Effect on Environmental, Social and Governance (ESG) Criteria on the
Firm Profitability of Listed Companies in Malaysia
NUR SHAHIRA BTE SHAHRUN, SUGANTHI RAMASAMY, YUEN YEE YEN
Faculty of Business,
Multimedia University,
Ayer Keroh, Melaka,
MALAYSIA
Abstract: - This paper analyzes the effect of ESG criteria on the firm profitability among Malaysian listed
firms. Firm-specific variables such as firm size, revenue growth, and leverage were also included in the
analysis. A total of 42 companies from Bursa Malaysia are selected from Bloomberg’s database that has
complete ESG scores data from 2011-2021. Firm profitability was measured using ROA and ROE. Using panel
data analysis, this study found that ESG scores have a significant positive influence on firm profitability.
Meanwhile, Social Score individually has a significant negative impact on firm profitability. Individual
Environment and Governance scores do not have a significant relationship with firm profitability. Leverage and
firm size significantly negatively affect firm profitability.
Key-Words: - Environmental, Governance and Social (ESG), firm profitability, ROA, ROE, firm size, leverage
1 Introduction
As corporations nowadays are pressured by the
competitive environment, the combination of ESG
criteria can assist in strengthening the firm
profitability. Supported by, [1], indicates that
corporates should have a strategic plan on ESG for
their future used to avoid zero value gain. The
study, [2], stated that many previous scholars,
practitioners, and policymakers have been involved
in a discussion about the need for a global
transition to create new opportunities to advance
the ESG systems. Additionally, ESG has so many
advances that it has become a concern to the public,
investors, and stakeholders in many countries
including Malaysia. ESG initiative has drastically
increased, and many corporations aim to apply
ESG criteria.
Furthermore, [3], stated that the Malaysian
government has steadily encouraged corporates to
enhance their overall standard of life such as
exercising Corporate Social Responsibility (CSR),
particularly in improving the quality of living to
minimize the risks of pollution and be more
concerned about the environment. Thus, this
research aims to study the effect of ESG Criteria on
the firm profitability in Malaysia.
Environmental criteria, which are included in
ESG, are mainly focused on evaluating and
mitigating risks that may result in environmental
degradation, such as avoiding pollution that
contributes to climate change or utilizing animal
experimentation. According to, [4], Malaysia is
confronted with environmental health issues as a
consequence of industrial emissions that contribute
to pollution, climate change, and ozone depletion.
Added by, [5], Malaysia's ecology is deteriorating.
According to 2017 statistics from the Department
of the Environment (DOE), 219 (46 percent) of 477
rivers surveyed were deemed to be clean, 207 (43
percent) to be mildly contaminated, and 51 (11
percent) to be polluted, a little rise from 2011
levels. The study, [6], noted that in June 2019,
approximately 2000 individuals and 111 schools
were forced to shut down owing to water
contamination in the Pasir Gudang River in Sungai
Kim. As a result, the report recommends that
corporations in Malaysia embrace Corporate
Environmental Responsibility (CER). Given that
environmental health has become a critical concern,
organizations need to make more effort to mitigate
environmental hazards in their operations.
Effective social criteria include safeguarding
human rights, promoting equity, and managing
relationships among workers, suppliers, and
consumers. On the other hand, without a suitable
structure, preserving social standards may be
difficult. The study, [7], asserts that corporations
that adhere to ESG criteria demonstrate excellent
governance, a greater concern for the environment
and sustainable development, increased earnings,
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DOI: 10.37394/23207.2024.21.22
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Suganthi Ramasamy, Yuen Yee Yen
E-ISSN: 2224-2899
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and may have lower-cost funds. According to, [8],
corporate social responsibility (CSR) activities tend
to increase the firm cost thus leading to an
economic disadvantage position. Supported by, [9],
indicated that ESG criteria procedures were seen as
a cost, and it surpassed the legal minimum
requirements. Nevertheless, past researchers have
also encouraged the value-enhancing theory that
CSR and ESG activities do enhance firm
performance. Earlier evidence focused more on
ESG criteria only on firm performance. The study,
[10], discovered that the current status of ESG
criteria standards and the ESG effects in emerging
countries have not been well examined.
Meanwhile, corporations that adhere to a strict
governance standard would prioritize the fair
treatment of shareholders' rights, the disclosure of
corporate information, and the avoidance of
conflicts of interest in the selection of board
members. Thus, effective ESG standards have
advanced to the point that they have become a
source of concern for the public, investors, and
stakeholders. Following that, implementing
governance criteria may assist corporations in
having control over internal management functions
such as shareholder rights. Engaging in governance
yields benefits in terms of human capital, resources,
and firm value.
