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INDIAN INSTITUTE OF MANAGEMENT, SHILLONG

CORPORATE FINANCE

RESEARCH PAPER

ESG AND DISRUPTION IN THE MANUFACTURING SECTOR

Under The Guidance Of

Dr. Mousumi Bhattacharya

Submitted by Group 5B:

Ankit Srivastav 2022PGP254

Bhandaru Sai Ruthwik 2022PGP261

Paritosh S Nair 2022PGP281

Pulkit Gubgotra 2022PGP283

Tabraiz Hussain 2022PGP300

Vaishvee S Thacker 2022PGP305

TABLE OF CONTENTS

S.No. Particulars Page No.

1. Abstract 3

2. Introduction 3

3. Literature Review 7

4. Research Gap 8

5. Scope/ Objective 8

6. Hypothesis Formulation 9

7. Data and Methodology 9

10
8. Results/ Findings

9. Conclusion/ Implication of the Study 10

10. Limitations 11

11. References 12

12. Annexures 13
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ABSTRACT

The ESG disruption in the manufacturing sector in India has been happening fast, with all significant
corporations adopting newer and sustainable means in their value chain. This research paper aims to
study the impact of ESG adoption in the manufacturing sector on the financial performance of the top
10 manufacturing companies from the NIFTY Manufacturing Index in India. The paper employs an
inductive quantitative research methodology on secondary data of ESG scores and financial ratios,
along with the impact of the BRSR mandate by SEBI dated May 2021 on these companies' stock prices
(since the market tends to discount everything) and their beta values monthly. The paper employs
statistical measures like a multiple regression model to test the impact of independent variable – ESG
scores on dependent variables – ROE, ROCE, ROA, EPS, and P/BV. It also covers a paired t-test. The
paper concludes that ESG scores, BRSR mandate, and governance scores have little to no significant
impact on the financial performance and valuation of the company except for two companies (even
their r-squared value is close to 0.5, which shows the model is not that strong). The limitation applies
to the fact that a company's financial performance is not just limited to ESG scoring but a lot of other
factors which are generally heavy contributors towards share price and financial ratios.

INTRODUCTION

The demand for ESG has increased due to the impact of natural disasters and financial crises on
businesses, causing major corporations to disclose their contributions to environmental, social, and
Governance measures. ESG refers to conducting corporate management activities according to basic
laws and ethics, and with the growing need for sustainability, the emphasis has shifted from financial
to non-financial performance. ESG disclosures focus on a company's potential risks and positioning for
long-term sustainable investment realization. SEBI developed BRR (Business Responsibility Reports),
in which the top 100 listed companies (later expanded to 500 in 2015) were required to answer specific
questions about National Voluntary Guidelines (NVGs). Subsequently, BRR was renamed Business
Responsibility Sustainability Reporting (BRSR), and the top 1000 listed companies were required to
disclose information about their environmental, social, and Governance measures. Most progressive
CEOs want to be market leaders in ESG because it has a huge potential for attracting capital when
integrated with business strategy.

Investors are now scrutinizing non-financial parameters to the same extent as financial performance.
Global regulators are pushing the ESG agenda, and the regulatory aspect of ESG has gained momentum
with the introduction of BRSR in India. By 2022-23, the top 1000 companies in market capitalization
will be required to submit a BRSR report, which evaluates a company's performance on crucial ESG
parameters by asking over 150 questions across nine fundamental principles. ESG has become
increasingly critical for long-term business sustainability from all perspectives, including customers,
suppliers, employers, financial markets, regulators, and governments. As stakeholder capitalism has
grown, the business ecosystem has become more complex. Businesses must create holistic value for
stakeholders, and the reporting methods have evolved from non-financial reporting to integrated
profit-loss statements. This report attempts to quantify the positive and negative impact of business
operations and products on various types of capital (human, social, natural, and intellectual). Investors
increasingly recognize the value of such reporting, and the International Integrated Reporting Council's
(IIRC) integrated reporting framework guides the reporting of six capitals: social, human, intellectual,
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natural, manufactured, and financial. The foundation for developing integrated profit-loss accounts
combines financial and non-financial reporting. Given the vastness of the ESG arena, organizations
often struggle to determine where to start and how to piece everything together into a strategic
picture. The answer lies in what is most important to the business.

