally conscious orientation when considering social responsibility and corporate governance, and is the cutting-edge form of the sustainability concept. ESG comprises three pillars: environmental, social, and governance, which, in addition to economic benefits, takes into account the concern for environmental and social sustainability, focusing on stakeholder benefits and long-term value growth. The study and promotion of the ESG concept is important to promote high-quality economic growth and sustainable social development.
It is commonly believed that investments in ESG can provide numerous benefits to companies [
1], including a reduction in corporate risk [
2,
3], a decrease in the cost of capital [
4,
5], and an improvement in financial performance [
6,
7], non-financial performance [
8,
9], market performance [
10], and corporate value [
11,
12]. Investment ability, investment opportunity, and investment willingness are the main factors that influence firms to make investment decisions. ESG can alleviate the financing constraints faced by firms and enhance their investment ability, and a good relationship with stakeholders can bring more investment opportunities for firms; meanwhile, the risk mitigation effect and corporate governance effect of ESG can enhance management’s willingness to invest, therefore, reasonable expectation of corporate ESG performance can enhance the level of corporate investment. A review of the existing literature shows that no research has yet explored the relationship between ESG performance and corporate investment level. However, it is important to examine the relationship between them. First, investment decisions involve the allocation of core corporate resources and are an important part of corporate strategy, which is crucial for building corporate core competitiveness, generating cash flow, and enhancing share-holder wealth. Secondly, corporate investment is the basis of economic operation, and improving the level and efficiency of corporate investment is essential to enhance the sustainable development of the economy and society. Based on the above analysis, this paper intends to investigate whether corporate ESG performance can improve corporate investment levels, and at the same time, to investigate whether the degree of regional marketization plays a moderating role by taking advantage of the good opportunity brought by the uneven development of China’s regions [
13,
14]. Based on Chinese A-share listed companies from 2009 to 2021, we examine the relationship between ESG performance and investment, as well as the moderating role of marketization. The findings indicate that (1) ESG performance can significantly increase a company’s level of investment; (2) in regions with higher marketization, ESG performance is more effective in signaling, economic utility, and alleviating financing constraints. Consequently, the effect of ESG performance on investment enhancement is greater; and (3) the economic consequence analysis demonstrates that the investment induced by ESG performance is commensurate with the current state of firm development and will improve investment efficiency. The mediation test demonstrates that financing constraints and agency costs act as a mediator between ESG performance and investment level. An analysis of heterogeneity reveals that the effect of ESG performance on investment level is greater in firms with a smaller size, non-state status, weaker internal control, and in firms that are audited by non-big4 accounting firms.
The research contributions of this paper may include the following: (1) This study advances ESG research. Corporate ESG research includes studies of the drivers and economic consequences of ESG investments made by firms. The investment level is of great importance to companies, the economy, and society, and it is valuable to explore the relationship between corporate ESG performance and investment levels. This paper would contribute to the literature on the economic effects of corporate ESG by examining the relationship between ESG performance, investment level, and investment efficiency, as well as the moderating role of regional marketization. (2) The research on investment level is expanded in this paper. Existing research has concentrated on examining the relationship between a single factor of environmental, social, and governance and the degree of business investment due to the significance of increasing investment levels for economic development. Nevertheless, the interaction between environmental, social, and governance may result in discernible differences between the combined dimension and the single dimension in terms of investment level impact. For example, the positive impact of social aspects may counteract the negative impact of governance deficiencies, causing the impact effect of the integrated dimension to be obscured. This article explores the relationship between investment level and environmental, social, and governance factors. It suggests that despite the possibility of counteracting effects, the combined dimensions still have a positive impact on investment levels, and this paper will be a valuable addition to the literature on investment levels. (3) This paper will provide empirical evidence that regulators can use to better guide businesses in their application of ESG concepts. The investigation of the relationship between ESG performance and investment level and the analysis of the moderating effect on marketization enlightens regulators to modify ESG practices and information disclosure policies in accordance with regional marketization, which is conducive to the government and regulators’ full exercise of their guiding role, the advancement of the ESG concept, and the high-quality development of the economy.
