Linköping University | Department of Management and Engineering Master’s Thesis in Economics Master’s Programme in Economics Spring 2021 | ISRN-number: LIU-IEI-FIL-A--21/03680--SE
Sustainability in the European Union
–
The Role of Financial Development in Environmental,
Social and Governance (ESG) Performance
Caroline Håkansson Kristin Salu
Supervisors: David Andersson and Göran Hägg
Linköping University SE-581 83 Linköping, Sweden (+46) 013-28 10 00, www.liu.se
English titel:
Sustainability in the European Union
The Role of Financial Development in Environmental, Social and Governance (ESG) Performance
Swedish title:
Hållbarhet inom Europeiska unionen
Rollen av finansiell utveckling för hållbarhetsinriktade prestationer (ESG) Authors: Caroline Håkansson carha873@student.liu.se Kristin Salu krisa819@student.liu.se Supervisors:
David Andersson and Göran Hägg
Publication type:
Master´s Thesis in Economics
Master´s Programme in Economics at Linköping University Advanced level, 30 credits
Spring semester 2021, 30 credits
ISRN Number: LIU-IEI-FIL-A--21/03680--SE
Linköping University
Department of Management and Engineering (IEI) www.liu.se
Abstract
This thesis addresses the relationship between financial development and CSR performance, based on countries within the EU. The main objective of this thesis is to critically analyse and discuss the impact of financial development on CSR performance, through using ESG
performance as a proxy. Additionally, this study aims at analysing the inclusion of institutional factors when examining the relationship. While the issue of how financial development impacts individual sustainability dimensions is quite well-researched, only one study is found to examine the precise relationship between financial development and ESG performance, concluding a positive linkage in Asia. No similar study is found in the region of the EU. We find the
relationship to be complex, where various channels of influence are identified when examining ESG dimensions separately. To examine this relationship, we used panel data regression analysis, based on country level data for EU’s individual member states. Our findings show a complex relationship, implying that financial development has various impacts on ESG performance and varies throughout the range of financial development. This is in contrast to previous empirical research regarding the relationship, concluding an overall positive impact. This study provides no evidence that institutional factors affect the relationship between financial development and ESG performance, but argues for the importance of institutional inclusion, due to the identified influence on ESG practices through channels such as governing laws, regulations, norms and culture. Finally, financial development is concluded as an important catalyst to promote ESG performance within the EU. When suggesting any policy implementation, it is important to keep in mind that different countries within the EU may have different needs regarding the most efficient approach to increase ESG.
Keywords: Corporate Social Responsibility, ESG, Environmental performance, Social
performance, Governance performance, Financial development, Financial markets, Financial intermediaries, Institutions.
Sammanfattning
I denna studie undersöker vi sambandet mellan finansiell utveckling och CSR-prestation i länder inom EU. Studien syftar till att kritiskt analysera och diskutera effekten av finansiell utveckling på CSR-prestation genom att använda ESG-prestation som en proxy. Vidare syftar studien till att analysera hur förhållandet påverkas genom att inkludera institutionella faktorer. Frågan huruvida finansiell utveckling påverkar enskilda dimensioner av hållbarhet är relativt undersökt, men endast en tidigare studie har undersökt sambandet mellan länders finansiell utveckling och ESG-prestation, med slutsats om en positiv påverkan i Asien. Enligt vår uppfattning har ingen tidigare studie undersökt sambandet inom EU. Vid analys av tidigare studier kan vi däremot konstatera att förhållandet är komplext och olika kanaler av påverkan identifieras mellan finansiell
utveckling och ESG-dimensionerna. För att undersöka sambandet används paneldata och regressionsanalys, som baseras på data på landnivå för EU:s medlemsstater. Våra resultat indikerar på ett komplext förhållande som antyder att finansiell utveckling har varierande inverkan på ESG-prestation. Utfallet står i kontrast till den tidigare empiriska forskningen rörande förhållandet, med slutsatser om övergripande positiv inverkan. Vidare kan studien inte påvisa att institutioner påverkar sambandet mellan finansiell utveckling och ESG-prestation, men vi argumenterar för vikten av institutionell inkludering till följd av identifierat inflytande på ESG genom kanaler som lagar, regleringar, normer och kultur. Slutligen, konstateras finansiell
utveckling att verka som en viktig katalysator för att främja ESG-prestation inom EU. Vid framtida förslag rörande policyimplementering indikerar studiens resultat att det är av stor vikt att ta hänsyn till respektive medlemsstats individuella behov för att finna det mest effektiva tillvägagångssättet för att öka ESG-prestation.
Nyckelord: Corporate Social Responsibility, Environmental, Social, and Governance
Performance, ESG, Finansiell utveckling, Finansiella marknader, Finansiella intermediärer, Institutioner.
Acknowledgement
This study has been written at Linköping University, Sweden, as a Master’s degree Thesis in Economics with a major in Finance.
First of all, we would like to express our deepest and sincerest gratitude to our supervisors Göran Hägg and David Andersson for providing us with valuable guidance and support throughout the entire process of conducting this study.
Furthermore, we would also like to thank our fellow opponents for providing constructive criticism, good thoughts and ideas contributing to the study. We also wish to extend our appreciation to our seminar group for continuous feedback during our writing process.
Table of content
Abstract 2
Sammanfattning 3
Acknowledgement 4
Table of content 5
Tables and Figures 7
List of abbreviations 8
1. Introduction 9
2. Theoretical Approach 13
2.1 Corporate Social Responsibilities (CSR) 13
2.2 Environmental, Social, and Governance (ESG) Performance 14
2.3 Financial Development 14
2.4 Financial Market Environmental Kuznets Curve (FMEKC) 16
2.5 The Role of Institutions 17
3. Literature Review 19
3.1 Financial Development and ESG performance 19
3.2 Financial Development and Performance within the ESG Dimensions 20
3.2.1 Financial Development and Environmental Performance 20
3.2.2 Financial Development and Social Performance 21
3.2.3 Financial Development and Governance Performance 22
3.3 Sustainability within the EU as a institutional context 23
4. Hypothesis Development 25
5. Data and Variables 27
5.1 Sample and Variables 27
5.2 Data Processing 31
5.3 Criticism of Data 31
6. Methodology 33
6.1 Empirical Design 33
6.2 Pooled Ordinary Least Square (POLS) model 34
7. Empirical results 35
7.1 Descriptive Study 35
7.2 Pre-diagnostics Tests 37
7.3 Correlation and Multicollinearity Analysis 38
7.4 Regression results 39 7.5 Extended results 46 8. Discussion 49 9. Conclusion 56 References 57 Appendix 1 68
Tables and Figures
Tables
Table 1 - Variable definitions and sources.
