Unveiling the Relationship Between ESG and Growth of Unlisted Firms: Empirical Insights From Eastern Europe and Central Asia

2.1 Stakeholder Theory

The term ‘stakeholder’ was originally introduced by Stanford Research Institute in 1963 and has since developed with Freeman's book, Strategic Management: A Stakeholder Approach, making an important contribution (Mahajan et al. 2023). Stakeholder theory was formulated by Edward Freeman, a philosopher and business professor, in 1984. It is a conceptual framework that recommends organisations should not only consider the needs of shareholders but also take care of the interest of all stakeholders, including employees, suppliers, government and society to achieve the organisation's goals (Freeman 2010).

Stakeholder theory posits that a corporate firm should attempt to meet the needs of all relevant stakeholders, including the ESG dimensions, as these are also crucial for its success, although after conducting proper cost–benefit analyses for all concerned stakeholders (Donaldson and Preston 1995; Pozzoli, Pagani and Paolone 2022; Shou et al. 2023). For instance, a study by Clarkson et al. (2011) finds that private firms adopting ESG practices can enhance their relationships with local communities, thus potentially improving their social license to operate. Henisz, Koller and Nuttall (2019) state that by adopting ESG practices, companies demonstrate a commitment to sustainability, ethical behaviour and social responsibility. This can help them attract and retain employees who share their values and vision for unlisted firms' better legitimacy and growth. In the case of improving operational efficiency, ESG factors play an active role in implementing these practices and help these firms move towards cost savings through waste reduction, resource efficiency and competitiveness. It also helps to satisfy society at large (Henisz, Koller and Nuttall 2019). However, some studies show a negative relationship between the ESG role and organisational performance (Alareeni and Hamdan 2020; Wright and Ferris 1997) due to the lack of resources and the presence of unethical elements such as bribes, poor governance and undue resource wastage.

Bekaert, Rothenberg and Noguer (2023) suggest that firms need to balance the interests of multiple stakeholders while pursuing ESG initiatives because when unlisted firms implement ESG factors in their systems, they can protect themselves from probable detrimental results and achieve better growth. Therefore, stakeholder management is an acute concern; it requires simultaneous attention and response, which can impact a firm's image, growth and sustainability. Therefore, firms need to recognise and address stakeholders' concerns strategically (Bridoux and Stoelhorst 2014; Freeman, Harrison and Zyglidopoulos 2018; Porter and Kramer 2011; Russo and Perrini 2010).

2.2 Legitimacy Theory

Dowling and Pfeffer (1975) introduced legitimacy to organisational frameworks, indicating that maintaining legitimacy is fundamental for an organisation's existence and access to resources. Suchman (1995) enhanced the concept of legitimacy and explained it as ‘a universal view or belief that the actions of any organization are required, identifiable, or appropriate within some socially organized framework of traditions, rules, values, and beliefs’. He categorized legitimacy into three areas: pragmatic legitimacy, where stakeholders help the organisation because it benefits them; moral legitimacy, based on moral assessment of the organisation's actions; and cognitive legitimacy, where the organisation is seen as indispensable to society. Today, legitimacy theory is widely used in CSR and sustainability studies, rationalising why companies accept practices that are associated with stakeholders' expectations (Lee and Raschke 2023). By managing legitimacy, organisations aim to build confidence, maintain their ‘social license to operate’ and protect their goodwill in a dynamic social model. Pham and Tran (2020) also posit that every firm operates within a societal context and is expected to behave in a socially responsible manner to meet societal expectations. This theory is foundational in understanding corporate sustainability, asserting that businesses must align with society's norms, beliefs, values and culture to gain acceptance, thrive and survive (Burlea and Popa 2013). Consequently, corporations are urged to present a comprehensive economic, social and environmental package to fulfil stakeholders' needs and foster business growth (Deegan 2002). Maintaining legitimacy poses challenges for unlisted firms due to limited disclosure requirements and resource constraints (Pham and Tran 2020). In this context, adopting ESG practices is a tangible commitment to ethical conduct and sustainability (Dowling and Pfeffer 1975). Such practices become instrumental in demonstrating legitimacy, especially in industries with higher ESG-related risks or regions such as EECA, where regulatory scrutiny and sociocultural considerations are escalating (OECD 2007). Lakkanawanit et al. (2022) explore the connection between energy conservation efforts and firm performance in Thailand, providing valuable insights into how private firms in energy-intensive industries manage their legitimacy by addressing environmental and societal concerns. The performance of a corporate entity is considered legitimate when it aligns with social boundaries and meets stakeholders' expectations (Castelo Branco, Eugénio and Ribeiro 2008; O'donovan, G. 2002). In contrast, some scholars caution against the potential misuse of ethical practices within the legitimacy framework. Companies may participate in socially acceptable activities primarily for self-benefit and protection rather than fostering growth, even if they achieve a better image and acceptability (Borralho et al. 2022; Ortas et al. 2015). This underscores the importance of discerning authentic commitment to social responsibility from mere symbolic gestures in the realm of legitimacy.

