ESG, Cultural Distance and Corporate Profitability: Evidence from Chinese Multinationals

Abstract

In recent years, the demand for social responsibility arising from sustainable development has led to the gradual formation of a global consensus on the concept of environmental, social and governance (ESG), which has a wide impact on corporate operations. Based on legitimacy theory, this study examines the impact of ESG on corporate profitability. In addition, it explores the effectiveness of cultural distance as a moderator in the relationship between ESG and corporate profitability. Using fixed effects and moderated effects models, this study analyses panel data of Chinese manufacturing multinationals from 2014 to 2021. The results show that ESG significantly and positively affects corporate profitability and that the impact of ESG on corporate profitability is significantly and positively moderated by cultural distance. The research results are expected to provide meaningful insights into the importance of ESG and the factors to be considered by firms in their cross-border investment decision making.

1. Introduction

One of the key indicators of responsible investment is the environmental, social and governance (ESG) concept which is assumed to be a symbol of corporate social responsibility and a high-degree legitimacy [1]. In this context, companies are more focused on gaining legitimacy through ESG to ensure their profitability rather than by implementing profit-maximizing business strategies that only consider marginal costs and marginal benefits.

Existing studies pay more attention to the improvement of ESG by examining the factors that affect ESG assessment [2], methods to measure ESG [3] and ESG maturity [4], and draw the conclusion that firms play an important role in promoting ESG. Nevertheless, most studies ignore the profit-making purpose of firms. Noticeably, firms are motivated to improve ESG only when they are financially rewarded for developing ESG. In recent years, some ESG studies have been conducted to examine the impact of developing ESG on financial performance, but their findings are even more controversial. While some studies obtain negative or neutral results, most studies reveal a positive impact [5,6,7]

At the same time, given that ESG is a theory that has spread globally and serves as an important way for firms to gain legitimacy overseas, it is essential to explore the impact of ESG on corporate profitability in an international market environment. China is the world’s largest exporter of goods and one of the world’s largest importers of goods [8]. As a result of frequent cross-border operations, Chinese companies often experience social responsibility crises, such as employee rights crises, anti-corruption crises and business ethics crises in their outward foreign direct investment [8] and thus suffer great difficulties in gaining legitimacy overseas. In addition, low legitimacy damages their corporate image and reputation, threatening their survival and profitability [9]. Hence, it is of great practical importance to explore whether ESG can enhance corporate profitability by strengthening their legitimacy overseas. For Chinese companies, it is of great relevance to identify whether ESG can enhance their profitability by strengthening their legitimacy overseas. Therefore, the first research objective of this study is to explore whether the development of ESG enhances corporate profitability.

The moderating role of other factors has been considered in previous ESG studies, but the existing moderating variables examined are limited to internal factors such as chief executives [9], gender diversity of the board [10] and ownership structure [11], or to moderating factors, including audit quality [12,13], which are to some extent affected internally. The influence of factors external to the firm are ignored. Unlike external factors, such as policy changes, population movements and legal environments, cultural distance arising from differences in language, customs and values is stable, persistent and difficult to reconcile. Especially in multinational operations, cultural distance has a more significant impact, and a large cultural distance between the parent company and the host country could result in a hindrance to business operations [6,7]. In this study, cultural distance is defined as the degree of difference between countries in the norms and values they share [14]. According to the current experience of firms in cross-border investment, establishing subsidiaries in a host country that has a large cultural distance affects the effectiveness of corporate decision making [15], raises transaction costs, increases trade frictions for multinationals [16] and exposes firms to more legitimacy risks [17]. Accordingly, it can be concluded that even if ESG has a positive impact on multinationals’ profitability, it is still uncertain whether this positive impact is produced under the presence of cultural distance. To address this issue, the second research objective of this study is to explore the effectiveness of cultural distance as a moderator of the relationship between ESG and corporate profitability.

To explore whether the development of ESG by Chinese multinationals can promote corporate profitability and whether the relationship between ESG and corporate profitability is moderated by cultural distance between the location of the parent company and the host country, fixed effects and moderated effects models are established for an empirical analysis based on panel data of Chinese manufacturing multinationals over the period 2014–2021. While the fixed effects model can exclude the interference of influences that are universally applicable to all samples from the estimation results, the moderated effects model is able to extract the interactive effect of cultural distance on the relationship between ESG and corporate profitability. The regression results indicate that there is a significant positive relationship between ESG and corporate profitability. Our research also reveals that cultural distance has a moderating effect on the relationship mentioned above. In addition, a heterogeneity test is conducted to further validate the findings which demonstrate that the effect of ESG on corporate profitability is always significant and that there is heterogeneity in the effect of ESG on corporate profitability at the level of cultural distance. We conduct a robustness test using a sub-year sub-sample regression, an expanded sample regression and replacement variables, and an endogeneity test using lagged explanatory variables, instrumental variables and double-differencing. Finally, we use the president’s shareholding ratio (PSR), the general manager’s shareholding ratio (GSR) and organizational stigma (OS) as measures of legitimacy to verify the rationality of the theory of legitimacy.

This study has three main contributions. First, this study uses legitimacy theory as a theoretical basis to conduct an exhaustive mechanism test. In previous ESG-related research, many scholars have chosen to use legitimacy theory as a theoretical support [18,19], but their explanation of the reasons for this choice is mostly confined to the theoretical level. This paper not only argues for the application of legitimacy theory in theoretical analysis, but also carries out detailed empirical tests. Second, this study focuses on the issue of corporate profitability in multinational operations and extends the existing research on ESG and corporate profitability. Multinationals, which contribute more than one-third of global output, one-half of exports and one-quarter of employment, are well positioned to significantly affect global ESG outcomes [20]. Existing research has highlighted the need to study the role of ESG in the context of multinational operations [21,22,23]. In multinational operations, legitimacy is a pressing issue for companies [24], hinting at the necessity to study this issue based on the theory of legitimacy. Third, this study departs from mainstream research on ESG which considers moderating factors as existing outside the firm, and it more acutely captures the impact of cultural differences between the home and host countries on the likelihood of ESG enhancing corporate profitability. In contrast to previous articles which present cultural differences only from the perspective of individual cultural characteristics [25], this paper takes into account the six cultural dimensions of the Hofstede index rather than a single dimension to measure cultural distance and to reflect cultural differences between two countries. The moderating role of cultural distance has been examined in other cross-country domains, such as global supply chains, corporate performance and cross-border acquisitions [10,26,27], revealing the need to consider the role of cultural distance when identifying economic returns. According to the summarized research findings on the relationship between ESG and profitability, many scholars also call for the inclusion of the moderating role of factors such as cultural distance into the study of ESG and profitability [27,28]. This paper demonstrates through empirical research that cultural distance does affect the relationship between ESG and corporate profitability, providing managers with new decision-making ideas for the development of ESG.

The remainder of this manuscript is arranged as follows: Section 2 describes the existing studies on ESG, corporate profitability and cultural distance and proposes corresponding hypotheses. Section 3 explains the selection of the samples and variables, as well as the model design. Section 4 gives the analysis of the results of the regression of ESG on corporate profitability and the regression results of the moderating effect of cultural distance, as well as the results of the heterogeneity, endogeneity and stability tests. Section 5 depicts the mechanism test for the rationale of this study. Finally, there is a discussion of the findings.

