Financial constraints and ESG performance: a Signaling Theory perspective

This study explores the relationship between firm-level financial constraints (FC) and ESG performance using a sample of 1153 firm-year observations from 313 non-financial Indian firms during 2007 to 2024. Corroborating with the Signalling Theory, the findings suggest that financially constrained firms exhibit better ESG performance. Contrary to traditional belief, this behaviour is even more pronounced when firms’ financial constraints become more severe. Additionally, we report that when financial constraints improve, firms selectively boost ESG performance to seek immediate visibility and legitimacy from their stakeholders. The results significantly align with the signalling motivations for firms to engage in ESG initiatives.