Besides that, Malaysia’s government is also
concerned with social and governance and
contributes many efforts in making sure corporates
in Malaysia practice and improve it. Therefore, it is
precisely that this study aims to study the effect of
ESG criteria to improve firm profitability in
Malaysia. Additionally, firm-specific factors such
as leverage, firm size, and revenue growth were
also included to strengthen the aim of this study.
Hence, the outcomes of this study will be useful for
the government to reduce the cost in the future and
further implement policies that would improve firm
profitability in Malaysia.
2 Literature Review
2.1 ESG Scores
Research on ESG practice has grown remarkably in
recent years. Corporations might face bad
performance by neglecting the ESG criteria.
Practicing ESG has become one way that the
government reinforced to show concern towards
the community and universe. As a result, applying
ESG practices in the operations can escalate the
corporation's image. The history of corporate
responsibility practice was ongoing way earlier.
However, ESG criteria were developed in early
2004 in response to a request by Kofi Annan,
United Nations secretary-general, [11]. In 2010, the
United Nations Environment Programme Finance
Initiative (UNEPFI) and the World Business
Council for Sustainable Development (WBCSD)
encouraged corporations to include ESG elements
in their decision-making to reduce risks. Moreover,
the Malaysian Code on Corporate Governance
(MCCG) statement in 2012 has promoted
sustainability and advised corporates to disclose
ESG in its annual report, [12]. Moreover, the
Securities Commission Malaysia (SCM) has
developed the Sustainable Responsible Investment
(SRI) Sukuk Framework to encourage responsible
finance and investment. Numerous organizations
define ESG and SRI differently, but the main goal
is to include ESG criteria in investing decisions.
Apart from that, the United Nations also
recommends that corporations disclose ESG
practices by 2030, [13].
Using data from firms in Germany, [14], found
that ESG has a positive effect on firm profitability.
The author also found that governance has a
significant effect on financial performance. Similar
findings were also noted by [15], who explored the
association between ESG performance and energy
market financial indicators. Using energy sector
China firms, they found that higher ESG
performance may have an impact on enhancing
their financial performance.
On the contrary, a study by, [3], found that the
relationship between ESG practices and firm
profitability is negative. The study, [16],
investigated more than 1000 papers published
between the year 2015 and year 2020 focusing on
the link between ESG and firm financial
performance. The paper found that 58% of the
papers showed a positive relationship between ESG
and financial performance, 8% showed a negative
relationship, 13% showed no relationship, and 21%
showed mixed results. They concluded that, while
the majority of the study showed positive results,
the outcome indicates ongoing disagreement on the
matter.
The study, [17], investigated the impact of
Environment, Social, and Governance (ESG) on
firm profitability. The findings showed that ESG
combined score, Environment score, Social score,
and Governance score have significant positive
relationships with company profitability. These
findings suggest that investing in high ESG
performance guarantees financial return in terms of
profitability.
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From above, it is shown that the outcome of
previous research on the study of whether ESG
criteria would improve firm profitability
significantly. However, due to the discrepancies
between the findings and those of the previous
study, the conclusions on whether ESG criteria
improve firm profitability cannot be drawn.
2.2 Leverage
Two main theories commonly relate to capital
structures: trade-off theory (TOT) and Pecking
order theory (POT). According to, [18], in terms of
opting for the capital structure, both approaches
point in inverse ways. There were many previous
studies done on these two theories. However, the
results have shown inconsistency. TOT states that
tax benefits of debt are balanced against bankruptcy
costs to determine the firm leverage. On the other
hand, POT argued that firms prefer to choose
financing sources in sequential order. Leverage is a
method that firms use to maximize the
corporation's funds and value involving debt and
the possibility of insolvency risk and bankruptcy.
The risks are due to the obligations to pay the debts
and interest to the debt providers. However, it is
said that the more the risks taken by businesses, the
greater the future returns. Therefore, there are
plenty of corporations that have applied this
method to expand their corporations. There are two
main types of leverage. The first primary type is
financial leverage, a sum of debt that the company
owes to fund the corporation's operations.
Meanwhile, the second primary type is operating
leverage which is a method that assists corporations
in managing their expenses, estimating the
corporate breakeven point, and assisting in the
determination of selling prices to avoid risks on
returns.
Many previous researchers have proved the
impact of leverage on corporate performance. The
authors in, [19], [20], studies have shown that
greater leverage leads the corporation to higher
performance. Greater leverage can quickly
implement financial measures, and great
investment, and high collateral assets would assist
the leveraged corporations to lessen the chances of
bankruptcy, [21]. A study by, [22], suggested that
leverage is one of the external factors that decision-
makers had used to reduce expenses. Low expenses
would lead to greater productivity of the
corporations. Moreover, [23], found a positive
correlation between leverage and financial
performance in Malaysia. Added to the study, using
more debt and a lesser equity capital ratio would
improve the financial performance. Thus, firms can
use investing in fixed assets to improve the
shareholder's value which also can be used as
collateral to the leverage, and through increased
leverage, it can boost the financial performance.