Organizations measure their performance in crucial qualitative and quantitative areas and compare it
to their peers and leaders after determining their priorities. It is crucial to maintain a continuous
dialogue with stakeholders, develop an effective engagement and communication strategy that
includes ESG, and report ESG performance through appropriate reporting frameworks. Finally, ESG
organizations in the heavy manufacturing sector consider ESG a net zero enabler. To create a proper
ESG matrix in an organization that has progressed to the leadership stage, has a transparent ESG
approach, vision, and targets, and collaborates with industry peers to promote greater ESG adoption.
Metrics and KPIs are readily available to quantify the environmental aspect of ESG, and much is
happening in that area. However, the same cannot be said for social factors, as many companies
have yet to adopt uniform reporting on social issues. Only a few businesses have a reporting system
to present data on social issues to stakeholders. The difficulty of establishing any social indicators is a
contributing factor, given the broad range of topics that social issues encompass, including consumer
protection, product safety, labor law and workplace safety, diversity, anti-corruption efforts, and
respect for human rights throughout the supply chain. With a GDP of $5 trillion, India needs to
develop the concept of diversity and inclusion in business. A diverse workforce leads to more
effective input. While many companies have taken steps to empower women, India can go above
and beyond to create a better workplace for individuals with disabilities.

For any business to operate appropriately, Governance is a crucial starting point. Indian businesses
can consider several aspects, including inducting independent directors, ensuring board diversity in
gender and capabilities, and implementing appropriate policies and risk management structures.
Some companies are already developing an ESG charter, establishing ESG committees to strengthen
ESG governance, and creating comprehensive risk mitigation strategies.

The COVID pandemic has been a significant catalyst for reshaping global economies and business
practices. It has compelled the world to reset by exposing the fragility of current business and
economic models. It has also served as a warning about the impending challenges of climate change
and biodiversity loss and the extent of the damage they could cause. Many business leaders
acknowledge the risks posed by these threats and are working to safeguard stakeholders' interests.
One example of this is the evolution of how business leaders perceive risks, as demonstrated by the
changing composition of the Global Risks depicted by the World Economic Forum. Over the last
decade, the top five global risks have shifted from an economic focus to an environmental and
societal focus.
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Including Environmental Social Governance (ESG) in business models enhances resilience and shields
businesses from potential future shocks. ESG is becoming increasingly important as a strategic
approach, leading to improved business operations. Indian businesses are recognizing the need to
prepare for current and future challenges, and significant developments have taken place this year,
including:

• A pledge for responsible investments: The number of Indian organizations pledging to the
United Nations—Principles of Responsible Investment (UNPRI) tripled by 2020.
• Growth of environmental, social, and Governance (ESG) funds: India currently has eight ESG
mutual funds.
• Increased emphasis on climate risk in investments: The number of supporters of India's Task
Force on Climate-related Financial Disclosures (TCFD) has tripled in 2020-21.
• Greater transparency: 220 Indian companies now use CDP to disclose information to their
investors and customers.
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ESG is often confused with CSR, but CSR is only a small component of ESG. CSR is a general sustainability
framework primarily used by businesses, while ESG is a measurable sustainability assessment popular
among investors. Companies that adhere to ESG norms are believed to be more valuable in the future
than those that do not. An ESG-compliant company has a better chance of being valued higher among
investors if it focuses on its core business, the environment, employees, and all corporate governance
responsibilities. However, history has demonstrated that bad companies, such as those in the
gambling, tobacco, and alcohol industries, have provided at least 20% higher returns than good
companies. As a result, it is unclear whether ESG disruption has increased a company's value, which is
the primary focus of this research paper.
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LITERATURE REVIEW

Researchers Yu-Jin Chang and Byung-Hee Lee have found that ESG positively impacts firm value, but
the relationship is moderated by industrial concentration and growth rate. Despite the pandemic,
Shashuo Zhang notes that manufacturing companies have been reluctant to invest in ESG due to the
perceived high cost, competing with the need for cash flow. On the other hand, Webley Simon and
Elise (2003) found that businesses with ethical codes outperform those without financial metrics,
including market value added and economic value added. In a separate study, Lipper and GMI (2004)
found that large-cap mutual fund managers prefer companies with more robust corporate governance
profiles. Similarly, Brown and Marcus (2004) used ISS's CGQ to investigate the link between corporate
Governance and company performance, finding that businesses prioritizing ethics outperform the S&P
500 and generate higher profits. Parks (2008) discovered that an ethical culture could reduce the
likelihood of negative work situations and foster employee happiness, leading to increased
productivity and profitability. Finally, Mittal, Sinha, and Singh (2008) suggest that businesses with
ethical codes tend to produce higher economic and market value added. In a 2009 study, Standard &
Poor found a strong correlation between corporate governance scores and the market value of Indian
enterprises, indicating that investors should consider this connection before investing.