2. Review of Literature and Hypotheses
According to the MM theory, firm investment and financing decisions are independent in a perfect market [
15]. However, the real capital market is imperfect, and information asymmetries and transaction costs result in higher external financing costs than internal financing costs, causing firms to prioritize internal financing channels when raising capital for new projects [
16,
17]. Consequently, financing constraints become a significant factor limiting firm investment [
18]. Since ESG information disclosure has become a public demand [
19], companies can respond to this demand by proactively disclosing ESG information to reduce the information asymmetry between them and external stakeholders related to corporate sustainability, thereby enhancing the transparency of corporate sustainability strategies and alleviating companies’ financing constraints [
20,
21]. Due to the preference of socially responsible investors for firms with superior ESG performance, firms can reduce their cost of capital by increasing ESG investments [
2,
22]. Increasing ESG investments can also improve firms’ credit ratings, which reduces their capital costs even further. In addition, compared with social performance, the cost of the capital reduction effect of environmental performance and governance performance is greater, and the level of investor protection and the quality of information disclosure in the nation will both positively influence the cost of the capital reduction effect of ESG performance [
4,
5,
23,
24]. Therefore, firms with superior ESG performance can liberate capital by reducing the degree of information asymmetry with external investors, enhancing their capacity to make investments, and increasing the level of corporate investment.
Companies with superior ESG performance can signal to the outside world that they are highly capable and willing to uphold their implicit contracts [
25], which helps them establish a relatively stable relationship of trust with their stakeholders. This trust relationship will serve as “insurance” during a crisis, enabling the organization to attract more investment from its stakeholders [
26,
27]. Active engagement in ESG activities can also create and maintain a strong social network with stakeholders, which helps to increase trust between businesses and stakeholders and promotes the accumulation of social capital, which can create new investment opportunities for businesses [
28]. Therefore, good ESG performance facilitates the establishment of trust and network relationships with stakeholders, thereby increasing investment opportunities and boosting the investment level of companies.
Uncertainty increases the value of waiting for new information, and firms will invest only if the cost of delaying project investment is greater than the value of waiting for new information [
29]. Bloom et al., Pàstor, and Veronesi suggested that firms invest more cautiously in the face of political uncertainty and typically respond by reducing investment [
30,
31]. Similar to developed economies, Wang et al. discovered a negative relationship between economic policy uncertainty and firm investment levels in transitional economies such as China. Specifically, firms with higher asset returns, predominantly internal financing, and that are non-state owned are less susceptible to economic policy uncertainty in terms of investment levels [
32]. Czarnitzki and Toole discovered that when market return uncertainty increases, firms invest less in research and development [
33]. Uncertainty is strongly and positively correlated with risk. Existing research has demonstrated that ESG investments can reduce systematic and unsystematic risk [
2,
3,
22,
27,
34,
35] and litigation risk [
22], and protect firms from downside risk [
36]. Therefore, improved ESG performance can increase the investment propensity of management.
Corporate ESG performance increases management’s investment propensity not only by reducing investment uncertainty, but also from the perspective of corporate governance. Investing in ESG enables businesses to actively share the benefits of corporate growth with their stakeholders [
37], increase stakeholders’ affiliation with the business [
20], increase participation in corporate governance, which ensures management is held accountable by shareholders and stakeholders, and reduce management opportunism and agency costs. Large investments in ESG-related expenditures by companies may have a negative short-term impact because ESG-related investments frequently require more resources and effort, and corporate social responsibility, advertising, and R&D expenditures are characterized by a long investment cycle in which the specific amount of expenditures can be determined at the moment, but it is uncertain whether and when costs will be recovered or benefits achieved [
38]. Under the pressure of stakeholder monitoring, management will have a greater propensity to invest in projects with more stable investment returns, and corporate investment levels will rise. Consequently, companies with superior ESG performance can increase management’s willingness to invest by reducing agency costs, thereby increasing corporate investment levels.