Apart from that, the findings of, [24], [25],
discovered a significant link between leverage and
firm performance. Furthermore, [26], stated that
corporates must make leverage decision making.
Meanwhile, [27], suggested that a good mix of debt
and equity will assist firms to have a long-run
profit.
On the contrary, research by, [28], examined
the relationship between leverage and financial
distress has shown a positive result which indicates
that firms with debts may have greater risks of
financial difficulty. The study, [29], stated that
higher leverage minimizes firm performance due to
complications in raising the equity. Furthermore,
corporations that have high leverage increase the
corporation risk level, [30]. Further, [31],
discovered varied and contradictory empirical
evidence on the impact of leverage. The study,
[32], found no evidence between growth prospects
and leverage in Malaysia. Equally important, [33],
stated that most of the studies ignore optimum
leverage in emerging countries, resulting in few
studies on the context of emerging economies and
placing them in a nascent stage. The study, [34],
found that approaches to identifying the ideal
leverage amount are still unrecognized.
2.3 Firm Size
Firm size is used as an independent variable to
measure whether it would contribute to improving
Malaysia's firm profitability. It should receive more
attention from the corporation as it is one of the
characteristics that affect corporations in many
aspects. Firm size has been categorized as micro,
small, medium, and large enterprises. The
differences between the sizes can be analyzed
based on the manufacturing and services. For
micro, the sales turnover is less than RM300,000 or
hired below five employees for both manufacturing
and services and other sectors. For small, the sales
turnover is between RM300,000 to RM15 million
or hired 5 to 75 employees for the manufacturing
sector, and sales turnover is between RM 300,000
to RM3 million or hired 5 to 30 employees for
services and other sectors. For medium, the sales
turnover is between RM15 million to RM 50
million or employed 75 to 200 employees for the
manufacturing industry and sales turnover is
between RM3 million to RM20 million or hired 30
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to 75 employees. Hence, any higher than the above
numbers are considered larger firms.
The study, [35], stated that firm size has an
impact on corporate financial performance. Besides
that, [36], stated that firm size positively affects
sustainability reporting. Supported by, [37],
concluded that firm size influenced the corporate
sustainable growth rate. The study, [38], indicated
that sustainability reporting allows corporations to
present clear statements of risks and opportunities.
The study, [39], indicated that larger firms have
bigger advantages in growing businesses. Thus,
firm size affects sustainable growth and affects the
profitability level of a corporation. A prior study
by, [40], showed that profitability becomes the
main concern in Malaysia because it involves other
related parties' concerns and firm size
characteristics can impact profitability Consistent
with prior findings, [41], found that firm size can
give outcomes to cost of capital, which impacts
investment decisions.
The study, [42], revealed that larger firms
have a lower risk of bankruptcy than small-medium
firms. Larger firms are commonly known to have
privileges such as diverse conducts to generate
revenues, economies of scale, and the ability to
invest more in marketing, which leads to lower
bankruptcy risks for the corporation. The study,
[43], found that larger firms have more advantages
in having adequate resources and better in applying
green supply chain management practices, which
leads to advanced performance. Moreover, larger
firms can present their products faster due to brand
recognition. It is also known that it can attract
customers faster than small and medium-sized
firms due to customer loyalty. Other than that,
having more extensive data guarantees that the data
is converted into useful information for the
business and would lead to better efficient decision-
making, [44]. Moreover, larger firms have more
data, which may give an advantage for the larger
firms to have the best image in front of the
investors. Supported by, [41], indicated that larger
firms are involved more in economic activity, have
longer firm histories, and have bigger data. Added
in the study, stated that larger firms could grow
rapidly due to the ability of investors to process the
big data. In line with the previous study, [45],
predicted that larger firms are more influential in
the market, and, [46], stated that it could speed
corporate growth due to the performance.
Despite the advantages of a larger firm, SMEs
have played a vital role in Malaysia. According to
Malaysia Prime Minister Tan Sri Dato' Haji
Muhyiddin bin Md. Yasin, in the annual report of
SME Insight 2019, SMEs have formed 98.5% of
business establishments and accounted for 38.9%
of the Gross Domestic Product (GDP).
Additionally, SMEs benefited from unemployment
issues as they employ 7.3 million people. Through
SMEs, the surplus of the workforce employees
from the larger firms can reinstate employment,
[47]. The government has shown support by
introducing many alternatives and assisting the
SMEs in Malaysia. PRIHATIN Economic Stimulus
Package and PENJANA Recovery Plans are the
initiatives introduced by the Malaysian government
to assist SMEs during the COVID-19 pandemic
that has landed and caused damages in 2020. The
2021 budget report stated that the Malaysian
government had invested RM38.7 billion to
advance and raise the SMEs in Malaysia.