Table 2 - Number of identified firms reporting ESG performance at a country level. Table 3 - Descriptive Statistics of Variables.
Table 4 - Diagnostics Tests.
Table 5 - Pearson Correlation Analysis of Variables and Variable Inflation Factor (VIF). Table 6 - Financial Development and ESG performance.
Table 7 - Financial Development and ESG performance, excluded variables for institutions. Table 8 - Financial Development and ESG performance, Cyprus excluded.
Figures
Figure 1 - Definition of Financial Development. Figure 2 - The Environmental Kuznets Curve.
Figure 3 - Countries’ development of ESG performance over time. Figure 4 - Countries’ financial development over time.
Figure 5 - Financial Development and ESG Performance FE of entity. Figure 6 - Financial Development and ESG Performance with FE of time.
Figure 7 - Financial Development and ESG Performance FE of entity, with guidance to spot the U-shape between the countries.
List of abbreviations
CSR: Corporate Social Responsibilities CSP: Corporate Social Performance
ESG: Environmental, Social, and Governance E: Environmental dimension of ESG S: Social dimension of ESG
G: Governance dimension of ESG FD: Financial Development
FI: Financial Intermediaries FM: Financial Markets GDP: Gross Domestic Product FDI: Foreign Direct Investments TRADE: Trade Openness
RL: Rule of Law RQ: Regulatory Quality VA: Voice and Accountability EKC: Environmental Kuznets Curve
FMEKC: Financial Market Environmental Kuznets Curve OLS: Ordinary Least Squares
POLS: Pooled Ordinary Least Squares FE: Fixed Effects
1. Introduction
Over the past decades the urgency to act for sustainable development has increased considerably. The need to build a greener, fairer and more resilient world is greater than ever as the threat of climate change, environmental degradation, inequality and security has become more evident (UN, 2020). The focus on Corporate Social Responsibilities (CSR) has grown significantly, referring to a general belief that modern businesses have a responsibility to society that extends beyond the responsibilities to its stakeholders or investors (Caroll, 2018). Implying that
businesses should not only serve as economic, but also social and environmental ends (Han et al., 2016). As a result, the discussion has intensified among governments, regulatory bodies, non-governmental organisations and businesses. In light of the increased focus of evaluating performance through the objective of sustainability, there is a critical need to address which factors drive increased CSR performance and what causes the opposite effect. This study aims at examining whether and how financial development is a driving force for the transformation to a sustainable society, through analysing CSR performance in countries within the EU.
The term CSR often has come to be used interchangeably with Environmental, Social and
Governance (ESG), viewed as an extension of CSR by adding the environmental, social and
governance dimensions (e.g. Liang and Renneboog, 2020; Sila and Cek, 2017). This is in accordance with numerous scholars, such as Han et al. (2016) and Nollet et al. (2016), arguing that to compare CSR performance, ESG scores are one of the widely recognised measures used as a proxy. In other words, while CSR aims to make businesses accountable for their impact on sustainability, ESG performance makes such efforts measurable (Alva, 2020). This proxy is used in our study to measure CSR performance, where all three dimensions of ESG are applied. The foundation of our study can be described as a replication study and an extension of a study conducted by Ng et al. (2020), the only identified study that examines the relationship between financial development and ESG performance. The authors conclude financial development as an important catalyst to strengthen ESG performance within the region of Asia. No similar study is identified in the region of the EU, where we have reason to believe that the identified impacts may differ when examining countries within the EU, in comparison to Asia. In accordance with Ng et al. (2020), financial development is referred to as development within the two
subcategories of the financial system, namely financial intermediaries1 consisting of insurance
companies, mutual funds, banks and pension funds, and financial markets consisting of stock markets and bond markets. However, we critically question whether such development in the financial systems can generate improved sustainability performance within corporations. In contrast to Ng et al. (2020) our study includes a theoretical approach, as well as the role of institutions when examining the relationship.
Even though Ng et al. (2020) is the only previous study to examine such a linkage, numerous studies are found to examine the relationship between financial development and sustainability dimensions separately. These studies have varying evidence of the impact of financial
development, identifying different channels and directions from which financial development influences the separate ESG dimensions. On one hand financial development is concluded as an effective channel to mitigate sustainability risks, for instance through environmentally friendly technology, social development through economic growth or by broadening the access of finance and fostering high quality institutions through governance (e.g. Jalil and Feridun, 2011; Paun et al., 2019; Khalid and Shafiullah, 2020). Whereas, other studies conclude that financial development negatively impacts sustainability, for instance through increased pollution and demand for natural resources (e.g. Yuxiang and Chen, 2010; Moghadam and Loftalipour, 2014). This further underline the complexity of the potential relationship.
In recent times, the role of financial development has gradually gained attention in literature and among countries attempting to achieve sustainable growth (Paun et al., 2019). There is a large body of literature, such as Levine (1996) and Winkler (1998), concluding that long term
economic growth is directly connected with the efficiency and function of the financial systems, where financial development is argued to impact the economy at a global level. Similarly, Weber (2014) states that financial intermediaries and financial markets have a dominating influence on the economy, society and sustainable development. In line with this argumentation, the Swedish Financial Supervisory Authority (2016) has identified research regarding financial sectors' effect on sustainability as a necessity. Robson (2020) also believes in the financial sector as a crucial component to impact corporations' responsibilities and argues for the increased urgency regarding the establishment of sustainable development at a global level. In addition to previous studies arguing for a relationship between financial development and various dimensions of
1 Note: There are some terminological differences among various scholars regarding the term that we refer to as financial
intermediates. Some scholars use this term while others use financial institutions. Since this study also refers to the general term
of institutions, referring to a set of rules in society founded on regulations, governing laws, norms and culture among others, we have decided to fully disregard the term financial institutions in order to increase clarity. We only refer to the term financial
intermediaries concerning the subcategory of the financial system, which include banks, insurance companies, mutual funds,
pension funds, and other types of non-banks financial intermediaries. Note that some of our references use the term financial institutions, while we interpret this as financial intermediaries.
sustainability, there are also some theories that can be used to support the potential relationship. Even though the Environmental Kuznets Curve (EKC) is not directly applicable on the
relationship between financial development and ESG performance, it explains the relationship between economic growth and environmental degradation, through argumentation that countries overlook environmental degradation until their economic development reaches a certain turning point. A similar relationship pattern could potentially emerge between financial development and ESG performance. Especially given the re-conceptualised Financial Markets EKC, concluding a relationship between financial markets and environmental degradation consistent with the original EKC. However, this is a complex discussion. The re-conceptualised EKC theory introduces institutional quality as a moderator in decreasing environmental
degradation, hence we have theoretical arguments to include the role of institutions in CSR performance as well.
