Volume 4 Issue 2 (2023) Pages 379 - 390

Economics and Digital Business Review

ISSN : 2614-851X (Online)

Does Financial Slack Moderate Effect of Environmental, Social,

and Governance (ESG) on Firm Performance?

Pujangga Abdillah1 Szabyna Regytha Aura Gunawan2

Accounting Department, University of Merdeka Malang

Abstrak
The purpose of this study is to investigate the impact of ESG (Environment, Social, and Governance)
on firm performance as well as the function of financial slack as a moderating variable that may
enhance the impact of ESG on firm performance. Property sectors registered based on IC (Industrial
Classification) in the Indonesia Stock Exchange between 2019 and 2021 make up the population of
this study. Samples were taken using the judgment sampling technique with a total sample of 214
observations. The data analysis approach employed is moderated regression analysis (MRA) and
data testing was performed using STATA. The findings demonstrated that ESG influences firm
performance as evaluated by Return on Asset (ROA). In other words, firm performance can increase
with better ESG standards. The findings of this study also demonstrate that financial slack, when
used as a moderating variable, can boost the impact of ESG on firm performance.
Keywords: Firm Performance, Financial Slack, ESG
Copyright (c) 2023 Pujangga Abdillah
 Corresponding author :
Email Address : pujangga@yahoo.com

1. Introduction
One approach for businesses to enhance investor welfare is by increasing their profitability.
his achievement can be improved through better firm performance. Al-matari et al., (2014), the
company's performance is the first aspect that will be assessed by investors and other interested
parties. Financial performance measurement is used to determine the results the firm has
accomplished in accordance with the plan, therefore it may be used to measure overall firm
performance (Muntiah, 2013). Firm performance is the ability to carry out business activities and
the company uses it to determine the success of profitability (Riwukore, 2022).
Based on financial report data published on the Indonesia Stock Exchange (IDX), the
financial performance of the property and real estate sector in recent years has recorded a large
decline compared to the previous year (Ananda et al., 2022). Even in the last few years, the property
sector has always been one of the most attractive sectors for foreign or domestic investors
(Datanesia, 2023). Financial performance is one of the factors that is seen by potential investors to
determine investment, so financial performance must always be better (Wijayanti, 2018).
Implementation of good and correct performance has a positive effect on the company and produces
a good reputation in the eyes of the public or investors (Ningwati et al., 2022).
Currently, the disclosure of non-financial factors such as ESG disclosure indicators by
companies has the aim of providing additional information regarding the company's financial
performance that has not been raised in annual report data or financial reports. The financial reports
attached by companies often do not contain information such as company reputation, quality, brand
equity, and security. Through the disclosure of information related to ESG disclosure,
environmental, social, and corporate governance coverage factors can be displayed in company

