Stronger Financial Stress, Better Environmental, Social and Governance Scores – IIM-I Study
· Free Press Journal
Indore (Madhya Pradesh): A study by Indian Institute of Management Indore researchers has revealed that financially constrained firms in India tend to demonstrate stronger Environmental, Social and Governance (ESG) performance, reinforcing the principles of Signalling Theory.
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The research, titled “Financial Constraints and ESG Performance: A Signaling Theory Perspective,” has been published in the academic journal Applied Economics. The study was conducted by Prof Surya Bhushan Kumar and DPM participant Vishakha Jaiswal of IIM Indore.
The study highlights that firms facing financial constraints increasingly use ESG initiatives as a strategic tool to signal credibility, attract capital and reduce information asymmetry in India’s credit-constrained business environment. According to the researchers, recent regulatory reforms such as mandatory Corporate Social Responsibility (CSR) spending and the Securities and Exchange Board of India’s (SEBI) Business Responsibility and Sustainability Reporting (BRSR) framework have transformed ESG from voluntary philanthropy into a strategic business imperative.
The researchers analysed 1,153 firm-year observations from 313 non-financial Indian firms covering the period from 2007 to 2024. The findings indicate that financially constrained firms consistently exhibit stronger ESG performance. Interestingly, the tendency to invest in ESG initiatives becomes even more pronounced as financial constraints intensify.
The study also found that when firms experience an improvement in their financial constraints, they selectively strengthen ESG activities to gain immediate visibility and legitimacy among stakeholders. However, governance-related initiatives become less statistically significant during periods of financial improvement, suggesting that firms adopt dynamic and context-specific ESG strategies.
Economically, the study found that a one standard deviation increase in financial constraints is associated with a 7.86 percent rise in aggregate ESG performance. The impact was particularly notable in environmental and social dimensions, which recorded increases of 8.32 percent and 5.44 percent respectively.
To validate the findings, the researchers conducted extensive robustness and endogeneity tests using alternative measures of financial constraints, instrumental variable techniques and propensity score matching models. Across all testing specifications, the positive relationship between financial constraints and ESG performance remained statistically significant.
The researchers concluded that ESG initiatives are no longer discretionary or symbolic activities for firms operating under financial stress. Instead, sustainability practices are increasingly becoming essential tools for risk management, competitive differentiation, and long-term business survival.
The study also offers important policy implications for emerging economies. The researchers suggest that targeted incentives, concessional financing, tax benefits, and flexible ESG disclosure frameworks could encourage more meaningful sustainability adoption among resource-constrained firms.
According to the researchers, the findings provide practical insights for corporate leaders and policymakers by demonstrating that financial pressure, rather than acting solely as a barrier, can also become a catalyst for stronger sustainability performance.
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