Effect of Environmental, Social, and Governance Performance on Corporate Financialization: Evidence from China

Dear reviewer: 

First, we very much appreciate your favorable consideration and warm work earnestly. We would like to thank you for the positive and constructive comments and suggestions on our manuscript ID sustainability-1874242 entitled “Effect of Environmental, Social, and Governance Performance on Corporate Financialization: Evidence from China”. Our team has tried our best to revise the manuscript since we received the comments and suggestions. As suggested, we have substantially revised our manuscript after considering the insightful comments and suggestions. We have also amended areas of our manuscript with inadequate details to make the manuscript more persuasive.

We would be glad to respond to any further questions and comments that you may have, and look forward to hearing from you regarding our revisions.

Below are descriptions of our revisions according to your comments on an item-by-item basis.

Reviewer #1:

The phenomenon that an increasing number of Chinese nonfinancial firms invest heavily in financial assets has adversely affected financial market stability and healthy economic development in China. The empirical results of this paper show that ESG performance has a promoting effect on corporate financialization, suggesting that ESG activities may be a tool for firms to seek financial arbitrage and the rapid growth in ESG development of Chinese listed firms also comes with possible drawbacks. The findings are very interesting and important. I assess the article very highly and have the following comments for the authors to further improve the manuscript. 

1. In recent years, the tightening financial environment has exerted growing downward pressure on the real economy in China. The phenomenon that an increasing number of nonfinancial firms invest heavily in financial assets has adversely affected financial market stability and healthy economic development in China. Issues about corporate financialization are always one of major fields academic researched. This study explores the factors affecting corporate financialization of Chinese nonfinancial listed firms from the novel perspective of ESG performance, which can provide a deeper understanding of the complex driving factors behind corporate financialization, and thus provide empirical support for curbing the phenomenon of transforming the economy from real to virtual. However, the authors should justify and highlight the importance of the topic under investigation in Introduction. 

Reply: Thank you very much for your constructive suggestions. To further improve the introduction, as suggested, we have justified and highlighted the importance of the topic under investigation in the INTRODUCTION on page 1-2:

In recent years, the tightening financial environment has exerted growing downward pressure on the real economy in China. The rate of return on physical investment continues to decline, while the rate of return on financial investment remains high, making more and more nonfinancial firms invest heavily in financial assets rather than physical assets (Tang & Zhang, 2019). This phenomenon is referred to as corporate financialization, which is the main driver that transforms the economy from real to virtual (Xu & Guo, 2021). Although corporate financialization can create significant short-term improvements in corporate financial position, it will inevitably crowd out the resources for primary business, thus hindering the construction of core competitiveness and long-term development of the firms (Xu & Xuan, 2021). Perhaps of greater concern, as financial assets have the characteristics of excess volatility and high riskiness, corporate financialization of nonfinancial firms may hinder financial market stability and healthy economic development in China (Zhao & Su, 2022). Therefore, it is of great significance to explore the factors affecting corporate financialization of nonfinancial firms, to accordingly provide practical guidance for the government to lead corporate investment back to primary business, and thus prevent systemic financial risks and promote the sustainable development of China’s economy.

ESG describes a set of indicators used to systematically evaluate a firm concerning its environmental (E), social (S), and governance (G) activities (Gillan et al., 2021), reflecting a specific projection of the implementation of sustainable development strategy at the micro-firm level (Nekhili et al., 2021; Wang & Sun, 2022). The United Nations Environment Programme proposed the concept of responsible investment as early as 2004 and advocated that firms pay attention to ESG issues in their investment activities. Chinese government has paid considerable attention to ESG activities at the firm level since 2015 (Tan & Zhu, 2022). ESG provides a systematic and quantifiable operational framework for sustainable and green development, which is highly compatible with China’s approach to economic, political, cultural, social, and ecological progress, and also aligns well with China’s new development concepts emphasizing innovation, coordination, green development, opening up, and sharing. In recent years, with the continuous promotion of sustainable development strategy in China, government regulators and industry associations have launched a series of policies aimed at guiding firms to practice the concept of ESG. As a result, the ESG performance of a growing number of firms has been continuously improved in China.