Together, stakeholder and legitimacy theories propose that ESG practices can provide a mechanism for unlisted firms to gain support from both stakeholders and society. This dual support can drive firm growth by enhancing reputation, fostering regulatory compliance and attracting investment. Combining stakeholder and legitimacy theories provides a comprehensive framework for examining the research question. Stakeholder theory explains the benefits of ESG adoption from a relationship and value alignment perspective, while legitimacy theory focuses on how ESG practices help firms conform to societal expectations, both of which can drive firm growth. This integrated approach can highlight not only the internal value of ESG practices for stakeholder relationships but also their external value in aligning with societal norms and achieving legitimacy.

4.1 Data

Data were gathered from the World Bank Enterprise Survey (WBES), which conducted interviews with business owners and top executives of unlisted firms in 59 countries during the years 2019, 2020 and 2021. We chose 19,956 unlisted firms from 31 countries from EECA for which data regarding the green economy were accessible (see Appendix 1 for sample distribution). The selection of the EECA region for our study was motivated by its status as a global warming hotspot, as highlighted by Scheffran and Battaglini (2010), and in this context, heightened environmental concerns among investors, customers and the public drive the demand for eco-friendly practices and a focus on environmental innovation in firms (Boffo and Patalano 2020). The region is increasingly vulnerable to climate change impacts, including rising temperatures and erratic weather patterns disrupting ecosystems. The financial investment needed to shield EECA nations from climate change is substantial, with inaction posing even more significant costs. Central Asia, for example, could see a 30% reduction in food yields by 2050, displacing 5.1 million people due to untreated climate-related events. Unresponsive European Union (EU) member states may face job losses of over 400,000 by 2050, incurring €170 billion in costs from climate-related extreme weather events. Amid these challenges, climate change initiatives offer economic benefits by creating jobs and generating revenue.³ Companies in the EECA region acknowledge the imperative to align with ESG criteria to attract investment from socially responsible investors. Environmental sustainability is a significant concern in the region, known for its diverse ecosystems (Boffo and Patalano 2020). Recognising the region's distinct population attributes, dense culture and complex economic systems, there is a growing emphasis on social and governance issues, including diversity, labour rights and community engagement (Fay, Block and Ebinger 2010). Balancing rapid economic development with environmental challenges is a central issue for EECA economies. Coping with environmental challenges involves producing environmentally friendly, innovative products (Tolliver et al. 2021). Unlisted firms were chosen for our study due to their increasing recognition of the pivotal role of ESG factors in driving growth. Including ESG principles not only enhances reputation and access to capital but also enables effective risk management, operational efficiency and competitiveness against larger firms (Bansal and DesJardine 2014; Brown, Guidry and Patten 2009; Dakhli 2021; Govindan, Shaw and Majumdar 2021; Simo Kengne 2016). The agility of smaller firms allows them to respond swiftly to market changes, foster innovation and contribute significantly to economic growth (IFC 2019). Unlisted firms, with inherent flexibility and innovation capabilities, play a crucial role in promoting competition and preventing market monopolies, fostering more efficient markets (Anning-Dorson and Nyamekye 2020; Graves and Shan 2013; Wellalage and Kumar 2021). Despite challenges such as concentrated ownership and governance complexities, particularly in family firms, the adoption of sustainable initiatives addresses autonomy in sales growth and establishes sustainable growth paths, meeting diverse stakeholder needs (Cosenz and Bivona 2021 38; Przychodzen and Przychodzen 2013). By navigating challenges and leveraging inherent strengths, unlisted firms can play a critical role in shaping a more sustainable and competitive business landscape.