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reports in more detail (Nugroho and Hersugondo, 2022). Environment, Social, and Governance
(ESG) is believed to be able to encourage better firm performance (Alfaruq, 2021).
World-class institutions, such as Standard & Poor's, Bloomberg, and Fitch, among others,
have evaluated how well companies operate in terms of environment, social, and governance (ESG)
(Priandhana, 2022). Sustainability reports are applied to issuers based on the sector from 2019 and
will be fully implemented in 2025 (Woro and Dewita, 2022). According to Noviarianti (2020), ESG
is a standard of corporate investment practice that integrates and implements company policies in
a manner that is consistent with environmental, social, and governance concepts. The state of the
global industry that continues to grow, makes the company's business processes also develop. This
economic progress has also been accompanied by a decline in environmental aspects with
environmental damage in recent years (Husada and Handayani, 2021). According to the 2022
Environmental Performance Index, Indonesia's environmental preservation is classified as the
lowest on a global and Asia Pacific regional scale (Ahdiyat, 2022).
Based on Kalia and Aggarwal (2023); Liu et al., (2022), and Naeem (2022), explain that ESG
affects firm performance. Another study conducted by Pickwick and Sewelén, (2021); Junius et al.,
(2020), has different results in that ESG does not influence firm performance. In specific, there are
no consistent conclusions about the impact of ESG on firm performance. This study refers to the
research of Gao (2022), explaining the relationship between ESG and firm performance based on
panel data. The first distinction between this study and earlier ones is the use of ROA (Return of
Assets) instead of z-score normalization to measure financial success. ROA is a more accurate
indicator of a company's profitability since it demonstrates how well management uses its resources
to generate income (Kasmir, 2012).
The second difference in this study is the addition of financial as a moderating variable
between ESG and financial performance. Based on Duque and Caracuel (2021), explain that financial
slack has an influence on the disclosure of ESG and financial performance, so the financial slack
becomes a positive moderation of the relationship between ESG and financial performance. Based
on Chu et al., (2021); Guo et al., (2020), and Rafailov (2017), explain that financial slack affects
financial performance. Another study conducted by Silalahi, (2015), has different results in that
financial slack does not influence financial performance. The inconsistency of the research results
on the effect of financial slack on firm performance is thought to be due to differences in managers'
choices for investment, experimentation, and risk-taking that have performance. Financial slack can
be sourced from management policies used to improve environmental sustainability and finance
innovation or change and increase the company's response to environmental disturbances within
the company (Latham & Braun, 2008).
As a result, this study supports the legitimacy theory and stakeholder theories. The findings
can be utilized to advise management on appropriate corporate practices and boost business
success. Also, the regulator will use this research as a source of information when determining the
environment, society, and government. The stakeholder theory and legitimacy theory that is used
to explain and suggest the tested hypothesis is covered in the next section. As a result, the research
methodology section explains how this study was carried out. The research findings are presented
and discussed in the results and discussion section. The conclusion and recommendations for
further studies can be found in the last section of this research.

2. Literature Review
Legitimacy Theory
The business works to make sure that outsiders view its operations as "legal" (Degaan, 2006).
There will, undoubtedly, always be discrepancies between the values upheld by the business and
those maintained by the community. A "legitimacy gap," or discrepancy between corporate and
social norms, can make it difficult for a corporation to carry on with its operations. The broad
perception or idea that an entity's acts are desirable, legitimate, or suitable in some socially
constructed system of norms, values, and beliefs. Based on Suchman’s (2014), legitimacy theory
stated that companies must pay attention to each of their activities so that they are in accordance

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with the social values and norms that apply in the community where the company is located so that
the company gains legitimacy from the community
Legitimacy can be a very crucial consideration for businesses planning future expansion
strategies. Hadi (2014: 87) claims that the psychological condition of people and groups that choose
sides and are extremely sensitive to environmental symptoms in both the physical and non-physical
environment is legitimate. In other words, legitimacy is determined by the community's response,
and the corporation seeks that response. According to this viewpoint, legitimacy can be viewed as
a resource that the corporation may use to further its mission of survival. Hadi (2014: 87) defines
legitimacy as a management philosophy of businesses that emphasizes alignment with the
community, local governments, and community organizations. Based on Meutia (2010: 78) equates
legitimacy with the belief that group procedures are legitimate.

Stakeholder Theory
Stakeholder theory is one of the strategic issues surrounding how companies manage
relationships with stakeholders (Bani-Khalid & Kouhy, 2017). According to this theory, companies
must pay attention to and benefit stakeholders because their existence can influence or be influenced
by policies taken by companies in their business activities. The concerned stakeholders don't just
concentrate on the shareholders. It is intended that the support and attention offered by these
stakeholders would be able to positively affect the company's performance, notably through
investment support or capital involvement that can improve the business.
According to Hadi (2014: 93), stakeholders are people or groups that the business can affect.
Both internal and external stakeholders, including the government, rival businesses, nearby
communities, workers, and non-governmental organizations (NGOs), may have an impact on or be
influenced by the firm. Deegan (2004) introduced the idea of stakeholder theory, which showed that
management has a fiduciary duty to all stakeholders, not just shareholders. Stakeholder interests
must all be taken into account equally by management, and each stakeholder has a minimum
standard that cannot be disregarded.