2. Literature Review and Hypothesis Development

2.1. The Impact of ESG on Corporate Profitability

ESG theory originated in developed countries and has been applied in many areas in developed countries [29,30]. However, ESG theory has not been widely recognized and applied in many developing country companies due to various constraints such as low economic strength [31]; hence, ESG does not play a full role in the international market. As the largest developing country that trades frequently with developed countries across borders, China has become the world’s largest exporter of goods and one of the world’s largest importers of goods. If Chinese companies can reap economic rewards from ESG, China will not only inspire other developing countries to adopt ESG practices but also provide a scientific basis for developed countries to further prove the rationality of the theory of ESG. As a result, developed countries will be more successful in implementing their plans to apply the theory of ESG in practice. In this context, it is necessary to empirically test ESG and profitability of Chinese companies operating across borders, especially those companies in the Chinese manufacturing sector which have a nearly 30% share of global markets.

In the early days, when the theory of ESG was not widespread, some scholars argued from the perspective of the theory of agency costs that firms with better ESG have less value [30,32]. This theory required firms to have built up a reputation over time that was sufficient for them to gain trust from the government and society. In this case, ESG is an additional cost that does not significantly improve the legitimacy and reputation of firms but decreases their value.

The theory of cost, however, does not apply to multinationals with an inherent ‘outsider disadvantage’. In fact, the lack of legitimacy in operations abroad puts multinationals with an outsider disadvantage at an inherent competitive disadvantage [33]. Therefore, the acquisition of legitimacy in the host country is the key to the survival and growth of multinational enterprises.

ESG is a way of disclosing relevant non-financial information. ESG disclosure is conducive to gaining legitimacy advantages and overcoming public pressure. The theory of legitimacy suggests that there is a “social contract” between enterprises and society, with the former being required to obtain permission to operate from the latter if they seek the resources needed for their own operations. In order to gain legitimacy, multinationals have to be accountable to society as a whole by operating in a suitable manner and obtain permission to operate by regularly disclosing relevant non-financial information in response to pressure from all sectors of society [34]. Adopting ESG promotes the relationships with governmental departments, banks and investors and allows for gaining trust and support from government regulators, easing resource constraints on companies when coping with uncertainty and reducing corporate risks [10,35]. In addition, ESG can also prevent information asymmetry from causing information costs and differences in the business environment of two countries from causing business barriers; this reduces the negative impact of “outsider disadvantage” on multinational enterprises and lays the foundation for building a good corporate reputation and the space for growth [36].

Therefore, noticing the increasing importance of the theory of legitimacy and ESG, more and more studies conclude that ESG has a significant positive impact on corporate profitability [37,38]. Adopting ESG can help companies gain an advantage in aspects such as legitimacy when they face obstacles to doing business in the host country [39,40]. Legitimacy not only strengthens the positive relationship between ESG performance and firm value [40,41], but is in itself a key indicator of high corporate profitability [42]. Since Chinese firms are unique in terms of institutions, culture, legal regulations and economic development level, and are prone to trust in their dealings with foreign firms, governments and consumer stakeholders, they have a more pronounced outsider disadvantage [20]. The urgent need to gain legitimacy increases the significant positive impact of ESG on corporate profitability. The following hypothesis is proposed based on the analysis above:

Hypothesis 1.

ESG positively affects the corporate profitability of Chinese manufacturing multinationals.

2.2. Moderating Effect of Cultural Distance

Culture is the fundamental institution of society and represents the system of values and beliefs that support specific formal and informal institutions [43]. Cultural values reflect the shared notion of what is desirable and good in a society. Since cultural values can directly affect people’s expectations and preferences, which in turn guide their behaviors and decisions, they can have an indirect impact on economic outcomes [25]. In cultural applications, firms are affected by the differences between countries in terms of cultural values, resulting in their management systems, marketing strategies and appraisal methods differing from those of the host country [26,44,45] and in low productivity and competitiveness. In this sense, cultural distance is highly likely to affect the relationship between ESG and corporate profitability.

Cultural distance has a direct impact on the survival and development of multinationals in international trade. A larger cultural distance can lead not only to more conflicts and thus increase transaction costs [46], but also provide the basis for multinational companies to implement different strategies for building their brand in the host country [47]. These two different impacts are mainly caused by industrial differences. For the service and cultural sectors where individualization is pronounced, product uniqueness increased by cultural distance can mitigate the negative impact of cultural distance on management and productivity, and even bring additional benefits to the firm. However, for the manufacturing sector where production is process-oriented and product standards are specific, there is little room for individualization and a greater negative impact of cultural distance.

Therefore, even though ESG generally affects the profitability of manufacturing multinationals, it is undeniable that this impact can change depending on cultural distance. When multinationals are faced with a relatively unfamiliar cultural environment in the host country, they have all kinds of obstacles in gaining legitimacy in the host country [48,49]. Legitimacy is a state that reflects the party’s cultural congruence, normative support and coherence with relevant rules or laws [50]. The degree to which the behavior of a multinational subsidiary is consistent with the cultural values of the host country determines the level of legitimacy to some extent. Therefore, in the case of a larger cultural distance, companies need to pay more attention to social responsibility and engage in ESG disclosure to mitigate the problems of information asymmetry and outsider disadvantage caused by deepened cultural distance [35,51], so as to reduce their legitimacy barriers and ensure their profitability.

In summary, a larger cultural distance can exacerbate the outsider disadvantage of multinational firms. Notably, outsider disadvantage is typically characterized by a lack of legitimacy and information asymmetry [52]. The legitimacy and reputational value of ESG, however, can provide firms with a significant competitive advantage in view of the pursuit of ESG among investors and consumers, thereby enhancing corporate profitability [53]. When there is a larger cultural distance between the parent and subsidiary locations, it is more necessary for multinationals to raise ESG to weaken their outsider disadvantage, improve their own legitimacy and thus increase their corporate profitability. In other words, there is a stronger relationship between multinationals’ ESG and corporate profitability when the cultural distance is larger. The following hypothesis is therefore proposed:

Hypothesis 2.

Cultural distance positively moderates the positive impact of ESG on corporate profitability.

3. Data Description and Variable Selection

3.1. Sample

The Chinese mainland A-share listed companies with accounting periods from 2014 to 2021 obtained from the Wind Database [54] were selected as the sample and are processed as follows: (1) We selected the companies identified by the Securities and Futures Commission as belonging to the manufacturing sector. (2) We searched the locations of the subsidiaries of these companies for each year from 2014 to 2021 through www.cninfo.com.cn (accessed on 9 February 2023) [55], and selected those companies whose subsidiaries are concentrated in the same region in order to exclude the influence of geographical diversity [56]. (3) We excluded those companies lacking cultural distance data, and finally obtained a valid sample of 3229.

3.2. Variables

3.2.1. ESG

As in research methodology adopted by Tang [57], the ESG rating and its segmented ratings constructed by the mainstream domestic ESG rating agency Huazheng Index Information Service and obtained from the Information Financial Terminal of Wind are used in this study to measure the ESG of the enterprise and are logarithmically processed. The ESG evaluation system of the Huazheng Index Information Service draws on overseas ESG development experience and is also adapted to China’s current situation. As

Table 1. Variable definition.

