LIQUIDITY AND PROFITABILITY’S EFFECT ON THE ENVIRONMENTAL, SOCIAL, AND GOVERNANCE SCORES OF S&P 500 COMPANIES

Abstract

The relationship between financial performance and environmental, social, and governance (ESG) metrics in businesses has garnered significant interest in recent years. Unlike most previous research that primarily examines the impact of ESG initiatives on a firm’s financial performance (Whelan et al., 2022), this paper explores how financial liquidity and profitability influence ESG performance. We hypothesize that profitable firms are more likely to invest in ESG initiatives. We collect financial and ESG data of S&P 500 companies from Bloomberg. Using principal component analysis (PCA) to mitigate multicollinearity, the study identifies the main principal components representing various associations of liquidity and profitability metrics. Linear regression analysis is conducted with the identified principal components as the independent variables and ESG scores as the dependent variables. The analysis reveals that profitability positively affects ESG scores, while liquidity has a negative impact. The findings suggest that our hypothesis — that profitable companies are more likely to invest in ESG initiatives — is confirmed, whereas high liquidity may indicate underinvestment in such activities. This research contributes a fresh perspective to the empirical evidence in the existing literature (Friede et al., 2015; Hang et al., 2019; Whelan et al., 2022) on the relationship between financial and ESG performance.