4.2 Measurement of Variables

In the existing literature, firm growth is often measured using proxies such as sales, total assets, profitability ratios and employment levels (Ali and Shabir 2017; Audretsch, Coad and Segarra 2014; Reuber and Fischer 2002). This paper uses the WBES, focusing on sales, employment and asset growth. Kasznik and McNichols' (2002) insights guide the evaluation, emphasising that corporate strategies aim for both growth and profitability as fundamental determinants of a firm's overall value. Positive net present value investment opportunities are crucial for delivering value to shareholders (Kasznik and McNichols 2002). These opportunities, viewed as growth options, encompass efforts to enhance profitability, scale existing operations and explore new business domains (Ataünal, Gürbüz and Aybars 2016). The present study recognises the organisation's inclination towards prioritising growth over immediate profits, highlighting the pivotal role of growth rates in long-term success (Geroski, Machin and Walters 1997). Annual employment and asset growth are also assessed, creating a comprehensive framework for understanding firm growth dynamics and their interconnectedness with profitability and value creation. A firm's engagement in ESG activities may help satisfy its stakeholders, including society, environmentalists and ethical investors (Manita et al. 2018; Shin 2014). Stakeholder theory also suggests that socially and environmentally responsible firms enjoy better financial performance, as ESG performance motivates all concerned stakeholders to achieve organisational goals (Aouadi and Marsat 2016). In this research, the ESG index is developed by using different proxies of environmental, social and governance measures. The composition of the ESG index is shown in Table 2.

In addition, this study controlled several firm-specific and country-level variables to deal with the issues of reverse causality, endogeneity and simultaneity (Buallay 2019). The firms' specific variables include size, industry type, multi-established firm and sole proprietorship, whereas the country-level specific variables include liquidity ratio, FDI and inflation. The operational definition of the variables is presented in Table 1.

4.3 Model Specification

In Equations (1), (2) and (3), SG, EG and AG are dependent variables. The ESG index is an independent variable, Xi is a firm-level control variable and Zi is a country-level control variable. The results of baseline regression are reported in Table 4, but it is not an appropriate choice as it produces biased and inconsistent estimates in the presence of endogeneity (Weeks 2002). We apply the Breusch–Pagan/Cook–Weisberg test to check heteroscedasticity, and the results show an inconsistent variance in Model III only, as reported in Table 4.

Similarly, the Wu–Hausman test is used to check the endogeneity problem, and the results in Table 5 show an endogeneity problem in all three regressions. Therefore, in line with numerous prior studies (Hoepner and Yu 2010; Nyborg and Zhang 2013; Wellalage, Locke and Acharya 2018; Wellalage and Kumar 2021; Zhang and Fang 2022), this research adopts the country–industry average score of ESG as an instrumental variable (Table 2). This choice accounts for potential regional variations that may impact a firm's performance differently (Goss and Roberts 2011). Additionally, family ownership concentration and innovation are instrumental variables in the study. The approach involves a two-stage regression, incorporating family ownership concentration, process innovation and average ESG scores for both firms and countries. This methodology is consistent with previous studies (Rahman, Zahid and Al-Faryan 2023; Wellalage and Kumar 2021; Zahid et al. 2020). Moreover, in the case of model III, robust 2SLS is used due to the presence of inconsistent variance in the estimates. We check the validity of instruments by applying the Wald test. The value of the F statistics is greater than the critical value: Hence, we can accept the alternate hypothesis that the instruments are strong (Stock and Yogo 2002).