The drastic growth in ESG development in China has brought many economic benefits to the firms, but it also comes with possible drawbacks. The existing literature on ESG mainly focus on the effect of ESG performance on firm value or corporate financial performance, and forms two opposing views: the efficiency view and the agency view (Friede et al., 2015). The efficiency view mainly holds that ESG activities are a rational tool for improving firm value or corporate financial performance (Abdi et al., 2022; Wong & Batten, 2021; Fatemi et al., 2018). The agency view regards ESG activities as a form of agency conflict in which managers pursue private interests that damage firm value or corporate financial performance (Duque-Grisales & Aguilera-Caracuel, 2021; Lee et al., 2009; Masulis & Reza, 2015). Accordingly, it can be inferred that ESG may be used either as a governance tool to reduce corporate financialization or as a self-interested tool for managers to seek short-term financial returns by investing heavily in financial assets. Specifically, based on the efficiency view, good ESG performance can significantly improve information disclosure quality between the firm and stakeholders and mitigate agency conflict within the firm. As a result, it can reduce corporate financialization for short-term profit-seeking at the expense of long-term development. In contrast, according to the agency view, managers who are inclined to seek private interests will make instrumental use of the resources obtained from good ESG performance for financial asset investment in pursuit of short-term financial returns. Additionally, the reputation insurance effect generated by good ESG performance can mask the irrational overinvestment in financial assets. Under the circumstances of the economy transforming from real to virtual and the drastic growth in ESG development in China, it is important to explore whether and how does ESG performance affects corporate financialization. The exploration of this question is conducive to reveal the driving factors of corporate financialization, to provide policy implications for government regulators to restrain firms’ overinvestment in financial assets, and therefore to reduce systemic financial risks that adversely affect healthy economic development in China.

2.The reasoning that the authors used to develop the hypothesis (Dual Effects of ESG Performance on Corporate Financialization, i.e., ESG performance reduces corporate financialization and ESG performance promotes corporate financialization) should be backed with a more comprehensive list of literature. 

Reply: We would like to thank you for the positive and constructive comments and suggestions. We agree that the hypothesis regarding ESG performance reduces or promotes corporate financialization would be more persuasive with a more comprehensive list of literature. Specifically, we have made some supplements in the Literature Review and Hypothesis Development on page 4-5:

2.2.1. ESG Performance Reduces Corporate Financialization

Stakeholder theory and resource constraint theory provide the theoretical basis for ESG performance being a governance tool to reduce corporate financialization. According to stakeholder theory and resource constraint theory, ESG performance can reduce corporate financialization mainly through the following two aspects. First, ESG performance can reduce corporate financialization by alleviating information asymmetry and agency conflicts. As one of the most important kinds of nonfinancial information, ESG performance reflects financial situation, risk management, and other aspects of a firm, which can make up for defects in incomplete information that is reflected in financial reports, and thus reduce information asymmetry between different stakeholders such as investors, creditors and the government (Yuan et al., 2022; Chen &Yang, 2020). Therefore, firms with good ESG performance tend to exhibit characteristics associated with rich information environments (Naqvi et al., 2021), which is conducive to stakeholders in strengthening the supervision on managers’ inefficient investment behavior (Ellili, 2022; Benlemlih & Bitar, 2018), and thus restrain their speculations in financial asset investment for short-term returns. In addition, ESG activities may be an effective way to reduce agency conflict that exists between stakeholders and managers due to the existence of asymmetric information (Healy & Palepu, 2001; Tang, 2022). As a result, good ESG performance can reduce instances of misconduct, such as financial irregularities, inefficient investment, earnings management, and tax avoidance (Chen & Yang, 2020; Ellili, 2022; Velte, 2019; Yoon et al., 2021; He et al., 2022), and similarly may reduce the opportunistic behavior of managers seeking short-term returns through corporate financialization. Second, ESG performance can reduce corporate financialization by limiting resources available to managers and enhancing their long-term strategic awareness. According to resource constraint theory, for any firm, available resources are limited. Both ESG and financial asset investment activities show great dependence on available resources and therefore inevitably engender competition for resource allocation within the firms (Zhang et al., 2021). The availability of free cash flow under management control will induce them to invest in non-value-maximizing projects, while the implementation of CSR activities limits the amount of free cash flow available to self-interested managers, thus reducing the overinvestment problem (Samet & Jarboui, 2017). Good ESG performance means that firms spend a lot of resources on environmental protection, social responsibility and corporate governance. Therefore, ESG performance may mitigate the problem of overinvestment in financial assets by reducing the available resources of firms. In addition, managers of firms with good ESG performance often have strong professional integrity and moral awareness, and always focus on trust building with stakeholders and long-term strategic development objectives of the firms (Feng et al., 2022). As a result, they may make investment decisions from the perspective of maximization of firm value and reduce their irrational pursuit of short-term profits through heavy investment in financial assets.