The Swedish Financial Supervisory Authority (2016) finds it important to analyse policy
measures and include policy regulations on the financial markets when examining how financial development might impact sustainability performance. According to Coluccia et al. (2018), firms operate in a complex environment, defined by legislative measures, norms, expectations and national risks. This generates different pressures originating from the quality of institutions and governance, where social, political and legal dimensions exert important pressure on firms' CSR disclosure. Emerging practises in ESG are also argued by the OECD (2020a) to be influenced by financial intermediaries as well as governments and international organisation institutions. The Swedish Financial Supervisory Authority (2016) argues that ESG factors are linked to business gaining legitimacy and acceptance from both society and the specific field of business activity. Business conducted with no or little regard to ethically and socially acceptable measures risks being eliminated from the market through institutional change, such as policy measures and legislative framework or through investors, media and customers forcing them out of the market. Due to these previous conclusions of institutions as essential components in sustainability achievements, we criticise studies that have excluded this influence.
Thus, when examining the relationship between financial development and ESG performance in countries within the EU, the influence from institutional factors was included in this study. The EU is founded on rule of law, where every action is based on treaties, regulations, directives, decisions, recommendations or opinions (European Commission, 2019). The membership uniformly binds the countries to follow regulations above national law alongside implementing directives into national law, but also consists of recommendations simply suggesting a line of action without legal obligations (European Parliament, 2020). Sustainable development has come to develop into one of the fundamental objectives in the legislative framework of the
union. Over the last decade, the EU has laid down legislative measures on CSR, consisting of both mandatory and voluntary provisions, ensuring implementation of CSR strategies in the business community within the member states (European Parliament, 2020). Despite the fact that the EU, from a global perspective, is at the forefront of implementing actions towards sustainable development, there is a demand for rapid measures and solutions to face the challenges that Europe and the world stand before (European Environment Agency, 2019). On the basis of scarce previous research and exclusion of potentially important institutional factors, our main objective with this study is to examine and critically analyse whether and how financial development has an impact on ESG performance, based on countries within the EU. By examining the countries within the EU, we believe it allows us to keep institutional factors that are common within the union, more constant in comparison to the region of Asia. Hence, the paper is targeted to answering the following research questions through panel data regressions:
Question 1: How does a country's financial development impact ESG performance?
Question 2: How is the relationship between financial development and ESG performance affected when taking the role of institutions into account?
Our aim is to clarify the role of financial development as potential tools to mobilise sustainable growth and increase ESG performance. This with regard to the active work conducted by the EU to ensure sustainable economic growth, secure the stability of the financial systems, and foster a more long-term perspective and transparency in the economy (European Commission, 2020). Alongside possibly achieving more nuanced results to understand implications and policy insights in an EU context. An increased understanding could perhaps make the pursuit of ESG performance more effective, both at company, country and union level. The period of the study is set between 2009-2018 and country level data is used for EU’s individual member states. This study is organised into nine sections. Section 2 outlines an overview of the theoretical approach and discusses necessary concepts associated with the relationship between financial development and ESG performance. Section 3 is a review of previous studies on this relationship, and Section 4 validates our hypothesis, founded on the two previous sections. Section 5 explains data and variables, followed by explanation of the research methodology in Section 6. While,
Section 7 contains descriptive statistics, pre-estimation tests and our main statistical analysis
results. Finally, Section 8 contains a discussion of our results while Section 9 outlines our conclusions.
2. Theoretical Approach
The theoretical approach of this study is primarily based on theories concerning a
re-conceptualised Environmental Kuznets Curve (EKC), in order to explore how the relationship between financial development and ESG performance potentially depends on the observed stage of development in a country's financial system. This relationship is influenced through various channels, where the effect of financial development on economies and a sustainable economic development is a central part. It is through this influence where the re-conceptualised EKC theory can be applied. To make this approach clear, it is necessary to describe the theories behind the concept of CSR, ESG and financial development.
The re-conceptualised EKC theory introduces institutional quality as a moderator, to decrease environmental degradation. Due to this view, it is also necessary to introduce institutional theories and discuss the role of both formal and informal institutions in CSR performance. It is our view that the institutional framework may have an important effect, both on firms’
implementation on CSR measures itself, as well as on the potential impacts of financial development on ESG performance.
2.1 Corporate Social Responsibilities (CSR)
According to Carroll (2018), CSR refers to a general belief that modern businesses have a responsibility to society that extends beyond the responsibilities to its stakeholders or investors. In accordance with Caroll, Steurer (2009) argues that CSR aims to better integrate social and environmental concerns into business routines. The main idea behind CSR is known as the triple bottom line principle, implying that businesses should not only serve as economic, but also social and environmental ends. Since CSR requires engagement from both internal and external stakeholders, it enables enterprises to better anticipate and benefit from changing social
expectations and operating conditions. The European Commission (2011) argues that CSR is a driving force of the development of new markets and in creating growth opportunities.
A related concept of CSR is Corporate Social Performance (CSP), which can be described as an extension of CSR that concentrates on the achieved results, rather than the general perception of accountability to society. Another definition was made by Wood (1991; 2010), defining CSP as a set of descriptive categorisations of business activity, focusing on the impacts and outcomes of society, stakeholders and the specific firm. According to Carroll (2018), CSP is regarded as a natural consequence of CSR and it could therefore be argued that if CSR initiatives do not cause CSP they are ineffective.
2.2 Environmental, Social, and Governance (ESG) Performance
According to Liang and Renneboog (2020) the terms CSR and ESG have often come to be used interchangeably. In accordance with various previous studies, ESG scores is one of the widely recognised measures to proxy CSR, where environmental, social and governance have developed into fundamental components of CSR (e.g. Han et al., 2016; Nollet et al., 2016). Many
companies have come to develop an ESG policy alongside mitigating risk management. Diez-Cañamero et al. (2020) argue that ESG ratings constitute one of the most useful and direct instruments used by companies to present their sustainable development contribution.