5.1 Descriptive Analysis

Table 3 shows the descriptive statistics for all the variables. SG, EG and AG have average values of 1.629, 3.054 and 41.786, respectively. The statistics indicate that firms' asset growth exceeds sales and employment growth. This suggests that unlisted firms emphasise the AG of the business more than SG and EG. Likewise, ESG has a mean value of −0.0607, indicating that most sample firms do not prefer sustainable initiatives to increase their growth. The firm-level control variables, including small, manufacturing, multi-established firms and sole proprietors, have mean values of 0.4454, 0.1405 and 0.1070, respectively. Country-level control variables, namely liquidity ratio, FDI and inflation, have mean values of 0.5012, 0.36940 and 4.1551, respectively. Correlation analysis is provided in Appendix 2. The statistics show that ESG positively relates to SG, EG and AG. Both sole proprietorship and multi-established firms contribute positively to all three growth variables. None of the values is greater than 3 in the correlation matrix, which indicates that results are free from biases (Hair et al. 2012). Moreover, the VIF value is also less than the threshold value of 10 (Rahman, Zahid and Al-Faryan 2023; Zahid et al. 2020).

5.2 Findings

Table 4 shows the estimation results for Model I (SG), Model II (EG) and Model III (AG). In the three regressions, the value of R² for Model I is 0.0721, for Model II is 0.0133 and for Model III is 0.1439, indicating that Model III has a better goodness of fit due to a more significant R² value. For these OLS regressions, the estimated coefficients represent the changes in growth variables in response to a one-unit change in explanatory variables, ESG and control variables. All three models indicate a statistically significant relationship between the ESG index and the growth variables at a 1% significance level, supporting H1, H2 and H3. The probability of an increase in AG, SG and EG is 6.50%, 5.23% and 2.37%, respectively. The results are consistent with previous studies (Khamisu, Paluri and Sonwaney 2024; Lee and Raschke 2023; Rajesh 2020; Sadiq et al. 2020; Zhou, Liu and Luo 2022), but the extant studies lack the relationship between ESG and SG, EG and AG for unlisted firms in EECA. Significant and positive relationships indicate the impact of organisations embracing ESG initiatives in safeguarding the legitimate rights of stakeholders. Beyond regulatory compliance, a commitment to ethical practices resonates positively with stakeholders, enhancing an organisation's reputation and overall growth. Stakeholders, including customers and investors, increasingly value businesses dedicated to social and environmental responsibility, strengthening relationships, trust and reciprocity (Bagh et al. 2024). By integrating these initiatives based on legitimacy and stakeholder theory, organisations can strengthen their legitimacy, build positive stakeholder relationships and enhance overall firm growth. Delmas and Blass (2010) also note that corporations significantly contribute to greenhouse gas emissions through their manufacturing processes, energy consumption and supply chain activities, contributing to global warming and climate change. Our results align with the concept of stakeholder theory. Based on our findings, the stakeholder theory confirms the positive impact of ESG initiatives on firms' sales, employment and asset growth by highlighting the strategic importance of meeting stakeholders' expectations. Our results indicate that companies focusing on ESG factors are better able to build confidence and boost relationships with key stakeholders, which directly help firms' growth. The results are aligned with previous studies (Bagh et al. 2024; Khamisu, Paluri and Sonwaney 2024; Zahid et al. 2020; Zhou, Liu and Luo 2022). As in previous studies, the findings also suggest that incorporating ESG factors into business operations can enhance a company's legitimacy, enabling it to secure a social license to operate in a competitive environment. This, in turn, can lead to improvements in reputation, driving growth in areas such as sales, employment and asset value (Lee and Raschke 2023; Minutolo, Kristjanpoller and Stakeley 2019).

To our knowledge, this is the first research to determine the relationship between ESG and the growth of unlisted firms. A range of other studies (Buallay 2019; Chouaibi, Chouaibi and Rossi 2021; Liu, He and Yan 2014; Porter and Kramer 2006; Rettab, Brik and Mellahi 2009; Velte 2017) find a positive relationship between ESG and firm performance of listed firms, but these previous studies did not focus on unlisted firms in the EECA region.

Regarding control variables, the estimates have marginally different significance levels and magnitudes for Model I, Model II and Model III. ESG initiatives, in the case of small-sized firms, significantly contribute to sales growth (Minutolo, Kristjanpoller and Stakeley 2019) but negatively contribute to employment and asset growth as they face a lack of resources. Manufacturing firms negatively contribute to growth prospects due to heavy investment in ESG activities and limited access to finance from financial institutions (Zhang and Wellalage 2022). With regard to the legal ownership structure of firms and multi-established firms, our research indicates that sole proprietorships do not significantly contribute to the business's sales, employment and asset growth. In the case of country-level control variables, the results show that a high liquidity ratio positively contributes to employment growth and negatively contributes to employment sales and asset growth. A possible reason is that a high liquidity ratio signals financial stability, encouraging investment in ESG initiatives and job creation. Governments may use their liquidity to support social and environmental projects, promoting ESG and employment growth. Excessive liquidity can represent missed investment opportunities as funds are not used for productive assets or sales expansion.