From the foregoing discussion, we propose the following hypothesis:

Hypothesis 1. ESG performance is negatively associated with corporate financialization.

2.2.2. ESG Performance Promotes Corporate Financialization

Agency theory and resource dependence theory provide the theoretical basis for ESG performance being a self-interested tool to promote corporate financialization. According to agency theory and resource dependence theory, ESG performance can promote corporate financialization mainly through the following two aspects. First, ESG performance can promote corporate financialization through its reputation insurance effect. Good ESG performance can help firms accumulate moral and reputation capital, which can help firms cope with external adverse shocks and reduce losses resulting from the misconduct of firms or managers (Murè et al., 2021; Shiu & Yang, 2017). Firms or managers can take advantage of the reputation effect formed by good ESG performance to cover up or divert public attention from misconducts such as inferior products and earning manipulation, so as to mitigate or offset the negative effects caused by their misconduct (Kotchen & Moon, 2012; Reber et al., 2021). Therefore, under the cover of good ESG performance, managers may give up physical asset investment that could be conducive to the firm’s long-term value creation and instead may invest heavily in financial assets that fit their own private interests, which could increase the degree of corporate financialization. Second, good ESG performance can promote corporate financialization by alleviating financial constraints. Good ESG performance meets the implicit needs of key stakeholders, making it easy for firms to obtain external resource support, such as government subsidies and bank loans, which can alleviate financial constraints faced by the firms (Tan & Zhu, 2022; Tang, 2022; Zhang & Lucey, 2022). Therefore, good ESG performance can provide a source of external sources for financial asset investment activities, leading to an aggravation of corporate financialization.

Based on the above analysis, we propose the following hypothesis:

Hypothesis 2. ESG performance is positively associated with corporate financialization.

3.The authors incorporated several theories, which are stakeholder theory, resource constraint theory, agency theory, and resource dependence theory. However, the authors should work to strengthen the use of theory throughout the paper.

Reply: Thank you very much for your constructive suggestions and comments. As suggested, we have strengthened the use of stakeholder theory, resource constraint theory, agency theory, and resource dependence theory throughout the manuscript, especially in the supplementary arguments and hypotheses related to ESG performance reduces or promotes corporate financialization in 2.2.1. ESG Performance Reduces Corporate Financialization and 2.2.2. ESG Performance promotes Corporate Financialization on page 4-5:

2.2.1. ESG Performance Reduces Corporate Financialization

Stakeholder theory and resource constraint theory provide the theoretical basis for ESG performance being a governance tool to reduce corporate financialization. According to stakeholder theory and resource constraint theory, ESG performance can reduce corporate financialization mainly through the following two aspects. First, ESG performance can reduce corporate financialization by alleviating information asymmetry and agency conflicts. As one of the most important kinds of nonfinancial information, ESG performance reflects financial situation, risk management, and other aspects of a firm, which can make up for defects in incomplete information that is reflected in financial reports, and thus reduce information asymmetry between different stakeholders such as investors, creditors and the government (Yuan et al., 2022; Chen &Yang, 2020). Therefore, firms with good ESG performance tend to exhibit characteristics associated with rich information environments (Naqvi et al., 2021), which is conducive to stakeholders in strengthening the supervision on managers’ inefficient investment behavior (Ellili, 2022; Benlemlih & Bitar, 2018), and thus restrain their speculations in financial asset investment for short-term returns. In addition, ESG activities may be an effective way to reduce agency conflict that exists between stakeholders and managers due to the existence of asymmetric information (Healy & Palepu, 2001; Tang, 2022). As a result, good ESG performance can reduce instances of misconduct, such as financial irregularities, inefficient investment, earnings management, and tax avoidance (Chen & Yang, 2020; Ellili, 2022; Velte, 2019; Yoon et al., 2021; He et al., 2022), and similarly may reduce the opportunistic behavior of managers seeking short-term returns through corporate financialization. Second, ESG performance can reduce corporate financialization by limiting resources available to managers and enhancing their long-term strategic awareness. According to resource constraint theory, for any firm, available resources are limited. Both ESG and financial asset investment activities show great dependence on available resources and therefore inevitably engender competition for resource allocation within the firms (Zhang et al., 2021). The availability of free cash flow under management control will induce them to invest in non-value-maximizing projects, while the implementation of CSR activities limits the amount of free cash flow available to self-interested managers, thus reducing the overinvestment problem (Samet & Jarboui, 2017). Good ESG performance means that firms spend a lot of resources on environmental protection, social responsibility and corporate governance. Therefore, ESG performance may mitigate the problem of overinvestment in financial assets by reducing the available resources of firms. In addition, managers of firms with good ESG performance often have strong professional integrity and moral awareness, and always focus on trust building with stakeholders and long-term strategic development objectives of the firms (Feng et al., 2022). As a result, they may make investment decisions from the perspective of maximization of firm value and reduce their irrational pursuit of short-term profits through heavy investment in financial assets.