In conclusion, companies with a superior ESG performance disclose more information, the information asymmetry between companies and external investors is reduced, and the cost of external financing is reduced. Companies are subject to fewer financing constraints, their investment capacity is enhanced, and the level of investment also rises. Second, companies with a superior ESG performance have a greater ability and willingness to fulfill implicit contracts and can establish solid trust and network relationships with stakeholders, thereby attracting more investment opportunities and increasing the level of corporate investment. Lastly, companies with a better ESG performance are typically less risky, have less investment uncertainty, and have a higher investment propensity among firm management. Meanwhile, companies with a superior ESG performance have a larger stakeholder base, more management oversight, and lower agency costs. Management, which is overseen by shareholders and other stakeholders, has increased its willingness to invest to mitigate the short-term negative impact of ESG investment spending on corporate profitability, resulting in a rise in investment levels. The following hypothesis is proposed based on the preceding analysis:
Hypothesis 1 (H1). In comparison with firms with poor ESG performance, firms with better ESG performance have a higher investment level.
Companies interact with stakeholders through ESG investments, and the interaction space, that is, the market in which they are located, will have a significant impact on the economic effects of ESG performance. China’s vast geographical region and unbalanced regional development provide a good context for studying the impact of the marketization process on the relationship between ESG performance and investment levels. According to Wang et al., regional marketization encompasses the relationship between the government and the market, the development of the non-state economy, the degree of product market development, the degree of factor market development, and the development of market intermediary organizations and the legal institutional environment [
39]. We intend to examine the impact of regional marketization on the relationship between ESG performance and investment levels from the current perspective of these subitems. Initially, the government-market relationship will have a negative impact on the financial constraint relief effect of ESG performance. Bank lending decisions may be affected by government intervention. Yan et al. used the natural experimental opportunity provided by the different responses of Chinese interbank associations in Shanghai and Tianjin during the 1934 “Silver Boom” in the 1930s to test the impact of government intervention on the performance and behavior of financial organizations. The study determined that the Shanghai Interbank Association, which was closer to the Nanjing National Government than the Tianjin Interbank Association, was subject to greater government intervention and greater transparency of bank information, and therefore did not experience a market run during the crisis. In contrast to the Tianjin Interbank Association members, who reduced lending to control risks, the Shanghai Interbank Association members increased lending to the market due to their bailout responsibilities and engaged in vigorous countercyclical operations [
40]. In regions with greater government intervention, companies with better ESG performance have reduced information asymmetry with external investors, particularly banks, by enhancing information disclosure. Nonetheless, because banks’ lending decisions are more influenced by the government than by the market, the financial support available to companies with better ESG performance is still less under the condition that the capital stock is determined, and the effect of ESG performance investment level enhancement is severely constrained.
Second, regions with developed non-state-owned economies and higher product and factor market development have a more competitive market, and ESG can be used by businesses to increase their market competitiveness. Researchers discovered that the relationship between socially responsible performance and firm value is influenced by the firm’s market, specifically the consumer goods market. When the market is related to products, society, and the environment, companies have a greater need to differentiate themselves from competitors, the need for companies to make socially responsible investments is greater, and companies benefit more from such investments [
41,
42]. Using a scenario of massive import tariff reductions in the U.S. manufacturing sector between 1992 and 2005, Flammer investigated the relationship between market competition and CSR in a quasi-natural experiment. The study found that domestic firms responded to the increased competition caused by the entry of foreign firms into the domestic market by maintaining good relationships with local consumers, employees, and other stakeholders [
43]. This lends credence to the notion that CSR is a competitive strategy and that trade liberalization is a major factor influencing corporate ESG practices. When the market is more competitive in the region where a company is located, the need for firms to differentiate themselves from other competitors increases, and this increased need amplifies the impact effect of ESG performance, thereby increasing the company’s benefits [
41].