Furthermore, it is argued by Deegan (2014) to be highly associated with stakeholder’s legitimacy, regulations and standards. Therefore, applying combined ESG ratings provides an overview of firms’ CSR activities (Carroll, 2018). In other words, in order to compare performance between regions and firms with regard to appliance of ESG dimensions, ESG ratings are widely used. According to Akulov (2015), ESG has come to develop into an important piece of the sustainability puzzle, concerning the intertwinement of both financial value and ESG
performance. On one hand it concerns the importance of generating financial value, through securing long-term stakeholder value and maximising corporate governance. On the other hand, it concerns generating non-financial ESG performance with regard to minimising environmental and social harm (Rezaee, 2017). The environmental considerations of the ESG practises can refer to climate change mitigation and adaptation, as well as the environment on a broader level, such as preservation of biodiversity, pollution prevention and circular economy. Whereas the social consideration aspect refers to issues of inequality, inclusiveness, labour relations, investment in human capital and communities, as well as human rights issues. Followed by the governance dimension of ESG, referring to the governance of public and private institutions, including management structures, employee relations and executive compensation. Furthermore, the governance aspect plays a fundamental role in ensuring the inclusion of the environmental and social considerations in the decision-making process (European Commission, 2020).
2.3 Financial Development
In our study, we define financial development as a combination of depth, access and efficiency, which can be measured within the two subcomponents of the financial system, namely financial intermediaries and financial markets. The components of financial development are illustrated in
Figure 1: Definition of Financial Development.
According to the World Bank (n.a.), the financial sector is the set of intermediaries, instruments and markets, as well as the legal regulatory framework that permit transactions to be made. In broad terms the financial system can be classified into two subcomponents, namely financial intermediaries and financial markets. In accordance with the IMF (2015), financial
intermediaries include banks, insurance companies, mutual funds, pension funds, and other types of non-banks financial intermediaries. Financial markets mainly include stock and bond markets, as well as forex market and derivatives market among others. Each of these segments play a unique role in providing various financial services and facilities to lenders, investors and borrowers.
The dimension of depth refers to the size and liquidity of the markets, followed by access referring to the ability of individuals to access financial services, and ultimately efficiency concerning the ability of institutions to provide financial services at low cost and with sustainable revenues, and the level of activity of capital markets. The World Bank (n.a.) argues that financial sector
development occurs when financial instruments, markets and intermediaries ease the effects of information, enforcement and transaction cost. Correspondingly, providing better conditions in the economy through improving essential functions within financial sectors. Our view of
financial development is also consistent with the definition of IMF (2015), which has developed the FD index, in order to capture the multidimensional aspects of financial development. The FD index is used to measure financial development in this study, which is discussed further in
Section 5. Institutional framework Dimensions of development Efficiency Access Depth Financial System Pension Funds Mutual Funds Bond Market Stock Market Banks Insurance Companies Financial Markets Financial intermediaries Financial Development Institutional framework
In Figure 1 we also include institutions as a central part of financial development, which is based on the view of institutions as a set of rules in society founded on regulations, governing laws, norms and culture, causing external constraints for individuals. As illustrated in Figure 1 we believe that the development of the financial systems occurs within the framework of established institutions. The role of institutions is further discussed in Section 2.5.
2.4 Financial Market Environmental Kuznets Curve (FMEKC)
The Environmental Kuznets Curve (EKC) posits that there is a hypothesised relationship between environmental degradation and economic development (Grossman and Krueger, 1994; Shahbaz et al., 2020). Traditionally the relationship takes the form of an inverted U-shape, with indicators of environmental degradation and income per capita or economic development on the respective axes (Stern, 2004), illustrated in Figure 2.
Figure 2: The Environmental Kuznets Curve.
The common interpretation of this relationship is that at the initial stages of growth,
environmental degradation is not considered because the concern is placed on increasing output, where people are too poor to consider the consequences of economic growth. As a country becomes richer the environmental degradation increases, until the so-called turning point is reached, where further economic development results in decreased degradation. Implying that as a country gets richer, with persistent growth and increased technological advancement, people can afford to concern themselves with other issues, such as the environmental quality and therefore degradation declines (Grossman and Krueger, 1994; Shahbaz et al., 2020). In a similar way income inequality increases along the curve until the turning point is reached, whereas income per capita increases, inequality decreases (Kuznet, 1955). Hence the link between inequality and economic growth could take the form of an inverted U-form as well.
Turning point Environmental
Degradation
Economic Development
Ntow-Gyamfi et al. (2020) re-conceptualised the EKC into the Financial Market
Environmental Kuznets Curve (FMEKC), including institutional quality as a moderator while
explaining the relationship between financial market development and environmental degradation, as an inverted U-shape. The interpretation of the FMEKC is consistent with the original EKC but uses development of financial markets instead of economic growth in general. In addition, it is concluded that institutional quality has a substantial negative relationship with environmental degradation, implying that a strong institutional framework is necessary to reduce degradation. Similarly, Grossman and Krueger (1995) argue that increased environmental policy stringency may cause reduced environmental degradation. Ntow-Gyamfi et al. (2020) suggests that strong institutions are capable of reducing the negative effects on the environment, but not enough to fully eliminate the impact. This indicates that high quality institutions are important in order to further decrease degradation until financial development positively impacts the environment. To ensure sustainability improvements, economies should therefore implement institutional and regulatory enhancements, and not only rely on financial development (Mahmood et al., 2018; Ntow-Gyamfi et al., 2020).
The re-conceptualised EKC into the FMEKC also raises the question whether such a U-shaped relationship could be found between financial development and ESG performance as well? Even though the FMEKC is not directly applicable on the relationship between financial development and ESG performance we believe that there are strong arguments for using the theory when analysing the relationship. If such relationship is to be found, countries in the initial stages of financial development give less attention to sustainability issues and once the turning point is reached, financial development is sought with sustainability in mind. Since competitive advantages are obtained from the application of sustainable financial practices, there is a
probability that financial intermediaries will show their responsibilities by funding projects that are considered ESG goals. If this U-shaped relationship and the FMEKC theory would be applicable on the relationship between financial development and ESG performance, it could also be argued that a strong institutional framework is a necessity, in order to reduce negative effects and to increase ESG achievements.
2.5 The Role of Institutions
North’s (1990) framework of institutional change defines institutions as the rules of the game in a society, primarily seen as external constraints for individuals, whose goal is utility maximisation. Institutional theory is traditionally concerned with how groups and organisations secure their position and legitimacy by conforming the rules and norms of the institutional environment (Glover et al., 2014). In accordance with David et al. (2019) and Chiu (2018), institutional theories are often used in explaining the adoption and spread of formal organisational structures,
such as policies and standard practices and structures. According to Rezaee (2017), the theory also focuses on the role of normative influences and social aspects in decision-making processes that affect organisational structures. Institutional theory can also be used in explaining how changes in social values, technological advancements, and regulations affect decisions regarding sustainable activities (Glover et al. 2014).