2.2.2. ESG Performance Promotes Corporate Financialization

Agency theory and resource dependence theory provide the theoretical basis for ESG performance being a self-interested tool to promote corporate financialization. According to agency theory and resource dependence theory, ESG performance can promote corporate financialization mainly through the following two aspects. First, ESG performance can promote corporate financialization through its reputation insurance effect. Good ESG performance can help firms accumulate moral and reputation capital, which can help firms cope with external adverse shocks and reduce losses resulting from the misconduct of firms or managers (Murè et al., 2021; Shiu & Yang, 2017). Firms or managers can take advantage of the reputation effect formed by good ESG performance to cover up or divert public attention from misconducts such as inferior products and earning manipulation, so as to mitigate or offset the negative effects caused by their misconduct (Kotchen & Moon, 2012; Reber et al., 2021). Therefore, under the cover of good ESG performance, managers may give up physical asset investment that could be conducive to the firm’s long-term value creation and instead may invest heavily in financial assets that fit their own private interests, which could increase the degree of corporate financialization. Second, good ESG performance can promote corporate financialization by alleviating financial constraints. Good ESG performance meets the implicit needs of key stakeholders, making it easy for firms to obtain external resource support, such as government subsidies and bank loans, which can alleviate financial constraints faced by the firms (Tan & Zhu, 2022; Tang, 2022; Zhang & Lucey, 2022). Therefore, good ESG performance can provide a source of external sources for financial asset investment activities, leading to an aggravation of corporate financialization.

4.The conclusion and discussion of the paper should be more cautious with careful discussion. For example, the conclusion likes this one: “Our findings, however, suggest that firms make instrumental use of ESG activities to pursue short-term financial returns, indicating that the rapid growth in ESG development of firms also comes with possible drawbacks. Therefore, the government should guide firms to make full use of the strategic role of ESG activities to drive long-term sustainable development”. Since the paper mainly focused on Chinese nonfinancial listed firms, it was inappropriate to extension deduces all firms. 

Reply: We are very sorry for our negligence. We totally agree that the paper mainly focused on Chinese nonfinancial listed firms, it is inappropriate to extension deduces all firms. As suggested, we have corrected the description in the Discussion on page 19:

Our findings, however, suggest that Chinese nonfinancial listed firms make instrumental use of ESG activities to pursue short-term financial returns, indicating that the rapid growth in ESG development of firms also comes with possible drawbacks. Therefore, the government should guide nonfinancial firms to make full use of the strategic role of ESG activities to drive long-term sustainable development.

5.On p3, the title of section 2.1 “Corporate Financialization” seems a little broad. According to the content of this part, I suggest the authors to rename it, i.e., “Behavioral motivation and economic consequences of Corporate Financialization”. 

Reply: Thank you very much for your constructive suggestions. We agree that the title of section 2.1 “Corporate Financialization” seems a little broad. As suggested, we have renamed the title of section 2.1 as “Behavioral motivation and economic consequences of Corporate Financialization”. 

6. The number of decimals should be consistent throughout the paper.

Reply: We are very sorry for our negligence. As suggested, we have made some corrections to make the number of decimals consistent throughout the manuscript.