According to Peavler (2010), ethics are crucial for a firm's long-term prosperity. The dishonest
businesses may succeed in the short term but fall short in the long run because their stakeholders—
including the public, shareholders, bondholders, and employees—know what they are doing. Living by
morals and ideals is the only way to endure solid and viable over time. Using a board-level aggregate
variable, Rashid, Ramli, and Zakaria (2010) investigated the connection between board composition
and firm performance. They performed a panel data analysis with 277 non-financial listed Malaysian
enterprises from 2002 to 2007 to analyze the association between these variables. According to the
study, company boards with a higher percentage of outside and international directors perform better
than boards with a preponderance of insider executives and related non-executive directors. Azim
Mohammad (2012) examined the degree to which the board and its committees, shareholders, and
independent auditors are complements (i.e., a positive covariance) or substitutes (i.e., a negative
covariance) for one another in a study utilizing structural equation modeling (SEM). He discovered that
there were linkages among monitoring mechanisms that were both complementary and substitutable.

The study examined whether corporate governance measures affect firm performance using data from
before and after the global financial crisis. In 157 Indian non-financial enterprises, Kumar and Singh
(2012) looked at the effectiveness of outside directors on corporate boards in 2008. The study's main
goal was to determine whether or not monitoring by grey (non-executive, non-independent) and
independent directors impacts company performance. The study's conclusions showed that while
having more grey members on the board has a negligibly worsening influence on business value, having
more independent directors has a negligibly better benefit. According to Karpagam and Selvam (2013),
it is impossible to increase shareholder value and protect their interests without excellent corporate
Governance. Their research focused on determining if corporate governance mechanisms impact
business performance. The study examined the board of directors' independence and the financial
results of companies listed on the Bombay Stock Exchange (BSE 100). According to the study's findings,
corporate Governance practices that take promoters' ownership and profitability into account provide
more opportunities and resources for improved performance.
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RESEARCH GAP

Financial institutions and retailers are becoming more aware of ESG norms and risks concerning the
non-conformance of disclosures. By analyzing the literature, the gap is found majorly in terms of
specificity. The manufacturing sector has not been covered intensively in terms of ESG. There are
several papers to prove that ESG may have a slight impact on the financial performance of companies.
No literature on Nifty Manufacturing Index's companies is available on how ESG has impacted their
financial performance. Accordingly, this paper intends to explore the impact of ESG disruption on
select companies from the Nifty Manufacturing Index. This paper also intends to explore the ESG
scores of respective Nifty Manufacturing Index companies and how it influences each company's ROA,
ROCE, ROE, EPS, and P/BV.

SCOPE AND OBJECTIVE

The paper intends to explore the impact of ESG disruption on the financial performance of
manufacturing companies, particularly in the Nifty Manufacturing Index in India, and to explore the
impact of ESG disruption on the risk profile of the Nifty Manufacturing Index in India from the period
of before the amendment of Business Responsibility and Sustainability Reporting (BRSR) to the period
after BRSR. The idea behind this is that many companies follow the ESG disclosures diligently, and after
the BRSR, those companies will get external validation of their hard work toward ESG. When the news
about the BRSR came in May 2021, most of the stocks following the ESG norms diligently must have
had their stock pricing impacted by this as the market discounts the news early so that the ESG impact
will be visible in stock much earlier. However, this paper will also investigate the aspects of ESG scores
of the top 10 manufacturing companies from 2013 to 2022, i.e., a span of 10 years, and will analyze
whether an improvement or degradation in ESG scores has an impact on the profitability and valuation
ratio of the company. This paper will evaluate ratios like return on net worth, return on capital
employed, return on assets, earnings per share, and price to book value.

HYPOTHESIS FORMULATION

The paper attempts to determine the significant difference in the risk and returns of the Nifty
Manufacturing Index companies in the pre-and post-Business Responsibility and Sustainability Reports
(BRSR) that the SEBI has mandated. The paper also attempts to determine any impact on investor
perception and actual performance through profitability and valuation ratios to determine if there is
significant evidence that ESG impacts these measures.