Institutional theory is argued by Farooq and Maroun (2008) to offer a useful framework for examining sustainability accounting. This theory allows for better understanding of the diversity and dynamics of CSR. The development of sustainability reporting reflects operations of
powerful social and institutional forces. Firms’ implementation of CSR measures and ESG practices are thereby argued to be influenced by legislative measures, norms, expectations and national risks (Coluccia et al., 2018), as well as pressure from its stakeholders and the society (Carroll, 2018; European Commission, 2011; Chiu, 2018). Coluccia et al. (2018) concludes that social, political and legal dimensions exert important pressure on firms' CSR disclosure. Evidence is also presented of three institutional variables that affect CSR disclosure, namely the regulatory quality, rule of law, and voice and accountability. This implies an impact on sustainability performance from both formal and informal institutions. Companies’ implementation of CSR measures may therefore be a response to extensive social and institutional pressure, rather than improving profits. Similarly, the Swedish Financial Supervisory Authority (2016) claims that ESG factors have come to link business gaining legitimacy and acceptance. Businesses conducted with no or little regard to ethically and socially acceptable measures, risk being eliminated from the market, through institutional change or through investors, media and customers forcing them out of the market.
Additionally, Khalid and Shafiullah (2020) motivate the use of the institutional framework through defining a causal relationship from financial development to governance, where new institutional and governance structures emerge when social benefits of change exceed costs. The existing institutional framework does not only have an effect on sustainable performance, but also influences financial stability. For instance, the IMF (2015) claims that the pace of financial development matters, since when proceeding too fast, expanded financial intermediaries can lead to economic and financial instability. If regulation and supervision in this case is poor, this spreads limits in greater risk-taking and higher leverage. As financial development proceeds, it is of high value to develop good institutional and regulatory frameworks to achieve good
sustainable performance, where Ahmed et al. (2020) claims that the governance of a country is a fundamental factor for guaranteeing efficient environmental management. Although, it is also suggested by Mahmood et al. (2018), that market forces and institutional constraints may prevent financial development from bringing improvements in the environmental quality.
3. Literature Review
3.1 Financial Development and ESG performance
One of the greatest challenges, facing humanity at a global level, is how to institute sustainable development. Despite the widespread adoption of ESG in portfolio analysis and business management, recent research literature linking financial development and ESG practices is scarce.
Only one study is found to examine the relationship between financial development and ESG performance, conducted by Ng et al. (2020) in the context of Asia. Their empirical findings conclude that financial development within nations is vital to pursue ESG goals. A higher
achievement in ESG performance is argued to be caused by a development in the financial system for the better. However, in order to increase the ESG goals among the nations the authors argue for a necessary precondition, which is the establishment of ESG standards within marketplaces. The need to extend ESG governance frameworks and practices into the financial sector in order to increase the integration of ESG in financing and investment decisions is also acknowledged. No similar studies are identified among European countries. Hence our aim is to fill this gap in literature. In order to clarify how financial sectors and financial regulations affect sustainability, the Swedish Financial Supervisory Authority (2016) finds it important to analyse policy
measures, including policy regulations on the financial markets. However, such an institutional inclusion is not to be found in the study conducted by Ng et al. (2020). This also implies that there is a gap in literature regarding the relationship between financial development and ESG performance.
There is a large body of literature, such as Levine (1996) and Winkler (1998), concluding that long term economic growth is directly connected with the efficiency and function of the
financial systems. Financial development has the capacity to impact the economy at a global level and therefore the potential capacity to stimulate an economic crisis, in particular referring to the 2007-2009 financial crisis. Similarly, Weber (2014) states that the dominating influence of financial intermediaries and financial markets on the economy, society and sustainable development first became evident during the financial crisis. Due to this strong influence of financial markets and financial intermediaries on sustainable economic development, Paun et al. (2019) argue that the financial sector development has gradually gained importance within countries interested in achieving sustainable growth.
3.2 Financial Development and Performance within the ESG Dimensions
Despite scarce empirical research linking financial development to all dimensions of ESG performance, there are various studies that examine the impact of financial development on the three ESG pillars separately. However, the findings differ among various scholars.
3.2.1 Financial Development and Environmental Performance
Scholars examining the impact of financial development on environmental performance have identified different channels from which financial development influences environmental performance. On one hand, several studies conclude financial development as a source to
increase environmental quality (e.g. Shahbaz and Alam, 2016; Aluko and Obalade, 2020; Ahmed et al., 2020), while other studies reveal a negative linkage (e.g. Sekali and Bouzahzah, 2019; Moghadam and Loftalipour, 2014).
According to Yuxiang and Chen (2010) financial development affects the environment through various factors, namely capitalisation, technology, income and regulation, specifically
environmental regulations incorporated in the financial systems. Hence, the effects of financial development on environmental performance are sorted into four aspects. Financial development facilitates the investments of enterprises, which consequently is found to have capitalisation effects on environmental performance. Some effects are found positive, due to increased investments that facilitate the abatement equipment and growth of large and medium-sized enterprises, providing benefits of economies of scale in resource use and pollution reduction. At the same time, negative environmental impacts are observed, as financial development
encourages the growth of capital-intensive sectors, where the upward movement is found to increase pollution intensities. In addition, it is found to directly affect small enterprises, with few benefits of economies of scale in resource use and pollution reduction, making it more difficult to enter the market and establish growth.
When examining how financial development affects environmental dimensions through technological factors, various studies argue for the importance of increased research and development (R&D) activities and development of advanced technologies, to reduce
environmental pollution (e.g. Ahmed et al., 2020; Ng et al., 2020; Yuxiang and Chen, 2010). According to Mahmood et al. (2018) developed countries have achieved an advanced level of technological evolution, in comparison to developing countries, which allows them to optimise their businesses. Although, in developing regions it is common that the efficiency regarding production has not been achieved, which could worsen the environment as production increases. In addition, Yuxiang and Chen (2010) argue that technological improvements may stimulate the development of new environmentally friendly technologies, which consequently could increase
the demand on natural resources. Therefore, the technological effects of financial development on the environment should be regarded as varied and evaluated with caution.