7. It is well organized, but it needs professional editing to make it more readable and easily understandable.

Reply: We would like to thank you for your comments and suggestions. As suggested, we seek the help of professional language embellishment organization to make our manuscript more readable and easily understandable, and we thank LetPub (www.letpub.com) for its linguistic assistance during the revision of our manuscript.

Dear reviewer: 

First, we very much appreciate your favorable consideration and warm work earnestly. We would like to thank you for the positive and constructive comments and suggestions on our manuscript ID sustainability-1874242 entitled “Effect of Environmental, Social, and Governance Performance on Corporate Financialization: Evidence from China”. Our team has tried our best to revise the manuscript since we received the comments and suggestions. As suggested, we have substantially revised our manuscript after considering the insightful comments and suggestions. We have also amended areas of our manuscript with inadequate details to make the manuscript more persuasive.

We would be glad to respond to any further questions and comments that you may have, and look forward to hearing from you regarding our revisions.

Below are descriptions of our revisions according to your comments on an item-by-item basis.

Reviewer #2:

This paper examines the promoting effect of ESG performance on corporate financialization and confirms that corporate financialization of Chinese nonfinancial listed firms is motivated mainly by maximizing short-term financial returns, rather than reserving funds for long-term development. It is an interesting paper and deals with an important issue. It is well organized and I recommend its acceptance for publication with minor revision listed below.

1. On p2, the authors state that this paper investigates the effect of ESG performance on corporate financialization adopting the perspectives of stakeholder theory, resource constraint theory, agency theory, and resource dependence theory. I suggest the authors should work to strengthen the use of theory throughout the paper.

Reply: Thank you very much for your constructive suggestions and comments. As suggested, we have strengthened the use of stakeholder theory, resource constraint theory, agency theory, and resource dependence theory throughout the manuscript, especially in the supplementary arguments and hypotheses related to ESG performance reduces or promotes corporate financialization in 2.2.1. ESG Performance Reduces Corporate Financialization and 2.2.2. ESG Performance promotes Corporate Financialization on page 4-5:

2.2.1. ESG Performance Reduces Corporate Financialization

Stakeholder theory and resource constraint theory provide the theoretical basis for ESG performance being a governance tool to reduce corporate financialization. According to stakeholder theory and resource constraint theory, ESG performance can reduce corporate financialization mainly through the following two aspects. First, ESG performance can reduce corporate financialization by alleviating information asymmetry and agency conflicts. As one of the most important kinds of nonfinancial information, ESG performance reflects financial situation, risk management, and other aspects of a firm, which can make up for defects in incomplete information that is reflected in financial reports, and thus reduce information asymmetry between different stakeholders such as investors, creditors and the government (Yuan et al., 2022; Chen &Yang, 2020). Therefore, firms with good ESG performance tend to exhibit characteristics associated with rich information environments (Naqvi et al., 2021), which is conducive to stakeholders in strengthening the supervision on managers’ inefficient investment behavior (Ellili, 2022; Benlemlih & Bitar, 2018), and thus restrain their speculations in financial asset investment for short-term returns. In addition, ESG activities may be an effective way to reduce agency conflict that exists between stakeholders and managers due to the existence of asymmetric information (Healy & Palepu, 2001; Tang, 2022). As a result, good ESG performance can reduce instances of misconduct, such as financial irregularities, inefficient investment, earnings management, and tax avoidance (Chen & Yang, 2020; Ellili, 2022; Velte, 2019; Yoon et al., 2021; He et al., 2022), and similarly may reduce the opportunistic behavior of managers seeking short-term returns through corporate financialization. Second, ESG performance can reduce corporate financialization by limiting resources available to managers and enhancing their long-term strategic awareness. According to resource constraint theory, for any firm, available resources are limited. Both ESG and financial asset investment activities show great dependence on available resources and therefore inevitably engender competition for resource allocation within the firms (Zhang et al., 2021). The availability of free cash flow under management control will induce them to invest in non-value-maximizing projects, while the implementation of CSR activities limits the amount of free cash flow available to self-interested managers, thus reducing the overinvestment problem (Samet & Jarboui, 2017). Good ESG performance means that firms spend a lot of resources on environmental protection, social responsibility and corporate governance. Therefore, ESG performance may mitigate the problem of overinvestment in financial assets by reducing the available resources of firms. In addition, managers of firms with good ESG performance often have strong professional integrity and moral awareness, and always focus on trust building with stakeholders and long-term strategic development objectives of the firms (Feng et al., 2022). As a result, they may make investment decisions from the perspective of maximization of firm value and reduce their irrational pursuit of short-term profits through heavy investment in financial assets.