Finally, the evolution of market intermediaries and the legal institutional environment may influence the effect of ESG performance on investment levels by influencing the role of signaling. Spence was the first to propose signal theory to explain the adverse selection problem between employers and job applicants on the labor market as a result of information asymmetry [
44]. Economics, Management, and Sociology have made extensive use of it. Two important conditions must be met for the signal theory to be effective: first, the information superior party must release the signal on its own volition, which is non-coercive. Second, the signal must be expensive and difficult to imitate by businesses without this information advantage. In a highly competitive environment, businesses are incentivized to release proactive signals that they have made ESG-related investments. The better the ESG performance of a company, the more likely it is to release relevant information proactively, and the more detailed the information released. In regions with more developed market intermediaries and a more favorable legal climate, regulators are more responsive to false information and are more likely to punish it. Therefore, companies with poor ESG performance are expected to bear higher costs for “green washing” by disclosing false ESG information, which will further ESG practices and disclosures for companies with significantly better ESG performance. Investors have a greater degree of recognition of corporate ESG ratings, and ESG performance has a larger influence on investment levels.
In conclusion, the degree of marketization in the region where the company is located will have a substantial impact on the effect of ESG performance on investment level enhancement. Government intervention affects financial institutions’ lending decisions, which weakens the release effect of ESG performance on financing constraints and has a significant effect on companies’ investment decisions. The growth of the non-state economy and the extent to which product and factor markets have evolved have made the competitive environment more difficult for businesses. Consequently, businesses are under increased pressure to enhance their competitiveness by increasing their ESG investment, and this increased pressure amplifies the economic impact of ESG performance. In the meantime, the intense competitive environment and improved legal environment influence the relationship between ESG performance and investment level by affecting the signaling effect. The following hypothesis is proposed based on the preceding analysis:
Hypothesis 2 (H2). In comparison with firms located in regions with a lower level of marketization, the influence of ESG performance on investment level is more significant in firms located in regions with higher level of marketization.
7. Conclusions
We investigate the relationship between corporate ESG performance and investment level in light of the rapid growth of ESG. By disclosing more information, companies with better ESG performance can reduce information asymmetry with external investors, alleviate financing constraints, and improve investment capability. They can increase investment opportunities by establishing stronger relationships of trust and networking with stakeholders. In addition, they may increase management’s willingness to invest by reducing risks and agency cost. When companies are located in regions with a higher degree of marketization, the investment enhancement effect of ESG performance is more significant. Further analysis reveals that the level of investment caused by ESG performance is consistent with the company’s current development, resulting in an increase in investment efficiency. The mediation test demonstrates that ESG performance increases the level of corporate investment by easing financing constraints and decreasing agency costs. An analysis of heterogeneity reveals that ESG performance is more likely to alleviate financing constraints, reduce agency costs, and ultimately increase investment levels in firms that are a smaller size, are not state-owned, have lower internal control standards, and are audited by non-big4 accounting firms. After a series of robustness tests, the conclusions of this paper are still reliable.
Firms should enhance their ESG strategies and processes. As high ESG performance could relax financing constraints and reduce agency costs, thereby improving investment expenditure and investment efficiency, firms should integrate ESG deeply into all operation processes, improve ESG to build a differentiated competitive advantage, and ultimately achieve long-term sustainable growth and shared value creation. In addition, under the circumstances of less government intervention, greater competitive pressure, and better legal environments, ESG may play a better role in mitigating financing constraints and improving investment efficiency, and firms are more willing to use ESG performance as a competitive tool; therefore the government should reduce intervention in the enterprise, let the market play the role of resource allocation, improve the legal system, strengthen ESG information disclosure, such as making the requirement that companies should disclose ESG reports on time in the Securities Law or Measures for the Administration of Information Disclosure by Listed Companies, and gradually promote the implementation of ESG relevant policies.
Our study is limited because we use listed companies from China as a sample, and it is not clear whether the results are applicable to firms from other countries. Further research may extend our analysis by using a sample of firms from countries that have different characteristics compared with China. In addition, further research may also include the use of continuous ESG proxy variables for analysis.