Furthermore, Yuxiang and Chen (2010) argue that income level is a third way in which financial development affects environmental performance. According to Shahbaz et al. (2020), academics have shown an increased interest in the relationship between economic growth and
environmental performance. According to Mahmood et al. (2018), developed countries have favourable conditions in comparison to developing countries, to tackle the environmental implications and environmental quality challenges through financial development. Both positive and negative effects have therefore been observed depending on a country's income level. Finally, financial development is argued by Yuxiang and Chen (2010) to have regulatory impacts on environmental performance. Enterprises with dependence on external finance are found to strengthen the effects of the environmental policies, given incorporated environmental regulations in financial service. Ntow-Gyamfi et al. (2020) also argue for the importance of regulatory strengthening, since financial development both could impact positive environmental performance and environmental degradation heavily. Yuxiang and Chen (2010) have a similar approach, referring to the regulatory effects as consequently growing stronger with the establishment and improvement of a sound environmental protection framework.
3.2.2 Financial Development and Social Performance
According to Ng et al. (2020), the mechanism underlying the relationship between financial development and social welfare can be determined by strong economic growth. In other words, the impacts of financial development on social development can be analysed through economic growth. Similarly, Alie et al. (2016) argues that financial development stimulates economic growth within a nation, which further facilitates social development and higher levels of well-being. The overcoming of social injustices, in particular with regard to poverty reduction, demonstrates that economic development is fostered by financial development (Ng et al., 2020). On the contrary, Newman and Thomson (1989) do not support the expectation that social development will follow economic growth. It is argued to mainly increase through social development policies.
According to Demirguc-Kunt and Levine (2009) finance ought to be viewed as a tool to shape the gap between rich and poor, since it affects the width and persistence across generations. Financial development is argued to affect the rate of economic growth and in consequence the demand of labour, increasing the employment rate, which in turn may have profound
is achieved through reducing the fixed costs of accessing financial services, in turn successively increasing opportunities of low-income individuals. The World Bank (n.a.) also identifies financial development as a tool to reduce poverty and inequality, by broadening the access of finance, facilitating risk management through reducing vulnerability within risk groups, and establishing higher income levels through increasing investments and productivity. Jalilian and Kirkpatrick (2005) underline that the initial conditions in an economy are likely related to the actual impact of economic growth on reducing inequality, where the structural characteristics of an economy are found important to determine the growth-inequality relationship. Therefore, financial development is not only found to stimulate economic growth, but also address social issues.
In a study conducted by Yilmaz (2013) it is also concluded that bigger banks, within financial systems, have better social performance, as a result of more transparent intermediaries with higher levels of total assets publicly traded. On the other hand, big banks are known to disclose more information in comparison to smaller banks, which in turn might affect the outcome, possibly indicating misleading relations.
3.2.3 Financial Development and Governance Performance
According to Caprio and Levine (2002) corporate governance influences production efficiency within a firm at the corporate level, to such an extent that the effectiveness of a nation's
corporate governance system shapes the country's economic performance. Despite this
potentially crucial role of corporate governance, the empirical research regarding the relationship between financial development and corporate governance is scant. However, some empirical research is identified. Khalid and Shafiullah (2020) for instance conclude that financial
development positively affects governance, but the impact on governance strongly depends on the level of openness and development within a country. It is further argued that financial development drives governance reforms. In other words, financial development is considered an important tool to encourage governance reforms and drive institutional change, for instance route development within low-income countries to a course of high growth. Changes in financial development are found to shape cost-benefits possibilities of institutional
arrangements, where improvements in the level of financial development acts as a catalyst for the emergence of higher quality institutions and governance frameworks.
When there is greater financial development, various scholars argue that there will be improved access to external financing (e.g. Ng et al., 2020; Demirguc-Kunt and Levine, 2009).
Consequently, increasing the long-term financing in a country. According to Ng et al. (2020) a well-developed financial system, with various suppliers of capital, requires an enforcement of
investment rights, followed by efficient safeguards of legislative measures, such as investment freedom, voice of accountability, regulatory quality and property rights freedom. In comparison to high levels of financial development, Beck et al. (2001) argue that low levels of financial development increase economic volatility and uncertainty, which in turn increase the risk of political instability and degradation of the governance quality. However, the development of financial systems may also intensify the pressure from global stakeholders. Therefore Ng et al. (2020) claims that, in order to protect the interest of the domestic investors, regulators and governments place greater attention to the various aspects of governance.
3.3 Sustainability within the EU as an institutional context
This study holds the view that it is of importance to include institutional factors when studying the relationship between financial development and ESG performance. Following the notion set forth in Section 2.4, that institutions set the rules in a society through regulations, governing laws, norms and culture, institutions emerge as a potential factor to impact sustainability performance. Coluccia et al. (2018) shed light on the complex environment in which firms operate nowadays, defined by legislative measures, norms, expectations and national risks. The OECD (2020a) argues that emerging practises in ESG investments are influenced by institutions, as well as pressured by governments and international organisations. In the context of sustainability, Niesten et al. (2016) acknowledges collaborative forms of governance as a necessity to stimulate the transition to a more sustainable society. Lane (2018) concludes that given a diversified financial system that is populated by strong intermediaries, which can be observed at a European level, the most effective strategy to obtain benefits from the financial system is through financial integration. It is also important to understand that financial integration is upheld by regulatory and supervisory convergence and strengthened by the institutional framework required at a European level, which allows the safeguarding of financial stability.
The EU is based on the rule of law, where every action is founded on treaties, regulations,
directives, decisions, recommendations or opinions (European Commission, 2019). The body of law consists of a combination of uniformly binding regulations above national law, directives required to be transposed into national law within each member state and recommendations or opinions without legal obligation, simply suggesting a line of action. Sustainable development is one of the fundamental objectives in the legislative framework of the EU. Over the last decade, the EU has laid down legislative measures on CSR, consisting of both mandatory and voluntary provisions, ensuring implementation of CSR strategies in the business community within the member states (European Parliament, 2020). These CSR practices are argued by the European Commission (2006), to contribute to various policy objectives within the EU, such as higher level of social inclusion, more integrated labour markets, investment in public health due to
firm-initiatives and improved use of natural resources. The process of sustainable development is one of the fundamental objectives of EU policies, projects and EU Treaties. According to the European Parliament (2020), the EU strives to preserve a supportive role as the public authority and encourages companies to conduct their businesses responsibly.