H01 = Respective companies' returns in Pre and Post BRSR period are at par.

H02 = Respective companies' return on equity (ROE) is not affected by ESG scores over ten years

H03 = Respective companies' return on capital employed (ROCE) is not affected by ESG scores over ten
years

H04 = Respective companies' return on assets (ROA) is not affected by ESG scores over ten years

H05 = Respective companies' earnings per share (EPS) is not affected by ESG scores over ten years
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H06 = Respective companies' price to book value (P/BV) is not affected by ESG scores over ten years

H07 = Respective companies' return on equity (ROE) is not affected by Governance scores over ten
years

H08 = Respective companies' return on capital employed (ROCE) is not affected by Governance scores
over ten years

H09 = Respective companies' return on assets (ROA) is not affected by Governance scores over ten
years

H10 = Respective companies' earnings per share (EPS) is not affected by Governance scores over ten
years

H11 = Respective companies' price to book value (P/BV) is not affected by Governance scores over ten
years

DATA AND METHODOLOGY

The paper is based on an inductive quantitative study of secondary data. For BRSR reporting, the
notification from SEBI came around May 2021, and the market discounts every piece of news
information. This notification would. have had a positive effect on the stock prices of the companies
who were already following the ESG norms and disclosure diligently would be benefitted from this
notification that their stock price would be impacted in the coming months based on the BRSR
mandate from SEBI. Accordingly, from NSE official website, the data has been taken from June 2020 to
May 2021 for the pre-BRSR period and from June 2021 to May 2022 for the post-BRSR period.
Additionally, ESG scores for ten years of select manufacturing companies have been collected from
Refinitiv. Detailed reports have been mentioned in the annexures. The paper will conduct a multiple
regression analysis keeping ESG scores as the independent variable and ROE, ROCE, EPS, ROA, and
P/BV as the dependent variable. This will help us determine whether there is a significant change in
the company's performance due to ESG improvements. Generally, many companies focus on the
Environmental and Social Aspects of their namesake, and their primary focus is Governance. Investors
take governance issues very seriously, which is a driving factor in choosing and screening companies;
hence, this paper will also evaluate the impact of Governance scores on financial and valuation
performance through regression.

This paper will also perform a paired t-test on the daily stock returns and beta calculations to show the
impact of the BRSR mandate on companies already following ESG norms diligently.
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RESULTS/ FINDINGS

Companies H01 H02 H03 H04 H05 H06 H07 H08 H09 H10 H11

Reliance A A A A A A A A A R A

Vedanta A A A A A A A A A A A

Tata Steel A A A A A A A R A A R

M&M A A R A A A A A A A A

Sun Pharma R A A A A A A A A A A

Pidilite A A A A R R A A A A A

UPL NA A A A A R A A A A R

Siemens NA A A A A A A A A A A
Maruti
NA A A A A R A A A A A
Suzuki
Indian Oil NA A A A A A A A A A A

A = Accepted R= Rejected NA= Not Applicable

CONCLUSION/ IMPLICATION OF THE STUDY

By analyzing the regression models and paired t-test, this paper concludes that ESG scoring has slight
to no impact on the actual performance and valuation ratios for return on equity (ROE), return on
capital employed (ROCE), return on asset (ROA), earning per share (EPS) and price to book value
(P/BV) as in the majority of the cases the p-value is more than 0.05 and the r-squared value which
shows how strong the model is, is also less than 0.5 in the majority of the cases showing that there is
little to no correlation between ESG scores and fundamental and valuation ratios but in a few
companies like Maruti Suzuki and Pidilite p-value of price to book is less than 0.05 and the
corresponding r-squared value is more than 0.5, validating that ESG score had an impact on the
valuation metric. Additionally, the BRSR mandate impact on stock price is minimal, as only 1 out of 6
companies got its null hypothesis rejected. In every other case, the p-value was more significant than
0.05, proving the null hypothesis. Since many companies generally pay more attention to governance
(G) instead of environmental (E) and social (S), hence this paper also analyzed the impact of
Governance on fundamental and valuation ratios; the conclusion is that governance scores have little
to no impact as only 2/10 companies - Tata Steel and UPL were able to reject the null hypothesis as
p-value was less than 0.05. The R-squared value was close to 0.5, making the model intense as
compared to the rest of the companies who have their p-values above 0.05 with an r-squared value
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less than 0.5 showing that model is not robust, i.e., governance scores and overall ESG scores have
little to no impact on the performance of companies.