2.2.2. ESG Performance Promotes Corporate Financialization

Agency theory and resource dependence theory provide the theoretical basis for ESG performance being a self-interested tool to promote corporate financialization. According to agency theory and resource dependence theory, ESG performance can promote corporate financialization mainly through the following two aspects. First, ESG performance can promote corporate financialization through its reputation insurance effect. Good ESG performance can help firms accumulate moral and reputation capital, which can help firms cope with external adverse shocks and reduce losses resulting from the misconduct of firms or managers (Murè et al., 2021; Shiu & Yang, 2017). Firms or managers can take advantage of the reputation effect formed by good ESG performance to cover up or divert public attention from misconducts such as inferior products and earning manipulation, so as to mitigate or offset the negative effects caused by their misconduct (Kotchen & Moon, 2012; Reber et al., 2021). Therefore, under the cover of good ESG performance, managers may give up physical asset investment that could be conducive to the firm’s long-term value creation and instead may invest heavily in financial assets that fit their own private interests, which could increase the degree of corporate financialization. Second, good ESG performance can promote corporate financialization by alleviating financial constraints. Good ESG performance meets the implicit needs of key stakeholders, making it easy for firms to obtain external resource support, such as government subsidies and bank loans, which can alleviate financial constraints faced by the firms (Tan & Zhu, 2022; Tang, 2022; Zhang & Lucey, 2022). Therefore, good ESG performance can provide a source of external sources for financial asset investment activities, leading to an aggravation of corporate financialization.

2. The reasoning that the authors used to develop the hypothesis regarding ESG performance reduces corporate financialization and ESG performance promotes corporate financialization needs to be strengthened and backed with a more comprehensive list of literature.

Reply: We would like to thank you for the positive and constructive comments and suggestions. We agree that the hypothesis regarding ESG performance reduces or promotes corporate financialization would be more persuasive with a more comprehensive list of literature. Specifically, we have made some supplements in the Literature Review and Hypothesis Development on page 4-5:

2.2.1. ESG Performance Reduces Corporate Financialization

Stakeholder theory and resource constraint theory provide the theoretical basis for ESG performance being a governance tool to reduce corporate financialization. According to stakeholder theory and resource constraint theory, ESG performance can reduce corporate financialization mainly through the following two aspects. First, ESG performance can reduce corporate financialization by alleviating information asymmetry and agency conflicts. As one of the most important kinds of nonfinancial information, ESG performance reflects financial situation, risk management, and other aspects of a firm, which can make up for defects in incomplete information that is reflected in financial reports, and thus reduce information asymmetry between different stakeholders such as investors, creditors and the government (Yuan et al., 2022; Chen &Yang, 2020). Therefore, firms with good ESG performance tend to exhibit characteristics associated with rich information environments (Naqvi et al., 2021), which is conducive to stakeholders in strengthening the supervision on managers’ inefficient investment behavior (Ellili, 2022; Benlemlih & Bitar, 2018), and thus restrain their speculations in financial asset investment for short-term returns. In addition, ESG activities may be an effective way to reduce agency conflict that exists between stakeholders and managers due to the existence of asymmetric information (Healy & Palepu, 2001; Tang, 2022). As a result, good ESG performance can reduce instances of misconduct, such as financial irregularities, inefficient investment, earnings management, and tax avoidance (Chen & Yang, 2020; Ellili, 2022; Velte, 2019; Yoon et al., 2021; He et al., 2022), and similarly may reduce the opportunistic behavior of managers seeking short-term returns through corporate financialization. Second, ESG performance can reduce corporate financialization by limiting resources available to managers and enhancing their long-term strategic awareness. According to resource constraint theory, for any firm, available resources are limited. Both ESG and financial asset investment activities show great dependence on available resources and therefore inevitably engender competition for resource allocation within the firms (Zhang et al., 2021). The availability of free cash flow under management control will induce them to invest in non-value-maximizing projects, while the implementation of CSR activities limits the amount of free cash flow available to self-interested managers, thus reducing the overinvestment problem (Samet & Jarboui, 2017). Good ESG performance means that firms spend a lot of resources on environmental protection, social responsibility and corporate governance. Therefore, ESG performance may mitigate the problem of overinvestment in financial assets by reducing the available resources of firms. In addition, managers of firms with good ESG performance often have strong professional integrity and moral awareness, and always focus on trust building with stakeholders and long-term strategic development objectives of the firms (Feng et al., 2022). As a result, they may make investment decisions from the perspective of maximization of firm value and reduce their irrational pursuit of short-term profits through heavy investment in financial assets.