In a sustainability management context, ESG integration within Europe has achieved strong success (European Commission, 2020). The proportion of integrated ESG criteria in asset management is equal to 49 percent, in comparison to Canada, equal to 50 percent, and the United States, equal to 26 percent (GSIA, 2018). Despite the fact that the EU is at the forefront of implementing sustainability aspects from a global perspective, rapid system solutions and measures are required to meet the challenges that Europe and the world face (European Environment Agency, 2019). Therefore, there is an urgent call to speed up the change and demand for more policy actions. According to the European Commission (2018), the EU's sustainable finance initiative is the first of its kind to examine the shift to a sustainable future, through integration in the financial policy framework, where one example is the EU Taxonomy. The implementation of the EU Taxonomy aims to ensure common guidelines within the financial sector for which investments are sustainable or not. This is in combination with increased mandatory sustainability reporting. It is fundamental to direct investments toward sustainable projects, in order to reach the objectives of the European Green Deal and the EU's climate and energy target for 2030 (European Commission, n.a.).
The only study found to analyse the impact of financial development and ESG performance, conducted by Ng et al. (2020) in Asia, did not account for the role of institutions. In comparison to the study concerning the region of Asian, we believe that the EU can be described as a more homogeneous region. Since both the governance and business communities within the countries in the EU are restricted to the regulations and directives, we believe that there are similarities between the countries when analysing the effect of institutions on ESG performance. By examining financial development within the countries of the EU, we believe it allows us to keep institutional factors that are common within the union more constant in comparison to the region of Asia. At the same time, we acknowledge that member states are also found
heterogeneous, for instance through differences in national institutions, both formal and informal.
4. Hypothesis Development
The main purpose of this paper is to analyse the relationship between financial development and ESG performance. Based on the theoretical approach and previous literature, presented in previous sections, we outline three hypotheses to enable this analysis. The linkage is complex, and when analysing the impact of financial development on the sustainability dimensions one by one, due to insufficient empirical evidence linking financial development and ESG performance, various outcomes are observed.
The impacts of financial development on environment performance are on one hand concluded important with regard to reducing environmental risks, for instance through improving
environmental quality, stimulating environmentally friendly technology, facilitating investments and growth of enterprises with capitalization effects on the environment (e.g. Shahbaz and Alam, 2016; Ahmed et al., 2020; Mahmood et al., 2018; Yuxiang and Chen 2010). On the other hand, we acknowledged that various studies conclude a negative relationship, with identified
environmental damage due to insufficient technological development, increased demand for natural resources and growth of capital-intensive sectors with increased pollution (e.g. Sekali and Bouzahzah, 2019; Moghadam and Loftalipour, 2014; Mahmood et al., 2018).
Regarding social dimensions, financial development is argued to broader the access of finance in combination with facilitation of risk management reducing the vulnerability and inequality, and increase the employment rate through increased investments and productivity, in turn affecting income distributions (Demirguc-Kunt and Levine, 2009; World Bank, n.a.; Jalilian and
Kirkpatrick, 2005). Thereby, financial development is argued to stimulate economic growth within a nation, which in turn is concluded to increase social development through facilitating higher levels of social well-being and overcoming social injustices (e.g., Paun et al., 2019; Ng et al., 2020; Alie et al., 2016). On the other hand, Newman and Thomson (1989) argue that social development does not follow economic growth, but mainly increases through social
development policies.
Finally, the financial development of governance is argued to depend on the level of openness and development within a country. It is found to act as a catalyst for the emergence of higher quality institutions and governance framework, since a higher level of financial systems is found to require investment rights, efficient legislative measures and safeguards, for instance property rights, investment freedom and voice of accountability (Ng et al., 2020; Khalid and Shafiullah, 2020). Given such financial development is argued to positively affect governance, vice versa.
Overall, it is hard to hypothesise which effect financial development will have on ESG performance. Based on the empirical research we believe that it is possible to assume that financial development in general has a positive impact on ESG performance. This is also in accordance with Ng et al. (2020). However, questions are raised whether such a hypothesis is accurate throughout the whole range of financial development. According to the EKC theory there are various relations between economic growth and environmental degradation, indicating that the direction of the linkage depends on the stage of economic development. Similar
outcomes have been observed regarding financial market development and environmental degradation by Ntow-Gyamfi et al. (2020). Based on such theories in combination with observed literature regarding the impact of financial development on the individual dimensions of ESG, it could imply that the relationship between financial development and ESG performance changes with regard to the level of financial development. This view is also in line with other scholars, arguing for a negative relationship.
On the contrary to Ng et al. (2020) we identified institutional factors as important to include when examining the relationship between financial development and ESG performance. This hypothesis is based on previous literature and institutional theory, arguing that institutions have an important effect on sustainable performance. Consistent with previous research we believe the impact of financial development on ESG performance to change when including
institutional factors. On the basis of our established framework of previous literature and theories, we have come to develop and put forward the following hypotheses.
Hypothesis 1: There is a positive relationship between financial development and ESG performance.
Hypothesis 2: The direction of the relationship between financial development and ESG varies throughout the range of financial development.
Hypothesis 3: The relationship between financial development and ESG performance is affected by institutions.
5. Data and Variables
5.1 Sample and Variables
The period of the study was set between 2009 and 2018. Country level data were used for each accessible country within the EU, consisting of 19 out of 27 countries. These are presented in
Table 2. Due to inconclusive data, Bulgaria, Croatia, Estonia, Malta, Slovakia, Romania,
Lithuania and Latvia were excluded from the analysis. The study acknowledges that the United Kingdom left the EU in 2021, however due to being a member during the period of the study the country was included.
The set of data consists of annual observations of ESG performance and financial development. Furthermore, we included six control variables, namely GDP per capita, FDI net inflows and trade openness, all collected from the World Bank. We also included institutional variables, which consisted of rule of law, rule of quality, and voice and accountability, all collected from the Worldwide Governance Indicators at the World Bank. All these variables are commonly used in the sustainable development literature, where relationships with various aspects of
sustainability have been confirmed (e.g., UNCTAD, 2004; Li et al., 2019). The variables and definitions are presented in Table 1.
It is acknowledged that ESG ratings can vary greatly from one ESG provider to another. We utilised a unique set of ESG performance ratings from Refinitiv Eikon, which has been globally recognised as a premier source of financial market data, ranking publicly listed firms along the three pillars of sustainable management (Refinitiv, n.a.). It is a composite index based on optional reporting providing an overall ESG company score in the environment, social and governance pillar. Since ESG consists of three interconnected dimensions of sustainable development it must be developed through an integrated manner. Based on corporate
headquarters the inclusion is restricted within the EU. The ratings vary between zero and 100, where a high rating reflects better ESG performance for that particular firm.