Type of Variable	Variable	Symbol	Variable Definition
Dependent variable	Corporate profitability	ROA	Net profit × 2/(total assets at the beginning of the period + total assets at the end of the period) × 100%.
Independent variable	Environment, social and governance	ESG	Composed of 14 themes, 26 key indicators and 130+ underlying data indicators
Independent variable	Environment	E	Composed of 5 themes, 7 key indicators
Independent variable	Social	S	Composed of 4 themes, 8 key indicators
Independent variable	Governance	G	Composed of 5 themes, 11 key indicators
Mediator variable	Cultural distance	CD	$C{D}_j=\frac{1}{6}\sum _{i=1}^6\left[\frac{\left(I_{ij}-I_{ic}\right)}{V_i}\right]$
Control variables	Internationalization degree	I18N	Overseas operating revenue/Total operating revenue
	Market capitalization	MC	Natural logarithm/Market capitalization
	Leverage ratio	LEV	Total debt/Total assets
	Capital expenditure ratio	CAPEX	Total capital expenditure/Total assets
	Research and development intensity	R&D	Total R&D expenditure/Total assets
	Intangible assets ratio	I.A	(Total intangible assets/Total assets)/100
	Foreign institutional ownership	FOR	(Foreign institutional ownership/Domestic institutional ownership)/100
	Corporate ownership	SOE	State-owned enterprise is 1 and private enterprise is 0

Note: Table 1 reports the symbols and definitions of all variables. All data are from the Wind Database, except for cultural distance data from the six cultural dimensions on the Hofstede website hofstede-insights.com (accessed on 16 April 2023), and the results are derived from the Euclidean distance formula measure. To avoid the generation of too small coefficients of I.A. and FOR, I.A. and FOR are divided by 100. In the formula for cultural distance, $I_{ij}$ denotes the index for country $j$ in dimension $i$, $I_{ic}$ denotes the index for China in dimension $i$, $V_i$ denotes the variance in dimension $i$. The specific themes and key indicators for ESG, E, S and G are shown in Appendix A.

shows, the system is constructed in line with China’s localized indicator system and consists of 14 themes, 26 key indicators and 130+ underlying data indicators. In addition, the ESG index system of the Huazheng Index Information Service considers factors such as poverty alleviation and has advantages including wide coverage and timeliness.

3.2.2. Corporate Profitability

The research methodology adopted by Attig [41] uses the total net asset margin ROA to measure corporate profitability. We use return on assets (ROA) to measure corporate profitability. ROA refers to the ratio of the operating income earned by the company during the reporting period that is available for distribution to investors to total assets, thus reflecting the ability of investors. This indicator eliminates the effect of the parent company’s holding percentage on the return on investment and can be used to compare different companies in the same sector with regard to their return levels.

3.2.3. Cultural Distance

The personal motivation of middle-level managers from culturally different countries is heavily affected by their country of origin [58]. In the process of research, the cultural distance between the parent and subsidiary companies of multinational enterprises can be replaced by the cultural distance between the countries where they are located.

Regarding the measurement of cultural distance, existing studies [59] have defined the cultural distance between two countries as their deviations in the six dimensions of Hofstede’s index. In virtue of its large sample size and wide applicability, Hofstede’s cultural model has become the most important model on which many scholars base their cultural distance indicators [60]. Hofstede’s cultural dimensions theory is a theory put forward by Dutch psychologist Hofstede to measure cultural differences between countries, where the culture of different countries is quantified through six basic dimensions of cultural values. These dimensions include six indicators: power distance, uncertainty avoidance, individualistic collectivism, masculinity and femininity, long- and short-term orientation and indulgent restraint. The specific data sources and calculation methods are shown in Table 1.

The Implicit assumption in this study is that the cultural values of individual firms are generally aligned with the countries in which their stakeholders are located. Hofstede preferred to analyze cultural values at the societal level. Many studies have shown that an individual’s cultural behavior is susceptible to nationalistic sentiment, so that individual- and country-level analyses tend to be highly correlated [61]. The personal motivation of middle-level managers from culturally diverse countries is heavily affected by their country of origin [58]. In other words, it is argued that firms in a particular country act within the cultural values of their stakeholders in that environment, which can be reflected through the primary nation-level structure. For this reason, the cultural distance between firms can actually be replaced by the cultural distance between the countries where the firms are located.

3.2.4. Control Variables

Based on the existing studies, we have chosen the following control variables in our research: Degree of internationalization(I18N): The degree of internationalization of a firm may affect its profitability, as multinational firms face different challenges and opportunities than local firms; Market capitalization (MC): Market capitalization is a measure of a firm’s size, and larger firms may have more resources to improve their profitability; Capital expenditure ratio (CAPEX): The capital expenditure ratio is a measure of the ratio between a firm’s total capital expenditure and its total assets, which may affect the firm’s profitability; R&D intensity (R&D): R&D intensity is a measure of the ratio between the firm’s total R&D expenditure and its total assets, and it may have an impact on a firm’s profitability; Intangible assets ratio (I.A): A firm’s intangible assets ratio may affect its profitability as these assets may include patents, trademarks, technology and brand value, among others, which have an impact on a firm’s long-term competitiveness and profitability; Leverage ratio (LEV): The leverage ratio is a measure of a firm’s level of indebtedness. A firm with a high leverage ratio may face higher interest expenses and debt servicing pressure, which may affect its profitability; Foreign institutional ownership/domestic institutional ownership (FOR): Foreign institutional ownership/domestic institutional ownership may affect the management and operating decisions of a business, which in turn may have an impact on its profitability; State-owned enterprise (SOE): State-owned enterprises usually have a different ownership structure and management style, which may affect their profitability. The above variables are all important corporate financial and operational indicators that can be used to control for other factors affecting profitability and to accurately assess the impact of ESG. Relevant definitions of the variables are shown in Table 1.

3.3. Model Design

Equation (1) shows the correlation of ESG and its segmented factors with corporate profitability. Panel data for the period 2014–2021 is used for empirical analysis in this study based on the fixed effects model. Equation (2) shows the moderating effect of cultural distance on the relationship between ESG and corporate profitability. The moderation model is adopted in this study for analysis. In order to reduce the effect of non-essential multicollinearity on the results, the variables involved in the moderating effect are first pooled in this study and then multiplied to obtain their interaction terms.

$$RO{A}_{ht}={\beta }_0+{\beta }_{1}ES{G}_{ht}+{\beta }_i\sum control{s}_{ht}+{\mu }_t+{\lambda }_h+{\epsilon }_{ht}$$

(1)

$$RO{A}_{ht}={\beta }_0+{\beta }_{1}ES{G}_{ht}+{\beta }_{3}es{g}_{ht}\times C{D}_{ht}+{\beta }_i\sum control{s}_{ht}+{\mu }_t+{\lambda }_h+{\epsilon }_{ht}$$

(2)

where $h$ represents the different regions where the subsidiaries are located; $t$ represents the different times; $RO{A}_{ht}$ is the explained variable that represents corporate profitability;$ES{G}_{ht}$ is the core explanatory environmental, social and governance variable; $control{s}_{ht}$ is the set of control variables; ${\mu }_t$ indicates that time fixed effects are controlled; ${\lambda }_h$ indicates that region fixed effects are controlled (the region where the subsidiary is located); $ES{G}_{ht}\times C{D}_{ht}$ is the centralized interaction term, which represents the moderating effect of cultural distance ($CD$) on the relationship between the explanatory variable ($ESG$) and the explained variable ($ROA$); ${\epsilon }_{ht}$ is the error term.

