ESG scores and financial performance of shariah-compliant firms : empirical evidence on Indonesia and Malaysia Islamic capital market

Abstract

Environmental, social, and governance (ESG) performance presents a global challenge for companies, particularly concerning Corporate Financial Performance (CFP). While significant research has explored this impact, the ESG performance of Shariah- compliant companies remains under-investigated. This study utilizes a ten year database for bibliometric analysis to examine the global research landscape on ESG performance, meanwhile, twelve years database for analyzing the impact of ESG metrics on corporate performance. The primary aims are to propose future research directions on ESG performance and to evaluate the impact between ESG scores and CFP of Shariah- compliant firms in Indonesia and Malaysia. The study is grounded in Maqasid Shariah and Stakeholder Theory, providing a framework for assessing stakeholder salience through power, legitimacy, urgency, and Agency Theory. Independent variables considered include Environmental score, Social score, Governance score, and the overall ESG score for Shariah-compliant firms. Given the limited studies on ESG practices in Indonesia and Malaysia, this research offers additional empirical evidence on the impact of ESG scores on CFP (measured by ROA, ROE, and Tobin’s Q) in these countries. Control variables at the firm, industry, and country levels (e.g., financial leverage, firm size, firm age, inflation, and GDP) are also considered. Findings indicate a significant positive impact between ESG scores and market performance of Shariah- compliant companies in these regions, although the impact on ROA and ROE are insignificant. Specifically, the regression analysis indicates that environmental and social scores generally show significant positive impacts with Tobin’s Q, suggesting that firms with better social performance tend to have higher market valuations. However, the governance score and overall ESG score did not exhibit statistically significant impacts on Tobin’s Q. Additionally, firm size and age showed a significant negative impact with market valuation, particularly in the post- pandemic period, indicating that larger and older firms tend to be valued lower in the market. Industry-level factors, such as dynamism, had a significant positive impact on market valuation before the pandemic, while higher inflation rates were positively impacted with Tobin’s Q. Conversely, GDP showed varied results, with a significant positive impact post-pandemic, underscoring the complex interplay between ESG scores and firm characteristics. The study findings emphasize the importance of integrating ESG principles to attract ethical investments, improve long-term financial performance, and create sustainable value for all stakeholders. Recommendations include prioritizing transparency in ESG reporting, embedding ESG into strategic planning and operational processes, and aligning management incentives with ESG performance. Future research should address data consistency and expand geographical contexts to enhance the generalizability of findings. Longitudinal studies and qualitative approaches will offer deeper insights into ESG's impact on financial performance, guiding more effective policies and investment strategies. Keywords: ESG performance, Corporate Financial Performance, Shariah-compliant firms, Indonesia, Malaysia, bibliometric analysis, panel regression.