ESG
ESG is a socially constructed phenomenon (Eccles et al., 2020). ESG refers to a company's
corporate governance, social responsibility, and environmental initiatives. ESG is essentially the
collection of environmental, social, and governance activities carried out by any firm with the aim
of ensuring its sustainability and meeting the needs of all stakeholders while preserving and
boosting its financial worth (Naeem and Çankaya, 2022). Publicly traded firms have seen an increase
in the use of ESG disclosures in recent years as they try to involve stakeholders, meet investor, build
credibility, and respond to crises and competition in their industries. various industries (Olsen et
al., 2021). ESG is a development of corporate social responsibility (CSR) and socially responsible
investing (Chen and Xie, 2022).

Firm Performance
Firm performance is a picture of the condition of a firm in a certain period of time which is
the result of operational activities carried out by utilizing the resources (Abdillah, 2022). According
to Sianturi (2020), a company's financial performance is a description of a company's financial
condition which is analyzed using financial analysis tools so that it can be known about the
company's financial condition that reflects work performance in a certain period. It is imperative for
a company to maintain and improve financial performance so that these shares remain in demand
by investors (Islamiya, 2016).
The company's financial performance is one of the factors considered by potential investors
to determine investment (Abdillah and Mennita, 2022). The good and bad conditions of a company
can be described through the financial performance of the company (Sartini et al., 2023). This can be
known by conducting analysis using financial analysis tools to find out the pros and cons of a

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company's financial condition and financial performance at a certain time (Wibowo & Faradiza,
2014).

Financial Slack
Financial slack can be sourced from management policies used to improve environmental
sustainability and finance innovation or change and increase the company's response to
environmental disturbances within the company (Latham & Braun, 2008). Financial Slack can be a
useful resource for organizations to help achieve organizational goals (Vanacker et al., 2013). A
concept called "financial slack" relies on the idea of "financial reserves as a buffer" and "accessible
financial resources may enable organizations to develop and grow more quickly." (Jaber and Yasir,
2022). Financial slack is the least absorbed form of slack, especially because this slack can be fully
divided and separated for the allocation of various activities (Greve, 2003).
Based on Beuren et al., (2014) there would be evidence of an inverse relationship between
slack and short-term performance -although in the long term, there is a decrease in effect. The basic
definition of financial slack is that resources include potential or actual resources that can help any
organization successfully adapt to change (Bourgeois, 1981; Meyer, 1982).
The Influence of ESG on Firm Performance
Non-financial disclosures like ESG are anticipated to transform into a societal investment to
satiate stakeholder interests, which will subsequently improve firm performance (Sarasmitha et al.,
2022). Due to the increased attention that sustainability initiatives receive from company
stakeholders, businesses will experience higher demand and greater development (Buallay, 2019).
ESG disclosure is also a tool to gain strong legitimacy in the eyes of society and stakeholders so this
disclosure it is hoped that a good image for the company can be created (Triyani et al., 2020).
According to the legitimacy hypothesis, it is anticipated that the corporation would keep
looking for legitimacy among people who have an interest in it both directly and indirectly. ESG is
a tool for businesses to keep up their credibility. Stakeholder theory and some recent empirical
research support the idea that ESG will boost firm performance. Based on Kalia and Aggarwal
(2023); Liu et al., (2022), and Naeem (2022), explained that in general the results of research
conducted on the relationship between ESG and finance performance showed positive results. Thus,
the hypothesis regarding the effect of ESG on firm performance is
H1 : ESG has a positive effect on firm performance

The Influence of ESG on Firm Performance is Moderated by the Financial Slack

Concerns are raised by the lack of funding for public education on environmental and social
issues, highlighting the relationship between easier access to knowledge and E