4. Empirical Results

4.1. Descriptive Statistics

Table 2. Descriptive statistics.

Variables	Obs	Mean	Std. Dev.	Min	Max
ROA	3784	0.045	0.08	−0.343	0.236
ESG	3630	1.863	0.034	1.76	1.93
E	3630	1.781	0.056	1.655	1.912
S	3630	1.87	0.055	1.681	1.976
G	3630	1.891	0.047	1.698	1.954
CD	3785	1.288	1.461	0.331	4.465
I18N	3783	0.173	0.217	0	0.899
MC	3784	9.783	0.406	9.077	11.091
LEV	3388	0.384	0.196	0.05	0.92
CAPEX	3784	0.052	0.048	0.001	0.235
R&D	3784	0.025	0.019	0	0.107
I.A	3783	0.016	0.028	0	0.18
FOR	3775	0.002	0.040	0	1.52
SOE	3780	0.243	0.429	0	1

Note: This table shows the sample size, median, standard deviation and minimum and maximum values of each variable in this study. Particularly, ROA is the explained variable in the baseline regression; ESG, E, S and G are the explanatory variables in the baseline regression; CD is the moderating variable; I18N, I.A, FOR, SOE, CAPEX, R&D, MC and LEV are the control variables.

lists the descriptive statistics for all variables used in our research. All variables are minorized at the 1% level, curbing the impact of the outlier.

From Table 2, it can be seen that the mean of ROA is 0.045, indicating that the sample companies are somewhat profitable. The highest ESG score is 1.93, while the lowest ESG score is 1.76, thus indicating that there are differences among the sample companies in ESG performance. The mean of CD is 1.288, with a minimum value of 0.331 and a maximum value of 4.465, indicating that there are large differences in cultural distance from the countries and regions in which the sample companies are located. The mean of I18N is 0.173, with a minimum value of 0 and a maximum value of 0.889, hinting at an overall low level of internationalization with some degree of variation among the sample companies. The mean of MC is 9.783 which indicates that most companies in the sample have a medium level of market capitalization. The mean of LEV is 0.384 which indicates that the companies in the sample basically tend to use debt for financing. The mean of CAPEX is 0.052 which indicates that the companies in the sample basically invest less in CAPEX. The minimum value of R&D is 0 and the maximum value is 0.107; this indicates that there are significant differences among the companies in the sample in R&D investment, which may be related to their industry, size and technological strength. The mean of I.A is 0.016 which indicates that the companies in the sample generally invest less in intangible assets. The mean of FOR is 0.002 which indicates that cross-border investment is not a common practice among the companies in the sample and that the equity of most companies is still controlled by domestic institutions. However, the maximum value of 1.52 indicates that there are some companies whose equity has been already controlled by foreign institutions. The dummy variable SOE has a mean of 0.243, which indicates that about a quarter of the companies in the sample are SOEs. These results are informative for further research on the impact of ESG on corporate profitability and other related studies.

4.2. The Impact of ESG on Corporate Profitability

The fixed effects model is used in this study for empirical analysis. The fixed effects of the year and the country where the subsidiary is located are controlled.

Table 3. Baseline regression results.

Variables	(1)	(2)	(3)	(4)
	ROA	ROA	ROA	ROA
ESG	0.2755 *** (0.0343)
E		0.0208 (0.0205)
S			0.0633 *** (0.0212)
G				0.2530 *** (0.0255)
I18N	0.0106 ** (0.0052)	0.0105 ** (0.0053)	0.0114 ** (0.0053)	0.0086 (0.0052)
MC	0.0631 *** (0.0029)	0.0668 *** (0.0029)	0.0660 *** (0.0029)	0.0635 *** (0.0029)
LEV	0.0317 (0.0265)	−0.1704 *** (0.0061)	−0.1701 *** (0.0061)	−0.1476 *** (0.0064)
CAPEX	0.0191 (0.0237)	0.0483 * (0.0267)	0.0445 * (0.0267)	0.0230 (0.0264)
R&D	−0.0569 (0.0641)	−0.0447 (0.0650)	−0.0575 (0.0647)	−0.0703 (0.0638)
I.A	−0.3662 *** (0.0430)	−0.3956 *** (0.0433)	−0.3911 *** (0.0432)	−0.3646 *** (0.0427)
FOR	−0.0049 (0.0258)	−0.0038 (0.0261)	−0.0062 (0.0260)	−0.0061 (0.0257)
SOE	−0.0045 * (0.0027)	−0.0037 (0.0028)	−0.0033 (0.0028)	−0.0066 ** (0.0027)
Year FE	YES	YES	YES	YES
Region FE effects	YES	YES	YES	YES
_cons	−1.0177 *** (0.0660)	−0.5745 *** (0.0443)	−0.6487 *** (0.0463)	−0.9894 *** (0.0533)
N	3229	3229	3229	3229
adj. R2	0.3499	0.3369	0.3386	0.3567

Note: This table shows the fixed effects regressions for the interaction of ESG, E, S and G with corporate profitability (ROA). Standard errors are in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01.

, Column (1) shows the regression of ESG on ROA among Chinese manufacturing multinationals. The results suggest that every unit increase in the ESG score of a listed company results in an increase of 0.2755 in its ROA. In other words, ESG positively affects corporate profitability at the 1% level. Columns (3) and (4) show the results of the regression of social performance and governance performance on ROA among Chinese manufacturing multinationals, respectively; they are all significant at the 1% level. Nevertheless, the results of the regression of environmental performance on ROA shown in Column (2) are not significant. This is mainly due to China’s remarkable achievements in environmental management in recent years, especially in the manufacturing sector where total wastewater emissions fell by 18.7%, total waste gas emissions fell by 12.9% and total solid waste emissions fell by 23.7% from 2014 to 2020, with green manufacturing firms increasing exponentially. Because of the green normalization of Chinese enterprises, environmental performance can no longer significantly affect the profitability of enterprises in China’s manufacturing sector. The regression results above indicate that for Chinese manufacturing multinationals, both overall ESG behavior and segmented social and governance performance have a significant positive impact on corporate profitability; hence, Hypothesis 1 is preliminarily tested.

4.3. The Moderating Effect of Cultural Distance

In this study, on a fixed year and regional basis, the variables involved in the moderating effect are first centralized and then multiplied to obtain their interaction terms. Equation (2) uses ROA as the dependent variable and incorporates the control variables, the independent variable (ESG) and the moderating variable (cultural distance). As shown in Column (1) of

Table 4. Results of moderation analysis.