From the foregoing discussion, we propose the following hypothesis:

Hypothesis 1. ESG performance is negatively associated with corporate financialization.

2.2.2. ESG Performance Promotes Corporate Financialization

Agency theory and resource dependence theory provide the theoretical basis for ESG performance being a self-interested tool to promote corporate financialization. According to agency theory and resource dependence theory, ESG performance can promote corporate financialization mainly through the following two aspects. First, ESG performance can promote corporate financialization through its reputation insurance effect. Good ESG performance can help firms accumulate moral and reputation capital, which can help firms cope with external adverse shocks and reduce losses resulting from the misconduct of firms or managers (Murè et al., 2021; Shiu & Yang, 2017). Firms or managers can take advantage of the reputation effect formed by good ESG performance to cover up or divert public attention from misconducts such as inferior products and earning manipulation, so as to mitigate or offset the negative effects caused by their misconduct (Kotchen & Moon, 2012; Reber et al., 2021). Therefore, under the cover of good ESG performance, managers may give up physical asset investment that could be conducive to the firm’s long-term value creation and instead may invest heavily in financial assets that fit their own private interests, which could increase the degree of corporate financialization. Second, good ESG performance can promote corporate financialization by alleviating financial constraints. Good ESG performance meets the implicit needs of key stakeholders, making it easy for firms to obtain external resource support, such as government subsidies and bank loans, which can alleviate financial constraints faced by the firms (Tan & Zhu, 2022; Tang, 2022; Zhang & Lucey, 2022). Therefore, good ESG performance can provide a source of external sources for financial asset investment activities, leading to an aggravation of corporate financialization.

Based on the above analysis, we propose the following hypothesis:

Hypothesis 2. ESG performance is positively associated with corporate financialization.

3. On p10, “Following Kaplan and Zingales, we construct the Kaplan-Zingales (KZ) index to measure financial constraints according to the operating net cash flow, dividends, cash holdings, asset-liability ratio, Tobin’s Q, and other financial indicators of the firms”. The authors need to clarify what “Kaplan-Zingales (KZ) index” is, or at least provide citations of related works.

Reply: Thank you very much for your constructive suggestions and comments. As suggested, we have clarified “Kaplan-Zingales (KZ) index” by providing its detailed definition and measurement on page 10:

Based on this analysis, we divide the sample firms into a high-financial-constraints group and a low-financial-constraints group according to the degree of financial constraints, and we regress the two groups separately. Following Kaplan and Zingales (1997), we construct the Kaplan-Zingales (KZ) index to measure financial constraints according to the operating net cash flow, cash dividends, cash holdings, asset-liability ratio, TobinQ, and other financial indicators of the firms. Specifically, the specific calculation formula for KZ index is −12.3103×CF_it / TA_it − 25.9919×DIV_it / TA_it − 4.6063×CASH_it / TA_it +6.6481×Lev_it + 0.5181×TobinQ_it, where CF_it / TA_it is the ratio of operating net cash flow to total assets; DIV_it / TA_it is the ratio of cash dividends to total assets; CASH_it / TA_it is the ratio of cash holdings to total assets; Lev_it is the ratio of total liabilities to total assets; TobinQ_it is the ratio of market value to total assets. The larger the KZ index, the higher the degree of financial constraints.

4. The discussion part of the paper seems to be a little superficial. The authors need to provide academic and managerial implications, which should be more specific, learned from this study.

