Garcia and Orsato (2020) tested the institutional difference hypothesis (IDH) — the claim that institutional contrasts between developed and developing economies reverse the relationship between firms' financial resources and corporate social and environmental performance — on a panel of 2,165 listed firms from developed and emerging countries (2007–2014). They found, using panel-data regression analysis that cannot by itself rule out reverse causality, a negative bidirectional association between ESG (environmental, social, governance) performance and financial performance in their emerging subsample, which contained only Brazil and South Africa, and a positive bidirectional association among developed-country firms. Whether this institutional-difference pattern generalizes to other emerging institutional regimes, survives a time window extended beyond 2014, and is robust to estimation methods that address endogeneity remains unresolved. Later IDH-grounded studies test modified designs (financial slack and corporate social performance in Asian multinationals; a single global industry with system GMM, a dynamic-panel generalized method of moments estimator that addresses endogeneity), and broader emerging-market ESG studies report mixed results, but none replicates the bidirectional cross-regime design on a broader emerging-country sample with alternative estimation. The problem is to determine, on firm-level evidence comparable to the original design, whether the IDH pattern persists, weakens, or reverses outside its original two-country emerging sample, window, and estimation approach.

Background

Environmental, social, and governance (ESG) performance refers to composite rating scores of firms' environmental protection, social responsibility, and governance quality, such as the Thomson Reuters ASSET4 score (0–100). Corporate financial performance (CFP) is typically measured by accounting indicators such as return on assets (ROA) or by market-based and cash-flow indicators such as free cash flow. Whether ESG and CFP are positively related is a long-contested question in management and finance: empirical findings range from positive to negative to null, and corporate social performance (CSP) research has long sought the conditions under which each pattern arises.

The institutional difference hypothesis (IDH), introduced by Julian and Ofori-Dankwa (2013) in a study of Ghanaian firms, holds that institutional contrasts between developed and developing economies — regulatory oversight, capital-market development, enforcement capacity — can reverse the relationship between firms' financial resources and their social engagement: positive in developed settings, but negative in developing ones, because under weak institutions firms prioritize capital accumulation and do not treat socially responsible investment as strategically valuable. Garcia, Mendes-Da-Silva and Orsato (2017) previously documented that firms in environmentally sensitive industries show better ESG performance in emerging markets, and Garcia and Orsato (2020) then imported the IDH into the ESG–CFP literature.

Garcia and Orsato (2020) assembled a panel of 2,165 listed companies from developed and emerging countries covering 2007–2014, with ESG measured by an ASSET4-type composite score. The emerging-country subsample consisted of Brazil and South Africa only, while the developed-country subsample covered firms from the US and Western European countries. They estimated the two directions of the relationship separately by subsample using panel-data regression analysis. Their findings supported the IDH: among emerging-country firms, the association between ESG performance and financial performance was negative in both directions, while among developed-country firms it was positive in both directions. For the generalization question below, an emerging institutional regime is a national economy classified as emerging by the MSCI Market Classification (Emerging Markets), applied consistently across the sample years, as distinct from the developed regimes represented in the source by US and Western European firms.

Conventional panel estimators, however, cannot by themselves separate reverse causality — profitable firms affording ESG engagement while ESG simultaneously affects profitability — from genuine bidirectional effects: fixed-effects regressions exploit within-firm variation over time to control for time-invariant unobserved firm heterogeneity, and random-effects models partially pool within- and between-firm variation and permit estimation of time-invariant regressors such as industry membership, but neither uses instruments or moment conditions targeting time-varying endogeneity; the standard remedies are instrumental-variable estimation and generalized method of moments (GMM) dynamic panel estimators. No endogeneity-robust reexamination of the source's bidirectional design has been reported, and the generalization question remains open on three fronts: the emerging subsample covered only Brazil and South Africa; the 2007–2014 window can be extended with data now available; and estimation methods that address reverse causality and time-varying endogeneity remain to be applied.

Problem Statement

Does the institutional-difference pattern documented by Garcia and Orsato (2020) — a negative bidirectional association between ESG performance and financial performance among firms in emerging institutional regimes, versus a positive bidirectional association among firms in developed regimes — hold outside the narrow conditions of the original study? Concretely: (i) does the pattern generalize to emerging-market economies beyond the Brazil and South Africa subsample when additional emerging institutional regimes are included; (ii) does it survive a time window extended beyond 2007–2014 using the data now available; and (iii) is it robust to estimation methods that address reverse causality and time-varying endogeneity, such as instrumental-variable or GMM dynamic panel estimators, in place of the original panel-regression design? These three components jointly serve one objective — establishing whether the institutional difference hypothesis, as imported into the ESG–financial-performance literature, is a general feature of emerging institutional regimes or an artifact of a two-country emerging sample, a short window, and an estimation whose robustness to reverse causality is unestablished. A resolution requires all three extensions together — the broader emerging-country sample, the extended time window, and the endogeneity-robust estimation — so evidence that addresses only one or two of them does not resolve the question. Empirical evidence addressing the question would report estimated bidirectional ESG–financial-performance relations by institutional regime, with coefficients and their statistical significance, using firm-level data with ESG and financial-performance measures comparable to the original (ASSET4-type composite ESG scores; return-on-assets-type and cash-flow-type indicators), covering emerging institutional regimes beyond Brazil and South Africa, a time window extended beyond 2007–2014, and estimation methods that address reverse causality and time-varying endogeneity, and would indicate whether the emerging-market sign pattern persists, weakens, or reverses relative to the original finding.

References

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