Variables	(1)	(2)	(3)
	ROA	ROA	ROA
		Small CD	Large CD
ESG	0.2164 *** (0.0464)	0.019 ** (0.084)	0.318 *** (0.097)
ESG × CD	0.0686 ** (0.0321)
I18N	0.0112 * (0.0065)	0.006 (0.009)	−0.004 (0.014)
MC	0.0664 *** (0.0038)	0.066 *** (0.006)	0.060 *** (0.007)
LEV	−0.1691 *** (0.0103)	−0.151 *** (0.018)	−0.217 *** (0.021)
CAPEX	0.0202 (0.0290)	−0.045 (0.041)	0.035 (0.071)
R&D	−0.2138 ** (0.1063)	−0.270 (0.173)	−0.550 *** (0.266)
I.A	−0.3890 *** (0.0674)	−0.268 *** (0.135)	−0.418 *** (0.135)
FOR	−0.0106 (0.0134)	3.425 ** (1.485)	0.011 (0.012)
SOE	−0.0059 (0.0039)	−0.011 * (0.006)	0.012 (0.009)
Year FE	YES	YES	YES
Region FE	YES	YES	YES
_cons	−0.9344 *** (0.0894)	−0.743 *** (0.152)	−0.992 *** (0.183)
N	3230	807	810
adj. R2	0.3571	0.307	0.349

Note: This table incorporates cultural distance (CD) as the moderating variable based on the fixed effects regression of the interaction between ESG, E, S, G and corporate profitability (ROA). It demonstrates the interaction between the cross product of ESG and cultural distance (ESG×CD) and corporate profitability (ROA); the samples are grouped according to the level of cultural distance and the results of the test of heterogeneity between ESG and corporate profitability (ROA) at different levels of cultural distance are shown. Standard errors are in parentheses. * p < 0.1, ** p < 0.05, *** p < 0.01.

, the cross product of the independent variable and the moderating variable (ESG × Cultural distance) is included. Furthermore, the regression coefficient of this cross product is significantly positive (β = 0.0686, p < 0.05) when the main effect regression coefficient is significantly positive (β = 0.2164, p < 0.001). This indicates that cultural distance reinforces the positive relationship between ESG and corporate profitability. Specifically, it has a positive moderating effect on the relationship between them. Hypothesis 2 is preliminarily tested.

Second, the samples investigated in this study are divided by cultural distance into four groups using the quartiles, where the group with the smallest cultural distance and the group with the largest cultural distance are selected for analysis. Columns (2) and (3) show the results of the regression on the 807 samples with the smallest cultural distance and the 810 samples with the largest cultural distance, further proving the relationship between ESG and ROA. Columns (2) and (3) show that ESG does not significantly affect corporate profitability when cultural distance is small. Only when cultural distance is large, ESG significantly and positively affects corporate profitability. In other words, there is heterogeneity in the relationship between ESG and ROA at the level of cultural distance. Hypothesis 2 is further tested.

4.4. Endogeneity Test

We use three methods to mitigate possible endogeneity in the models, and all the results support the baseline regression findings.

First, we use lagged explanatory variables. Although ESG positively affects corporate profitability and is significant at the level of 1%, it is also possible that ESG is essentially derived from higher corporate profitability. In other words, there may be some reverse causalities between ESG and corporate profitability. Considering that lagged variables of ESG are not easily affected by corporate profitability in the current period, lags one, two and three of ESG are used as explanatory variables. As shown in Columns (1), (2) and (3) of

Table 5. Endogeneity tests for lagged explanatory variables and difference-in-differences method.

Variables	(1)	(2)	(3)	(4)
	ROA	ROA	ROA	ROA
L.esg	0.1845 *** (0.0402)
L2.esg		0.1256 *** (0.0485)
L3.esg			0.1136 ** (0.0577)
ESG				0.1602 *** (0.0566)
DID				0.0079 ** (0.0037)
Year FE	YES	YES	YES	YES
Region FE	YES	YES	YES	YES
CV	YES	YES	YES	YES
_cons	−0.8386 *** (0.0780)	−0.7316 *** (0.0946)	−0.7043 *** (0.1126)	−0.8347 *** (0.1045)
N	2171	1446	955	3230
adj. R2	0.3546	0.3321	0.3396	0.3561

Note: Columns (1), (2) and (3) of this table show the interaction between lags 1, 2 and 3 of ESG and corporate profitability (ROA), respectively. Column (4) shows the regression results of the difference-in-differences method. Standard errors are in parentheses. *** 1% ** 5%, ** p < 0.05, *** p < 0.01.

, the coefficient of each lagged variable remains significantly positive, thus indicating that improved ESG has a long-term promoting effect on corporate profitability.

Second, we use difference-in-differences estimation. In 2018, the Asset Management Association of China (AMAC) released the “Report on the ESG Evaluation System for Chinese Listed Companies” and “Green Investment Guidelines (for Trials)”, setting the core evaluation index system for the ESG of listed companies, providing a credible baseline for third-party institutions to assess the quality of ESG disclosure by companies and stimulating Chinese companies to engage in ESG practices. As shown in Column (4), a difference-in-differences model is constructed with this event as a “quasi-natural experiment” and those companies with a high ESG investment level (companies with a current ESG rating greater than the sample median of 1.8630) as the treatment group. As shown in Column (4) of Table 5, the coefficient of this interaction term is 0.0079 and significant at the 5% level, thus alleviating the endogeneity problem arising from reverse causality and again testing the hypotheses of this study.

Finally, we use instrumental variables. As in the method applied by Quan [62] and to address the endogenous effect, the arithmetic average of the ESG of other companies in the Chinese manufacturing sector (AVESG) is used in this study as an instrumental variable for analysis with the help of the two-stage least squares of instrumental variables (with only the core variables being listed). The instrumental variable is closely related to the ESG of individual companies and meets the requirement of relevance but does not directly affect the ESG of individual companies and satisfies the requirement of exogeneity.

Two-stage least squares (2SLS) is used for the regression on instrumental variables. The results are presented in Columns (1) and (2) of

Table 6. Endogeneity tests for instrumental variable method.

Variables	(1)	(2)
	ESG	ROA
ESG		0.4697 *** (0.0756)
AVESG	0.7036 *** (0.3164)
Unrecognizable test	Number of iVs = endogenous variables
Weak instrumental variable test	Shea’s partial R-squared = 0.0115, F Statistical quantities = 37.4259, p_val = 0.0000
Exogeneity test	Robust score chi2(1) = 1.91918 (P = 0.1659)
Year FE	YES	YES
Region FE	YES	YES
CV	YES	YES
_cons	0.8580 (0.1411)	−1.7427 (0.5486)
N	3222	3222
adj. R2	0.1011	0.3017

Note: Columns (1) and (2) show the results of the first- and second-stage regressions of the instrumental variables using 2SLS, respectively. Standard errors are in parentheses. *** 1% *** p < 0.01.

. In the first stage, the coefficient of the regression of the annual average of ESG in the region where the subsidiary is located on ESG is significantly positive, indicating that regional average significantly promotes ESG and that ESG has a certain regional peer effect. In the second stage, the regression coefficient of ESG is 0.4697, which is significant at the 1% level, and thus indicating that ESG promotes corporate profitability. In addition, the statistic value of F in the weak instrumental variable test is 37.4259, significantly greater than the empirical value of 10. Meanwhile, the value of P is close to zero, implying that there are no weak instrumental variables and that the instrumental variables selected are correlated with the level of ESG practices. These results further provide evidence for the robustness of this study.

4.5. Robustness Tests

We use three methods to a conduct robustness test and the conclusions obtained are all consistent with the results of the baseline model.