3 Methods
The firms that are used in this study are the
corporates listed in Bursa Malaysia. 551 listed
companies were extracted from Bursa Malaysia for
the period 2011-2021, however, only 74 were
discovered on the Bloomberg website and only 45
companies have complete data. Since the study
only focused on construction, consumer products,
energy, finance services, healthcare, industrial
products, plantation, property, telecommunication,
and utilities industries, only 42 firms' data were
used in this study. Secondary data analysis was
used in this research. Firm profitability, leverage,
firm size, and revenue growth are calculated using
financial statements obtained from Bursa Malaysia.
ESG scores were extracted from the Bloomberg
database. In this research, the pooled least squares,
fixed, and random effect methods are utilized to
assess whether ESG, E, S, and G scores separately
and whether firm-specific factors impact firm
profitability. The Gretl software was used.
3.1 Firm Profitability
Increasingly, ROA/ROE approaches are utilized to
investigate the relationship between independent
factors and company performance. The study,
[48], found that ESG disclosure affects ROA and
ROE indicators of corporate performance.
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ROA = Net income / Average total assets
ROE = Net income / Average total equity
Thus, the ROA and ROE methods are applied using
the following formula.
4 Data Analysis
This study conducted the F test, Breusch- Pagan
and Hausman test to identify which regression is
the most appropriate. The result for both ROA and
ROE showed that fixed effect regression is the
most appropriate. Thus, this research will focus on
fixed-effect regression to explain the results.
4.1 The Impact of ESG, E, S, and G Scores
and Firm-specific Variables on ROA
Based on the result in Table 1, ESG scores have a
significant positive influence on firm profitability
(ROA). Leverage and firm size have shown a
significant negative influence on ROA meanwhile
revenue growth was found to be insignificant.
Table 1. Fixed-effects (ROA and ESG) using 386
observations
Based on the result in Table 2, E, S, and G
scores and revenue were found to be insignificant
toward the firm profitability (ROA). Leverage and
firm size have shown a significant negative
influence on ROA.
Table 2. Fixed-effects (ROA and E, S, G) using
386 observations
4.2 The Impact of ESG, E, S, and G Scores
and Firm-specific Variables on ROE
Based on the result in Table 3, ESG scores,
leverage, firm size, and revenue growth had
insignificant influence on firm profitability (ROE).
Table 3. Fixed-effects (ROE and ESG) using 386
observations
Based on the result in Table 4, E, G scores,
leverage, firm size, and revenue growth had
insignificant influence on firm profitability (ROE).
However, social, S scores have a significant
negative influence on firm profitability (ROE).
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Table 4. Fixed-effects (ROE and E, S, G) using 386
observations
5 Conclusions
Both ROE and ROE methods are increasingly
being used to analyze the link between ESG and
firm profitability. Measurement of a firm’s
performance among others to highlight its
significant benefit is still in substantial doubt about
the role of ESG in shaping the firm profitability.
This study has examined whether the ESG criteria
influence firm profitability.
Based on the result of this study, ESG scores
have significantly positively affected firm
profitability. When the ESG scores are higher,
firms’ profit is also higher. This is in contrast to the
findings by, [3], [49]. Social scores were also found
to be significantly negatively affecting firm
profitability. An inverse relationship is noted
between social scores and firm profitability. On the
other hand, Environmental and Governance scores
do not significantly impact firm profitability.
Leverage and firm size significantly negatively
affect firm profitability. As leverage becomes
lower, firm profitability becomes higher. Evidence
also shows that smaller firms are more profitable.
Acknowledgment:
The authors would like to thank the Ministry of
Higher Education (MOHE) for the FRGS grant
sponsorship in publishing this paper.
FRGS/1/2020/SS01/MMU/02/10.
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WSEAS TRANSACTIONS on BUSINESS and ECONOMICS
DOI: 10.37394/23207.2024.21.22
Nur Shahira Bte Shahrun,
Suganthi Ramasamy, Yuen Yee Yen
E-ISSN: 2224-2899
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Contribution of Individual Authors to the
Creation of a Scientific Article (Ghostwriting
Policy)
The authors equally contributed to the present
research, at all stages from the formulation of the
problem to the final findings and solution.
Sources of Funding for Research Presented in a
Scientific Article or Scientific Article Itself
The authors would like to thank the Ministry of
Higher Education (MOHE) for the FRGS grant
sponsorship in publishing this paper.
FRGS/1/2020/SS01/MMU/02/10.
Conflict of Interest
The authors have no conflicts of interest to declare.
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n_US
WSEAS TRANSACTIONS on BUSINESS and ECONOMICS
DOI: 10.37394/23207.2024.21.22
Nur Shahira Bte Shahrun,
Suganthi Ramasamy, Yuen Yee Yen
E-ISSN: 2224-2899
247
Volume 21, 2024
