“ESG disclosure and its impact on firm leverage: Moderating role of quality of financial reporting and financial constraints”

Abstract

This paper examines the impact of sustainable practices proxied by environment, social and governance (ESG) disclosures on accounting-based and market-based leverage ratios. Additionally, it explores the moderating effects of financial reporting quality (FRQ) and financial constraints (FC) on the ESG-leverage nexus. Leveraging data from 2700 non-financial firms across 16 emerging nations over 8 years from 2015 to 2022, the findings indicate that firms with higher ESG scores exhibit greater book and market leverage. This implies that ESG disclosures provide additional valuable information that reduces information asymmetry and aligns with lenders' expectations. The positive association between ESG and leverage is more pronounced for firms with lower FRQ and those facing higher FC. Findings are robust to different sensitivity tests, including lagged regressions to mitigate reverse causality, 2SLS and system GMM regression to address endogeneity concerns, and tests with alternate variables, samples and time periods. These findings offer valuable insights for policymakers, managers, lenders and investors, guiding policy development, corporate strategy and investment decisions. Overall, this paper highlights the crucial role of ESG and high-quality financial reporting in shaping the capital structure dynamics of firms in emerging markets.