First, we subdivide the samples by period. As a result of the outbreak of COVID-19 in early 2020, there have been great changes in the macroeconomic environment. In order to explore the difference in the impact of ESG behavior on corporate profitability before and after the outbreak of COVID-19, the samples are subdivided according to two periods, 2014–2019 and 2020–2021, as shown in Columns (1) and (2) of

Table 7. Robustness test regression results.

Variables	(1)	(2)	(3)	(4)	(5)	(6)
	ROA	ROA	ROA	ROE	ROIC	EBIT
	2014–2019	2020–2021
ESG	0.2544 *** (0.0414)	0.3313 *** (0.0634)	0.5176 *** (0.0320)	0.4894 *** (0.0658)	0.3923 *** (0.1014)	0.3923 *** (0.1014)
Year FE	YES	YES	YES	YES	YES	YES
Region FE	YES	YES	YES	YES	YES	YES
CV	YES	YES	YES	YES	YES	YES
_cons	−0.9969 *** (0.0799)	−0.9986 *** (0.0746)	−1.4055 *** (0.0602)	−1.8128 *** (0.1265)	−1.1332 *** (0.1948)	−1.1332 *** (0.1948)
N	2223	999	16,681	3229	3229	3229
adj. R2	0.3467	0.3446	0.0656	0.2324	0.0729	0.0729

Note: Columns (1) and (2) of this table show the results of the interaction between ESG and corporate profitability (ROA) in 2014–2019 and 2020–2021, respectively. Column (3) shows the results of the interaction between ESG and corporate profitability (ROA) for all manufacturing companies in China. Columns (4), (5) and (6) show the results of the interaction between ESG and the substitute variable for corporate profitability. Standard errors are in parentheses. *** p < 0.01.

. We find ESG significantly affects corporate profitability at the 1% level regardless of the outbreak of the epidemic, further testing the hypotheses.

Second, we expand the sample regression. Only 3229 samples with multinational operations and subsidiaries in the same host country are selected in this study to ensure that the moderating effect of cultural distance is not disturbed by cultural diversity. To further examine the relationship between ESG and corporate profitability in the manufacturing sector, the samples are expanded to all Chinese manufacturing firms, covering a total of 16,681 samples. The empirical results are consistent with the baseline regression results, demonstrating that ESG in China’s manufacturing sector can indeed significantly and positively affect corporate profitability.

Third, the explained variable is replaced. In order to enhance the persuasiveness of the research findings, three indicators are used to replace the explained variable ROA in this study, in line with the research methodologies adopted in existing studies [63,64,65]. The first indicator is return on net assets (ROE, net income divided by net assets). ROE reflects the profits generated from the use of assets by a firm and can measure the effective use of assets by a firm. ROE is also an effective measure of profitability as it considers shareholders’ equity and profits. The second indicator is return on invested capital (ROIC, (Net profit + finance costs) / (Total assets-current liabilities + notes payable + short-term borrowings + non-current liabilities due within one year)), which reflects the firm’s corporate profitability by considering its overall capital structure and the extent to which it efficiently utilizes its capital. The third indicator is earnings before interest and tax (EBIT, Net profit + income tax expense + finance costs), which directly reflects the revenues and expenses earned from the sales of goods or services and therefore reflects the firm’s core profitability. As shown in Columns (4), (5) and (6), the regression results are highly consistent with the results of baseline regressions, all demonstrating that ESG significantly and positively affects corporate profitability at the 1% level.

5. Mechanism Test: Legitimacy Theory

5.1. Formatting of Mathematical Components

We included two parts to test the rationality of using legitimacy theory as the theoretical basis for the relationship between ESG and corporate profitability, with the first part using the fixed effects model approach for prime verification and the second part using a heterogeneity test for further verification. In terms of measuring legitimacy in relation to corporate profitability, regulatory legitimacy is used in most existing studies [50]. In particular, a higher proportion of equity, which is a formal power granted by law, indicates higher regulatory legitimacy [66]. On this basis, Zhao [66] used the president’s shareholding ratio (PSR) and the general manager’s shareholding ratio (GSR) to measure legitimacy and found that legitimacy is higher when both ratios are higher.

In the first part, we use PSR and GSR as separate measures of legitimacy. The relationship between legitimacy and corporate profitability is first regressed in this study using PSR as an indicator of legitimacy. From Column (1) of

Table 8. Preliminary test of ESG, corporate profitability and legitimacy.

Variables	(1)	(2)	(3)	(4)
	ROA	PSR	GSR	ROA
PSR	0.0403 *** (0.0079)
ESG		0.2006 ** (0.0781)	0.1432 ** (0.0660)
GSR				0.0393 *** (0.0094)
Year FE	YES	YES	YES	YES
Region FE	YES	YES	YES	YES
CV	YES	YES	YES	YES
_cons	−0.5869 *** (0.0296)	0.2049 (0.1501)	0.1182 (0.1267)	−0.5794 *** (0.0296)
N	3370	3229	3229	3370
adj. R2	0.3572	0.1685	0.1048	0.3556

Note: Columns (1) and (4) of this table show the results of the interaction between the measures of legitimacy, president’s shareholding ratio (PSR) and general manager’s shareholding ratio (GSR), and corporate profitability (ROA), respectively. Columns (2) and (3) show the results of the interaction between ESG and the measures of legitimacy, president’s shareholding ratio (PSR) and general manager’s shareholding ratio (GSR), respectively. Standard errors are in parentheses. ** p < 0.05, *** p < 0.01.

, it can be seen that PSR significantly and positively affects corporate profitability at the 1% level. In other words, corporate profitability is significantly promoted by increasing corporate legitimacy. Column (2) verifies the relationship between ESG and legitimacy, showing that ESG positively and significantly affects the level of corporate legitimacy at the 1% level. Thus, improving ESG is significantly beneficial to the increase in corporate legitimacy. Second, the rationality of the theory of legitimacy is tested using GSR as an indicator of legitimacy. The fixed effects model is also used to test the relationship between GSR and ROA and the relationship between ESG and GSR. The corresponding findings are consistent with those obtained using PSR as an indicator. Thus, it is preliminarily tested that the theory of legitimacy can be used as a theoretical support for the relationship between ESG and corporate profitability.

In the second part, we group the samples according to the development level of the host country and whether or not they are state-owned enterprises to test the relationship between ESG and legitimacy level by means of group regression. Noticeably, we still use PSG and GSR as the indicators of legitimacy to further test the rationality of using the theory of legitimacy as the theoretical basis for the relationship between ESG and corporate profitability.

In the theoretical derivation of this study, it is pointed out that developed countries are more concerned with using ESG to measure the legitimacy of foreign enterprises. Thus, it is concluded that multinational enterprises should gain legitimacy by improving their ESG. In the empirical process, it is found that the difficulty of gaining legitimacy abroad differs between state-owned enterprises aiming to maximize social benefits and private enterprises aiming to maximize their own benefits. Therefore, whether the firm is a state-owned enterprise or not is included as a control variable.

There is heterogeneity in the role of ESG in promoting corporate legitimacy depending on the economic development level of the host country. As shown in Columns (1), (2), (5) and (6) of

Table 9. Further test of ESG, corporate profitability and legitimacy.