Reply: Thank you very much for your constructive suggestions and comments. We agree that the discussion part of our manuscript need to provide more specific implications. Based on the empirical findings and conclusions of our manuscript, we supplement academic values and improve policy implications and identify some directions that can be expanded in the future research in discussion part on page 18-19: 

5.2. Discussion

In China’s new normal economy, an increasing number of Chinese nonfinancial firms have recently invested heavily in financial assets, adversely affecting financial market stability and healthy economic development in China. Based on the empirical findings and conclusions described above, this study can provide important academic   and policy implications in the following aspects.

This study has two academic implications. First, this study uniquely introduces ESG performance, which is an important nonfinancial factor, to explore its effect on corporate financialization, which can break through the limitations of the existing literature that mostly explores the influential factors of corporate financialization under an economic or financial framework, and thus expand the theoretical framework for analyzing the factors affecting corporate financialization. Second, this study provides strong evidence that ESG performance has a promoting effect on corporate financialization, indicating that the rapid growth in ESG development of Chinese listed firms also comes with possible drawbacks, which can expand the existing research on the negative economic consequences of ESG performance and hold great significance for the future research on ESG performance.

This study can also provide important policy implications in the following three aspects. First, the government regulators should implement targeted policies to restrain nonfinancial firms from investing heavily in financial assets and motivate them to engage in primary businesses. From the perspective of ESG performance, we provide a new analytical framework for the influential factors of corporate financialization, which can provide a theoretical basis and empirical support for government regulators to strengthen financial supervision to reduce the systematic financial risk triggered by corporate financialization of nonfinancial firms, and redirect finance to its fundamental purpose of practically and effectively serving the development of the real economy.

Second, the government should reinforce the supervision and governance of ESG activities and strengthen an appropriate match between ESG investment and long-term value creation of firms. China is a latecomer to ESG investment, which is still in its initial stages. As ESG has aroused significant concern from government regulators, academia, and market practitioners throughout China, firms have increasingly standardized and improved ESG information disclosure. Our findings, however, suggest that Chinese nonfinancial listed firms make instrumental use of ESG activities to pursue short-term financial returns, indicating that the rapid growth in ESG development of firms also comes with possible drawbacks. Therefore, the government should guide nonfinancial listed firms to make full use of the strategic role of ESG activities to drive long-term sustainable development.

Third, the policymakers and regulators should formulate relatively unified ESG disclosure guidelines with complete indicators for listed firms and should strengthen the guidance over ESG information disclosure, thus continuously improving the scope and quality of ESG information disclosure. China is in a critical period of constructing and standardizing its ESG related system. In addition to disclosing relevant nonfinancial information, it is also necessary to combine and disclose important financial information, such as investment in physical assets and financial assets. Strict supervision should be conducted on ESG activities and investment decisions to provide a reference for stakeholders to identify the real motivation of a firm’s ESG activities.

We also identify some directions that can be expanded in the future research. Currently, a unified evaluation system for ESG performance is lacking in the existing literature. In view of the authority and availability of ESG performance data, we use ESG comprehensive score and its three specific subdimensions regarding environment, social responsibility, and corporate governance provided by Bloomberg database to measure ESG performance. With the development and improvement of an ESG evaluation system, future research can adopt an evaluation system that is better aligned with China’s national conditions to measure ESG performance. Moreover, changes in the legal environment of ESG activities and firm characteristics may affect the validity of the effect of ESG performance on corporate financialization. Future research can explore the differential impact of firm heterogeneity on the relationship between ESG performance and corporate financialization under different influencing mechanisms.

5. Well written as this paper is, there are several typos and formatting issues. Please proofread and extend and update your references and keep the number of decimals consistent throughout the paper. Some fonts are weird in the current paper.

Reply: We would like to thank you for your comments and suggestions. As suggested, we have proofread and extended our references. We are very sorry for our negligence, and we have made some corrections to make the number of decimals consistent throughout the manuscript. In addition, we have also checked and corrected the fonts in the current paper.

6. In addition to the above issues, please be sure to address the questions regarding the methodology and concerns regarding the writing. A careful read to identify and correct any grammatical errors or employ a professional copy editor’s service is recommended.

Reply: We would like to thank you for your comments and suggestions. As suggested, we seek the help of professional language embellishment organization to make our manuscript more readable and easily understandable, and we thank LetPub (www.letpub.com) for its linguistic assistance during the revision of our manuscript.