Low interest rates associated with high liquidity may reduce lending incentives, affecting asset and sales growth. Concerns about inflation with high liquidity may lead businesses to invest in physical assets or increase sales instead of holding onto cash. Inflation negatively influences the sales growth and asset growth of unlisted firms. As indicated in previous studies, it also exposes more challenges for unlisted firms to compete with other business ventures, including listed firms (Egbunike and Okerekeoti 2018; Mirza and Javed 2013; Odusanya, Yinusa and Ilo 2018). The positive FDI coefficient in all three regression models is consistent with the conclusions drawn by Pattitoni, Petracci and Spisni (2014) and Pervan, Pervan and Ćurak (2019) because the continuous increase in FDI helps countries to attain economic stability, which in turn results in business opportunities, leading to economic prosperity.

5.3 Endogeneity

An endogenous variable is associated with the error term in a regression model, which could be due to omitted variables and measurement errors (Weeks 2002), and the problem of endogeneity can be resolved by including instrumental variables (Weeks 2002). In all three regression models, a problem of endogeneity was found, and OLS regression showed biased and inconsistent estimates. To resolve the problem of endogeneity and biased results, we used average ESG value for industry and country, process innovation and concentration of family ownership, as previous studies proposed different instrumental variables including lagged values of ESG, financial performance, equity ownership, executive compensation and corporate governance practices (Brammer and Millington 2005; Garcia-Castro, Ariño and Canela 2010; Van Duuren, Plantinga and Scholtens 2016).

Unlike listed firms, family ownership of unlisted firms is more likely to result in better performance due to the bonds between family members and the mutual interest or benefit they have in their family business (Borralho et al. 2022). Such family setups, with an increasing number of family members, require unlisted firms to keep on improving and demonstrating better operations. This primarily requires process innovation and upgrading, contributing to better firm performance and ESG context (Borralho et al. 2022). Table 5 shows a significant positive relationship between ESG and all growth dimensions. The results are consistent with previous research (Orlitzky 2013; Rahman, Zahid and Al-Faryan 2023; Wang et al. 2020; Zahid et al. 2020) The strong positive relationship underscores the impact of organisations adopting ESG initiatives on upholding stakeholders' legitimate rights. Going beyond mere regulatory compliance, a commitment to ethical practices fosters trust and goodwill among stakeholders, boosting an organisation's reputation and supporting its growth.

By using 2SLS, the research removes the endogeneity and the influence of ESG on firm growth, providing consistent estimators that yield a more reliable understanding of the relationship (Soytas, Denizel and Usar 2019; Stock and Yogo 2002). The coefficient in the case of 2SLS is more evident than in OLS, and the estimators are consistent in both cases. These findings support the hypothesis of the current study that ESG performance has a significant positive effect on firm growth after endogeneity control (Soytas, Denizel and Usar 2019). The results align with stakeholder theory and legitimacy theory (Donaldson and Preston 1995; Freeman, Harrison and Zyglidopoulos 2018) because firms can satisfy stakeholders by improving growth through legitimate ESG-related strategies in their business processes. According to stakeholder theory, firms that consider the stake of their stakeholders gain their support, fidelity and confidence, which can influence long-term monetary goals (Donaldson and Preston 1995; Freeman, Harrison and Zyglidopoulos 2018). For example, improved environmental performance and robust social and governance practices can attract stakeholders. Legitimacy theory further supports the study's findings: Companies gain a ‘license to operate’ by aligning with social norms and public expectations (Suchman 1995).

5.4 Robustness

Two countries, Turkey and Montenegro, contributed the most significant and minor numbers of observations to our entire sample. To lessen the concern that these countries could create bias in the results, we excluded both countries from the entire sample. The results reported in Tables 6 and 7 are like those in Tables 4 and 5. All these findings indicate that our main findings are not influenced by the countries involved.