Variables	(1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)
	PSR	PSR	PSR	PSR	GSR	GSR	GSR	GSR
	Developing Country	Developed Country	State-Owned Enterprise	Private Enterprise	Developing Country	Developed Country	State-Owned Enterprise	Private Enterprise
ESG	−0.2937 (0.2220)	0.3077 *** (0.1098)	0.0530 (0.1015)	0.1878 * (0.0979)	−0.3861 (0.2370)	0.2323 *** (0.0775)	0.0848 (0.0670)	0.2810 *** (0.0901)
Year FE	YES	YES	YES	YES	YES	YES	YES	YES
Region FE	YES	YES	YES	YES	YES	YES	YES	YES
CV	YES	YES	YES	YES	YES	YES	YES	YES
_cons	−0.3446 (0.6584)	0.1873 (0.1454)	0.1050 (0.1736)	0.2687 (0.1925)	−0.0377 (0.5928)	−0.2116 (0.1694)	0.0558 (0.1329)	−0.3191 (0.2175)
N	174	3059	760	2464	174	3056	763	2467
adj. R2	0.3913	0.1437	0.0531	0.0881	0.1853	0.0926	0.0470	0.0403

Note: Columns (1) and (2) of this table present the regression results of the interaction between president’s shareholding ratio (PSR) as the measure of legitimacy on the basis of grouping by whether it is a developed country. Columns (3) and (4) present the regression results of the interaction between president’s shareholding ratio (PSR) as the measure of legitimacy on the basis of grouping by whether it is a state-owned enterprise. Columns (5) and (6) of this table present the regression results of the interaction between general manager’s shareholding ratio (GSR) as the measure of legitimacy on the basis of grouping by whether it is a developed country. Columns (7) and (8) present the regression results of the interaction between general manager’s shareholding ratio (GSR) as the measure of legitimacy on the basis of grouping by whether it is a state-owned enterprise. Standard errors are in parentheses. * p < 0.1, *** p < 0.01.

, ESG does not significantly promote corporate legitimacy when the subsidiary is located in a developing country. ESG significantly and positively affects corporate legitimacy at the 1% level when the host country is a developed country. This is mainly due to the theory of ESG first originating in developed countries; it has a higher acceptance in developed countries, where it is believed that good ESG of a foreign firm indirectly corroborates the legitimacy of the firm. In this situation, ESG makes it easier for foreign firms to gain legitimacy. However, in developing countries, the theory of ESG is still in its initial development stage and has not yet been widely accepted. Consequently, ESG cannot yet help multinationals to gain legitimacy in developing countries [21].

There is heterogeneity in the role of ESG in promoting corporate legitimacy depending on corporate ownership. Chinese SOEs include fully state-owned enterprises, fully state-owned companies and state-owned capital holding companies, which are respectively set up by the State Council and local people’s governments on behalf of the state. In comparison with private enterprises which are founded or controlled by individuals, state-owned enterprises pursue the maximization of social value and have more stable sources of funds, higher social awareness and more guaranteed business commitment. Therefore, state-owned enterprises are more recognized for their legitimacy when they set up subsidiaries outside China and can gain legitimacy without the help of corporate ESG. In contrast, private enterprises pursue the maximization of profits and have a higher probability of resorting to illegal means in the pursuit of profits [7]. In response, the host country tends to verify the legitimacy of an enterprise by examining its ESG [67]. Consequently, as shown in columns (3), (4), (7) and (8) of Table 9, private enterprises’ ESG significantly and positively affects their legitimacy level at the 10% level, hence giving rise to heterogeneity.

This section discusses the contribution of ESG to corporate legitimacy in different host countries and for different firm types. The regression test on two sample groups verifies that more emphasis should be placed on developing ESG to gain legitimacy when firms are privately owned or when they establish subsidiaries in developed countries.

5.2. Test of Cultural Distance and Legitimacy

Two parts are included to verify that corporate legitimacy can be affected by cultural distance. In the first part, we use the fixed effects model approach for prime verification. In the second part, GDP and institutional distance of the host country are selected in this study as the moderating variables to explore whether the relationship between cultural distance and legitimacy is affected by other factors.

We consider that the cultural distance between countries is used to represent the cultural distance between firms; country-level indicators are also used to measure legitimacy when examining cultural distance and legitimacy to ensure the accuracy of the test results. According to Ramachandran and Pant [68], legitimacy disadvantage is mainly manifested by the organizational stigmatization of multinationals in emerging economies by stakeholders in the host country. According to the study of organizational stigma by Du and Zhang [69], the average value of the sum of the number of anti-dumping and countervailing actions initiated and implemented from 2014–2021 against China by the host country where the firm is located is used to specifically quantify organizational [70] stigma as an indicator of legitimacy deficit in this study.

In the first part, we use organizational stigma (OS) as a measure of legitimacy deficit to test whether cultural distance significantly and positively affects the legitimacy deficit at the 1% statistical level. As shown in Columns (1) of

Table 10. Preliminary mechanism test of cultural distance and legitimacy level.

Variable	(1)
	OS
CD	3.2173 *** (0.0699)
Year FE	YES
Region FE	YES
CV	YES
_cons	2.9815 (2.4939)
N	1552
Adj.R2	0.6145

Note: Column (1) of this table shows the results of the interaction between cultural distance (CD) and organizational stigma (OS) as a measure of legitimacy. Standard errors are in parentheses *** p < 0.01.

, each unit increase in cultural distance leads to an increase of 3.2173 in OS. In other words, when cultural distance is larger, the firm faces a greater legitimacy deficit. This offers preliminary evidence for the assertion that larger cultural distance indicates more need to take measures to gain legitimacy.

In the second part, we consider that cultural distance implies a comparison between the home and host countries, so the economic development level of the host country and institutional distance between the home and host countries are selected in further testing of cultural distance and legitimacy as moderating variables. These variables reflect the business environment of the host country or the difference between the home and host countries in the business environment.

First, GDP of the host country, which represents the economic development level of the host country, is included as a moderating variable. As shown in Column 1 of

Table 11. Further mechanism test of cultural distance and level of legitimacy.

Variable	(1)	(2)	(3)	(4)
	OS	OS	OS	CD
CD	0.6030 *** (0.0836)	2.4619 *** (0.0711)	2.3813 *** (0.0738)
ESG				−3.3497 *** (1.2626)
GDP × CD	3.7013 *** (0.0956)
ID1 × CD		−2.2083 *** (0.0926)
ID2 × CD			−4.7798 *** (0.2070)
GD × CD
Year FE	YES	YES	YES	YES
Region FE	YES	YES	YES	YES
CV	YES	YES	YES	YES
_cons	5.4625 *** (1.7638)	5.0347 ** (2.2978)	−1.3371 (0.8404)	8.7581 *** (2.3891)
N	1510	1202	3097	1430
adj. R2	0.8095	0.9070	0.9068	0.0529

Note: Columns (1) and (2) of this table include GDP of the host country (GDP), institutional distance 1 (ID1) and institutional distance 2 (ID2) as moderating variables based on the fixed effects regression of the interaction between cultural distance (CD) and organizational stigma (OS), demonstrating the results of the interaction between the cross product of GDP and cultural distance (GDP × CD), the cross product of institutional distance 1 and cultural distance (ID1 × CD) and the cross product of institutional distance 2 and cultural distance (ID2 × CD). The table presents the results of the interaction between ESG and cultural distance (CD). Standard errors are in parentheses. ** p < 0.05, *** p < 0.01.