Figure 1. Conceptual framework

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SG participation. More individuals are choosing products based on brands. Customers do

so because they think they have a chance to positively impact the world. Transparency in digital
technology makes it simple for the consumer to determine which brands are socially responsible.
Schuler and Cording (2006) found that there is a greater chance that ESG will improve firm
performance. Financial slack is firm performance. Thus, it's crucial to consider how to train
management to create ESG behaviors that genuinely consider stakeholders, boost sustainability, and
enhance financial success. Stakeholder and financial slack working together can give the business a
competitive edge (Yulinda et al., 2022). Based on Grisales and Caracuel (2021), explained that
financial slack strengthens the relationship between ESG and firm performance. Thus, the
hypothesis regarding the relationship of financial slack between ESG and firm performance is
H 2 : The financial slack strengthens the influence of ESG on firm performance

3. Research Method
Firms in the property sectors listed on the Indonesia Stock Exchange make up the study's
sample on IDX-IC. The firms that publish audited annual reports in Rupiah from 2019 to 2021 make
up the sample. There are evaluated these criteria, this study got a final sample of 214 firms with a
total of 258 observations with details in the following Table 1:

The annual reports were obtained from the Indonesia Stock Exchange (www.idx.co.id) and
the company's website. Moderate regression analysis (MRA) is used to maintain sample integration
and control the effect of moderating variables (Ghozali, 2009:203). Data testing was performed using
STATA. The operational definitions of each variable are shown in Table 2.

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4. Results and discussion

The purpose of the descriptive statistical test is to provide a description of the study's object,
including its minimum and maximum values as well as its average and standard deviation. The
outcomes of descriptive statistical analysis on the variable in this study are displayed in Table 4.

**Sig. at level 0.05 (p<0.05)

Notes:
Model 1: FP = α + β1ESG + β2AGE + β3SIZE + β4LEV + e
FP= Firm Performance, ESG= Environment Social Governance, SIZE= Firm Size, LEV= Leverage

**Sig. at level 0.05 (p<0.05)

Notes:
Model 2: FP = α + β1ESG + β2FS + β3ESG*FS + β4AGE + β5SIZE + β6LEV + e
FP= Firm Performance, ESG= Environment Social Governance, SIZE= Firm Size, LEV= Leverage

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Results of a common hypothesis test in the study utilizing the Shap-Wilk test revealed
significantly higher scores than alpha (O.O62). As a result, each variable's residual model has a
normal distribution. The Variance Expansion Factor (VIF) test, which is used to test the
multicollinearity hypothesis, reveals that each independent variable's tolerance value and VIF value
are individually larger than or equal to O.1O. As a result, no multicollinearity problems are
discovered. The Brusch-Pagan model test and the variable variance hypothesis test both yielded
significant values (Prob) above no variance issues.
The panel regression model between ESG on FP and financial slack as a moderating variable
was chosen for this study based on Hausman's test, producing a random effects model with a
random effect size of 0.098. The independent variable almost entirely gives all the information
required to predict the dependent variable, as indicated by the R-square value being close to 1.
(Ghozali, 2016). This indicates that the R-squared scores are high and that the model's ESG is
excellent at describing the differences in FP and financial slack as a moderation.

