ESG and Dividends: How law and ESG controversies shape dividend payouts
There is an increasing investor focus on the impact of environmental, social, and governance (ESG) considerations on corporate decision-making. In my study co-authored with Satish Kumar, ‘ESG Performance and Dividend Payout: The Moderating Role of ESG Controversies and Legal Systems’, we re-examine this crucial link in a cross-country setup, focusing on the dividend policy adopted by firms. We further study the influence of the dimensions, such as Investor protection and ESG controversies, on the dividend-paying capacity of firms. This study utilises a comprehensive sample of 2344 firms in G20 countries, covering the period from 2011 to 2022.
Firms engaged in ESG-related activities benefit through increased engagement with different stakeholders. This benefit manifests in the form of higher business revenues and lower perceived risk for businesses, due to better stakeholder relationships. In such an environment, the business would thrive, resulting in higher profits earned, which ultimately accrue to the shareholder. We find, in line with extant research, that increased earnings resulting from investing in ESG activities provide more cash to the firms, allowing firms to pay higher dividends to shareholders, without sacrificing investments for growth. Not just the overall ESG score, even the governance, social, and environmental pillars individually contribute to higher dividend payouts, indicating that the overall ESG framework plays a crucial role in shaping corporate financial decisions.
Often, firms are engulfed in controversies around their initiatives that are perceived to negatively impact the environment, society, or governance (ESG) aspects. In light of such controversies, the business is likely to be impacted, thereby reducing the profit pool for paying dividends. While we do find a reduction in dividends on account of ESG controversies, the impact of ESG controversies is dampened when the ESG scores are high. This is akin to a high ESG score providing insurance coverage for dividend payments in the face of ESG controversies.
The extant literature suggests that legal systems within the country play a critical role in investor protection. It has been seen that countries with a common law system tend to offer stronger shareholder rights than countries with civil law systems. Thus, stronger investor protection leads to higher dividends for shareholders in common law jurisdictions. Our research extends the idea of how companies distribute the ESG benefits to their shareholders through dividends, through the lens of investor protection available to shareholders in each country. We find that in common law countries, the stronger investor protection further increases the dividends paid to the shareholders, driven by a higher profit pool on account of better stakeholder interaction due to ESG activities. Investors in civil law system countries, with weaker investor protection, are unable to push the managers to share the increased profit pool.
Businesses need to understand that investments in ESG activities lead to positive outcomes. Managers should recognise that integrating ESG into business strategies can enhance firm value. Firms need to acknowledge that dividend policy is influenced by stronger investor protection mechanisms. Firms in common law countries need to prioritize dividend strategies to maintain investor confidence and compliance with shareholder-friendly regulations. Policymakers should take into account the role of legal systems in shaping corporate financial behaviour. Strengthening regulatory frameworks to promote ESG disclosure and responsible business conduct can enhance investor protection and encourage firms to adopt sustainable financial policies. Global investors need to evaluate not only a company’s ESG performance but also the legal context of the country in which the firm operates and any existing ESG controversies surrounding the firm. This comprehensive assessment can provide the investor with a more accurate picture of a company’s financial health and commitment to sustainable practices.
In conclusion, the paper addresses the relationship between ESG performance and corporate dividend policy in G20 countries. We emphasise the significance of country-level institutional factors, such as the legal environment, to enrich our understanding of the relationship between ESG performance and dividend payout. Firms facing ESG controversies exhibit lower dividend payouts, yet those with high ESG scores mitigate the adverse effects of negative publicity, highlighting the role of stakeholder relationships in financial resilience. Our study recommends greater collaboration among G20 countries to create an enabling environment for firms to enhance their investments in ESG activities, allowing for superior performance in the long run, which is a win-win situation for both firms and their shareholders.