Although there is an implicit opinion that ESG affects the firm's fundamentals, that may be true
theoretically, to establish that in 10 companies in Nifty Manufacturing Index in India quantitatively is
difficult.

ESG adoption should come naturally to the companies, and steps are being taken to integrate it into
financial reporting; though BRSR is a good measure, it is made voluntary for 1000 listed companies;
instead, it should be mandatory to gauge how much each company is contributing to ESG.

The research paper has established that the company's performance depends more on intrinsic
factors than ESG scores. They are a part of moving the stock or affecting the performance, but that
impact is too small in statistical terms.

LIMITATIONS

The paper attempts to cover all the aspects of the ESG scoring impact on the financial performance
and valuation of respective companies. However, several limitations arise in between. A company's
financial performance is a function of the fundamental operations of the company, and this dominates
any company's share price too. The companies chosen are from varied sectors within the
manufacturing space; since every industry has its pros and cons and regulations, a decrease in the
share price due to harsh regulation and a corresponding increase in ESG score is bound to give
misleading analysis. Private organizations do ESG scoring; getting hold of the data is quite expensive,
and some companies do not have full ten years of ESG scores, making it difficult to evaluate the results.
Also, SEBI has now tried to integrate ESG norms with financial reporting, but many companies do it for
namesake since it is voluntary; efforts need to be made on this front, especially by companies, to
understand the importance of ESG and sustainability. There is a hope to see ESG norms getting adopted
by companies in their day-to-day activities to make the world a better place.

REFERENCES

• https://m.economictimes.com/news/company/corporate-trends/esg-is-a-wakeup-call-for-
indian-suppliers-says-industry-veteran-girija-pande/articleshow/92743260.cms
• https://www.businesstoday.in/opinion/columns/story/esg-and-india-inc-companies-need-
not-forego-profit-in-order-to-attain-sustainability-goals-both-can-co-exist-356657-2022-12-
16
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• https://www.ey.com/en_in/climate-change-sustainability-services/how-esg-factors-can-
help-in-future-proofing-indian-businesses
• https://am.jpmorgan.com/content/dam/jpm-am-aem/emea/regional/en/insights/portfolio-
insights/esg-supply-chain.pdf
• https://etinsights.et-edge.com/8-innovations-in-advanced-manufacturing-that-support-
enhanced-esg-reporting/
• https://et-sdg.com/wp-content/uploads/2022/03/ESG-white-paper.pdf
• https://blog.protiviti.com/2021/04/12/the-why-and-how-of-esg-for-manufacturing-
companies/
• https://www.acumence.com/esg-what-is-it-and-why-should-manufacturers-care/
• https://www.forbes.com/sites/lisacaldwell/2022/03/16/responsibility-and-opportunity-how-
manufacturers-can-get-ahead-of-the-game-on-esg/
• https://parsable.com/blog/esg/importance-of-esg-in-manufacturing-18-statistics-that-can-
help-drive-value/
• https://blog.protiviti.com/2021/04/12/the-why-and-how-of-esg-for-manufacturing-
companies/
• https://www.servicenow.com/workflow/it-transformation/how-to-accelerate-esg-
compliance-efforts-in-manufacturing/
• https://sustainabilitymag.com/sustainability/four-driving-factors-of-esg-in-manufacturing-in-
2022-sustainability-digital-platforms-parsable-yasmin-zarabi
• https://www.sciencedirect.com/science/article/pii/S0959652622045243
• https://www.dbpia.co.kr/Journal/articleDetail?nodeId=NODE10611843
• https://link.springer.com/chapter/10.1007/978-981-16-2613-5_3
• https://www.atlantis-press.com/proceedings/icemed-22/125975495
• https://www.mdpi.com/article/10.3390/su142114444

ANNEXURES

Reliance Regression
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Vedanta Regression
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Tata Steel Regression

M&M Regression
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Maruti Suzuki Regression

Indian Oil Company Regression

Sun Pharma Regression

Seimens Regression
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Pidilite Industries Regression

UPL Regression
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