ESG on FP
The results of hypothesis 1 (table 4), statistically show a significance of 0.011 with a positive
coefficient value. This result showed that H1 was accepted. Based on the results of the hypothesis
testing, it can be seen that the research shows alignment with the stakeholder theory where the
theory states that the existence of stakeholders or stakeholders has an influence on the running of
FP through their support and trust. ESG is also seen as an activity that aims to maintain good
relations with customers, who are key stakeholders for the company. Better relationships with
employees and the environment will be able to create efficiency in the company's operations, which
will ultimately strengthen the influence of ESG on the FP. This is in line with the stakeholder
hypothesis, which holds that an organization's ability to sustain itself and grow will be influenced
favorably by the support of its stakeholders. One benefit is that there won't be as many impediments
to the company's improved image, which will lead to a rapid gain in market share and sales as well
as more cost-effective costs.
The company's reputation among stakeholders and shareholders is something favorable.
Stakeholders and shareholders respond favorably to the company by placing their trust in and
approving the goods produces, ensuring that the business will continue to make substantial profits.
An increase in profits continuously will automatically increase the value of company assets.
Through disclosure of all aspects of ESG Disclosure, it is able to improve the reputation of the FP to
stakeholders. In addition, through the ESG Disclosure as a whole, it turns out that it is also in line
with legitimacy theory which in this theory states that the existence of conformity to the norms
applied by companies in society has an influence on the running of FP with the ESG disclosure.
Companies' ESG disclosure methods lead to the heterogeneity and immobility of firm resources
(intangible resources), such as strong HR management procedures, a solid company reputation, and
satisfied customers. The company will have a competitive advantage over other businesses that are
competitors or competitors because it has more intangible resources.
The existence of the company's competitive advantage has an impact on increasing investor
expectations of the company's future profitability. Previous research according to Sahut and
Pasquini, (2015), stated that the results of an investigation found a positive effect between ESG
Disclosure and FP. This study, directly proportional to the research of Kalia and Aggarwal (2023);
Liu et al., (2022), and Naeem (2022), that the higher the value of ESG disclosure, the company's
performance will increase. Based on this opinion, disclosure aspects of environmental, social, and
corporate governance as a whole can improve FP in the view of stakeholders both investors and
society.

The role of financial slack as a moderating variable

Results for Hypothesis 2 (Table 4) demonstrate a positive coefficient value and statistical
significance of 0.041. This outcome demonstrated that H2 was approved. Overall, the findings are
consistent with the main argument that there is merit in financial underutilization. While

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uncertainty has reached its peak, the increased financial flexibility it provides is having a significant
influence on corporate performance. Only when a company's financial underutilization crosses a
predetermined threshold can its performance improve. It would be preferable to do without an
electronic Slack if not. Performance only increases after a company's financial underutilization is
exposed over time. A non-electronic flute alternative would be ideal (Odum et al., 2019).
Financial slack affects ESG activities, if ESG often uses financial slack the company will do
ESG well which can practically improve FP. Better use of financial slack will also have a good impact
on ESG activities on FP. The results of this study are in line with the research of Duque and Caracuel
(2021), explaining that financial slack strengthens the relationship between ESG and FP. This study
explains that financial slack moderates ESG on FP. Financial slack has an influence on ESG on FP so
financial slack becomes a positive moderation of the relationship between ESG and FP.

5. Conclusions
This study aims to investigate how environmental, social, and governance (ESG) factors
affect FP and financial slack in the property sectors based on Industrial Classification (IDX-IC),
which is listed on the Indonesia Stock Exchange. The findings of this study offer empirical proof
that ESG affects company success. Additionally, this research demonstrates that financial slack
plays a part in enhancing the impact of ESG on FP, but it also plays a part in enhancing the impact
of ESG on FP in the property sector.
This study makes a number of theoretical and applied contributions. The theoretical
contribution of this study, specifically the beneficial impact of ESG on FP can gain the support of
the community. This study has shown that corporations may utilize ESG to change public
perceptions of their actions as being socially responsible, increasing public trust and enhancing
business performance. The second hypothesis—that the financial slack plays a positive role—is
accepted using stakeholder theory, and thus amplifies the impact of ESG on business performance.
This finding backs up the stakeholder theory, which claims that when business performance
rises, management tends to become more active in ESG than stakeholders do since they are aware
that the actions taken have an impact on raising FP. The findings can be used as a guide for
businesses across all market segments to examine how finances play a role in successful ESG
implementation, which will inevitably have an impact on FP.
Several recommendations can be made based on the findings and restrictions of this study.
In order to create sustainable development (sustainable development) in Indonesia, the government
must first urge every enterprise in the country to adopt ESG. One method to do this is by
establishing policies/laws that are firm and explicit concerning ESG practices and disclosures.
Second, management should think carefully before implementing ESG practices in their
organizations because ESG practices are thought to enhance future business performance.

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Does Financial Slack Moderate Effect of Environmental, Social, and Governance…