, the cross product of the independent variable and the moderating variable (GDP × cultural distance) is included. Notably, the regression coefficient of this cross product is significantly positive when the main effect regression coefficient is significantly positive. This indicates that GDP has a positive moderating effect on the positive relationship between cultural distance and legitimacy deficit. In other words, when the host country is more developed in terms of economic activities, there is a larger cultural distance between the home country and the host country, making it more difficult for firms to gain legitimacy [71]. This is mainly related to the stricter legal norms and regulatory regimes in economically developed countries [72], which increase the challenge for foreign firms with more cultural differences to gain legitimacy. Therefore, it is more pressing for firms to take measures to gain legitimacy when they establish subsidiaries in culturally distant and economically developed countries.

Second, two methods are used in this study to measure the institutional distance (ID) between the home and host countries (ID1 and ID2). The calculation of the regime distance can be found in Appendix B. As shown in Columns (2) and (3) of Table 11, the cross products of the independent and moderating variables, namely “ID1 × cultural distance” and “ID2 × cultural distance” are included. The regression coefficients of both cross products are significantly negative when the main effect regression coefficient is significantly positive, indicating that institutional distance has a negative moderating effect on the relationship between cultural distance and legitimacy deficit. Specifically, even if the two countries are similar in terms of institutions, greater cultural distance increases the firm’s misunderstanding of the other country’s legal system, which leads to a more severe legitimacy disadvantage. This demonstrates that the legitimacy disadvantage of cultural distance is significant and requires timely measures to mitigate it.

Finally, ESG significantly and negatively affects cultural distance, mainly because ESG alleviates the information asymmetry between the firm and the host country, reduces the errors of understanding between the two parties and shortens the cultural distance between them. When cultural distance is smaller, the firm is faced with a weaker legitimacy deficit, thus ensuring its corporate profitability in the host country.

This section further demonstrates through a moderated effects model that while GDP and the institutional distance of the host country have an impact on the relationship between cultural distance and legitimacy, they do not change the positive relationship between cultural distance and legitimacy deficit and that the need to reduce the negative impact of cultural distance on legitimacy becomes more pressing when the host country has a higher GDP and lower institutional distance. The firm has a more pronounced legitimacy deficit and needs to adopt ESG to reduce the negative effect of cultural distance, so as to ensure its corporate profitability. In this way, it is further verified that the theory of legitimacy can provide a theoretical basis for the moderating effect of cultural distance.

6. Conclusions and Discussion

With the increasing globalization of society, the concept of ESG has penetrated from corporate governance to national economic and social governance and to global governance. Meanwhile, the building of ESG discourse capacity has now received extensive attention from the international community. In China, with the introduction, dissemination, implementation and pursuit of “innovation, coordination, green, openness and sharing” [73], ESG has also gradually received more attention from the government, financial institutions and investors.

In fact, from a theoretical perspective with relevant empirical evidence, there is controversy regarding the impact of ESG on corporate profitability. Existing studies argue, [30,32], based on the theory of agency cost, that firms with better ESG have less value. Nonetheless, when it comes to multinationals with an inherent “outsider disadvantage”, the key to their survival and development lies in the acquisition of legitimacy in the host country.

Based on legitimacy theory and a sample of 3229 Chinese manufacturing multinationals, this study uses fixed effects and moderated effects models to draw two main conclusions: First, the results demonstrate that ESG has a significant positive correlation with corporate profitability, which proves that developing ESG can improve the profitability of a company. However, contrary to the finding in existing articles that good environmental performance significantly affects corporate performance [5], we find that environmental performance has no impact on corporate profitability, mainly because China has achieved significant results in environmental management in recent years [74]. The green normalization of Chinese firms has made it impossible for environmental performance in China’s manufacturing sector to significantly affect corporate profitability. Second, using the moderation model and heterogeneity test, we find that cultural distance has a positive effect on ESG and corporate profitability. Furthermore, in combination with the legitimacy mechanism test, it is found that firms are more likely to improve their ESG when setting up subsidiaries in host countries with a larger cultural distance from China, so as to gain legitimacy and thus improve their corporate profitability. Therefore, this study deviates from mainstream research on ESG by shifting the focus from “how companies develop ESG” to “the impact of ESG development on corporate profitability”. Unlike Vastola [25], who only examines cultural gaps from individual cultural characteristics, this paper integrates the six cultural dimensions of the Hofstede index to measure cultural distance and more accurately capture the impact of cultural gaps between the home and host countries in terms of the way in which ESG enhances corporate profitability.

There are many possibilities for extensions in future research. First, it has been shown in recent research that there are greater differences in values within country groups than between country groups [75]. In future research, this study can be extended by exploring cultural distance at the micro level. Second, exploring the moderating role of institutional distance on the relationship between ESG and corporate profitability in future research is advised. A larger institutional distance implies that Chinese firms export to trading partners with a level of institutional quality unmatched by China, which is associated with higher adjustment costs that inhibit the effective functioning of firms in countries of their trading partners [14]. Third, while ESG can contribute to increased corporate profitability as a whole, the impact of environmental performance as one of its segmented factors on corporate profitability is not significant. Further research can be conducted in the future to explore the impact of this factor on corporate profitability.

Although this study broadens the boundaries of ESG research, explores the impact of ESG on corporate profitability and investigates the moderating effect of cultural distance on the relationship between ESG and corporate profitability, there are still some limitations. First, given that ESG activities have been promoted in China for a relatively short period of time, it is necessary to further observe and analyze the real impact of ESG activities on corporate performance. Second, return on assets (ROA) is used in this study to measure corporate profitability as in the research methodology adopted by Attig [41]. This variable is the ratio of operating income available for distribution to investors to total assets obtained by a firm during the reporting period, reflecting the ability of investors (including the gains and losses of minority shareholders) to make profits from all assets. Nevertheless, there is no unified conclusion on the measures of profitability. Finally, the cross-sectional data selected for this study are from the period of 2014–2021. It should be noted that the world was still affected by COVID-19 in 2020–2021. In this sense, the conclusions in this study do not exclude the impact of particular circumstances (such as COVID-19) on the relationship between ESG and corporate profitability.

In addition, based on our research findings, we offer some recommendations with regard to whether and how to develop ESG. First, the positive contribution of ESG to corporate profitability suggests that developing ESG is one of the channels through which companies can make more profits. Therefore, it is important to raise companies’ awareness of participation in ESG practices and investors’ awareness of ESG investments. The government should encourage companies to substantially engage in ESG practices, so that they no longer see ESG as a way of obtaining a ‘green label’ at an additional cost, but rather as an informative tool to promote their long-term green development and steadily improve corporate profitability. Second, as cultural distance positively affects the relationship between ESG and corporate profitability, multinational companies should be more proactive in developing ESG to ensure their corporate profitability when setting up subsidiaries in a host country with a greater cultural distance from their home country. The government can further improve the relevant incentive mechanism and ensure stable corporate development by giving more ESG incentives to multinational enterprises that make outbound investments in a host country with a greater cultural distance.