To measure financial development we used the FD index developed by the IMF (2015), where the data was collected from their macroeconomic financial database. The index encompasses financial intermediaries, including banking and non-banking, as well as financial markets. The inclusion of the FD index is based on the following identified factors. First of all, it is consistent with the three dimensions of financial development suggested by the World Bank (n.a.), namely
to acknowledge financial development as a multidimensional concept, due to the diversity of financial intermediaries and financial markets operating in financial systems. Previous
measurements of financial development were argued to be insufficient when evaluating financial systems, due to only inducing the dimension of depth and thereafter being considered equivalent to financial development (e.g. Ito and Kawai, 2018; Svirydzenka, 2016; Eryigit and Dulgeroglu, 2015). Finally, this index is also applied in accordance with Ng et al. (2020), who argue that the developed index is more accurate through capturing all of the intended meaning of financial development.
Furthermore, we included GDP per capita, based on observations of large-scale empirical research regarding the relationship between sustainability and economic growth (Mohan et al, 2020). A connection which is in the forefront of policy debates in both environmental and economic science (Mohan et al., 2020). Schepelmann et al. (2010) concludes a positive
relationship between GDP per capita and welfare growth. It is also found that economic growth causes severe consequences for the environment and its natural resources, particularly referring to biodiversity, pollution and intellectual property rights (Tampakoudis et al., 2014). At the same time GDP per capita is argued to improve social welfare, given fair institutions allocating goods and services in a manner to decrease poverty (Howarth, 2012).
Since attracting FDI is an important policy objective for countries (Oman, 2000) we decided to include FDI net inflows. Various studies, such as Singhani and Saini (2021), conclude that FDI has a positive impact on environmental degradation. Nepal et al. (2021) finds that FDI reduces the use of energy, carbon emissions and provides new ideas involving human capital and foreign technologies aiming to ensure a sustainable economic development. According to OECD (2020b) inward flows represent the value of inward direct investments conducted by foreign investors into the reporting economy. Outward flow, on the other hand, represents the value of outward direct investment to external economies conducted by the residents of the reporting economy, therefore our study only included FDI net inflow.
In the research context of finance and sustainability numerous studies, such as Menyah et al. (2014) and Jamel et al. (2017), include trade openness. Trade openness is defined as the total of imports and exports, measured as a share of GDP. We acknowledge that the empirical evidence regarding the relationship between trade openness and various ESG dimensions is inconclusive. According to Mahmood (2019), trade openness is positively correlated with CO2 emissions,
through increasing production and income, causing a negative environmental impact. On the contrary, IISD (2014) argues that the intersection between trade and the green economy ought to be viewed as a gateway to achieve sustainable development. Further, OECD (2020a) highlights
trade openness as a driver of employment and possible driver of social progress, provided that complementary trade policies, social protection systems and labour markets exist.
The inclusion of the institutional factors was mainly motivated by Coluccia et al. (2018), studying the relationship between institutional factors and CSR disclosure among European listed companies. The authors conclude significant effects of rule of law, regulatory quality, and voice and accountability on CSR disclosure. The motivation of the inclusion of institutional factors and its role in sustainability performance is presented in Section 2.5.
Rule of law measures how firms and individuals within society trust and follow contract
enforcement, the police, the courts and property rights (World Bank, 2010). It indicates to what extent a society is influenced by law and accepts authority, as well as the likelihood of violence and crime. According to the UN (n.a.) it is essential that countries' rule of law is consistent with international human rights and standards, and if not taken seriously it is considered capable of undermining sustainable development.
Regulatory quality describes the perceptions of the government’s ability to formulate and implement sound policies and regulations that permit and promote private sector development (World Bank, 2021). Presence of strong investor protection could increase the adoption of minimum standards along the social dimension of CSR, while ineffective regulations could cause firms to act in more irresponsible ways (Coluccia et al., 2018). De Villiers and Marques (2016) argue that CSR disclosures are found more informative in countries where investors are in a better position to voice their concerns, and where better regulations and more effective government implementation of regulations exist.
Finally, voice and accountability represent to what extent a country’s citizens are able to
participate in selecting their government, as well as freedom of expression, freedom of association and free media (World Bank, 2010). This factor identifies that democratic governments and systems improve the feeling of security and self-confidence among the population about the capacity of laws, law enforcement agents, and the judicial system to ensure freedom (Coluccia et al., 2018). Hence, voice and accountability reflect the degree of democracy and freedom. Firms in countries with higher levels of democracy are more committed to CSR disclosure in comparison to those operating in restricted or unstable contexts.
Table 1: Variable definitions and sources.
Variable Definition Source
Dependent
ESG rating The ESG rating provides an overall score for the selected county’s firms, consisting of the environmental pillar representing 68 metrics, the social pillar representing 62 metrics and the governance pillar representing 56 metrics. In total constructed and calculated on 186 metrics. The composite index gives the ratings on a scale of 1-100.
Refinitiv
E The environmental pillar reflects the selected country´s firm's environmental performance and how the practices are best used in order to generate long term shareholder value through capitalisation on environmental opportunities and reduction of environmental risk. It covers the impact on both living and non-living systems, including complete ecosystems, water, air and land.
Refinitiv
S The social pillar reflects the selected country’s firm social performance. It covers the categories of community, diversity, health and safety, production
responsibility, and training and development. Refinitiv
G The governance pillar reflects the selected county´s firm governance performance. It covers categories consisting of management, shareholders rights, CSR
strategy and ESG reporting and transparency. Refinitiv
Independent
Financial Development Index (FD) Defined as a combined index consisting of financial intermediaries and financial markets across the three dimensions of development; depth, access and
efficiency. IMF
Financial Intermediaries Development (FI) Defined as a sub-index of summarised FD-index, relying on the performance of financial intermediaries – including banks, insurance companies, mutual funds and pension funds – across the three dimensions of depth, access and efficiency. IMF Financial Market Development (FM) Defined as a sub-index of summarised FD-index, relying on the performance of financial markets – including stock and bond markets – across the three
dimensions of depth, access and efficiency. IMF
Control
Gross Domestic Product (GDP) Measured as GDP per capita. World Bank
Foreign Direct Investment (FDI) FDI net inflows, measured as % of GDP. World Bank
Trade Openness (TRADE) The total of export and import of goods and services, measured as % of GDP. World Bank Rule of Law (RL) Perception of the extent to which agents have confidence in and abide by rules of society. In particular the quality of contract enforcement, property rights, the
police, and the courts, as well as the likelihood of crime and violence. Between the range -2.5 to 2.5. World Bank Regulatory Quality (RQ) Perception of the ability of the government to implement and formulate stable policies and regulations that promote and permit private sector development.
Between the range -2.5 to 2.5. World Bank
Voice and Accountability (VA) Perception of the extent to which a country’s citizens are able to participate in selecting their government, as well as freedom of association, and freedom of
