The relationship between foreign direct investment and environmental, social and governance (esg)

The University of the West of England Pham Quynh Trang 22083659 THE RELATIONSHIP BETWEEN FOREIGN DIRECT INVESTMENT AND ENVIRONMENTAL, SOCIAL AND GOVERNANCE ESG MSc in Finance, the Uni

Dissertation submitted in partial fulfillment of the

Requirement for the MSc in Finance

Supervisor: Prof Dr Tran Thi Xuan Anh

The University of the West of England

Pham Quynh Trang

22083659

THE RELATIONSHIP BETWEEN FOREIGN DIRECT INVESTMENT AND

ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) MSc in Finance, the University of the West of England, Bristol

Academic year of presentation: 2022/2023 Faculty of Business and Law

Student projects and dissertations Faculty: Business and Law

Student’s name: PHAM QUYNH TRANG

Programme of Study: Master Science in Finance and Investment

Project/dissertation title: THE RELATIONSHIP BETWEEN FOREIGN DIRECT

INVESTMENT AND ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG)

I permit UWE Library Services to hold and make available an electronic copy of this

ACKNOWLEDGEMENT

First and foremost, I would like to express my heartfelt appreciation to my supervisor, Assoc Prof Dr Tran Thi Xuan Anh, for her unwavering encouragement of the Final Project, as well as her conscientiousness, patience, inspiration, and specialization throughout the method of inscribing this dissertation Her guidance truly helped me in all the time of researching and presenting this paper I could not have imagined having a better supervisor for my dissertation in the final year of my studies

My gratitude also goes to the lecturers of the International Bachelor Degree Program at the Banking Academy Vietnam for their constant support, insightful comments, and intellectual inquiries Thanks also go to the University of the West of England for providing me with a well-designed academic curriculum that increases my knowledge and abilities in executing this project I also would like to send my gratitude to my Quantitative Research Methods lecturers, Dr Roberto Ercole, Dr Pham Hung, and Dr Tran Kien for pointing me toward the econometric module as well as for delicately guiding me from the general to specific structure and steps of doing research

More particularly, I would like to thank my beloved family and friends for their unceasing encouragement and friendship during my university years Finally, I want to record my sense of gratitude to one and all, who have directly or indirectly given me their helping hand in this venture

This study aims to make suggestions about the relationship between foreign direct investment and environmental, social and governance (ESG) The study employs quantitative analysis methods to understand the relationship between these characteristics and FDI inflows by collecting secondary data on ESG indicators and other macroeconomic indicators from 2010 to 2020 A proposed model was tested, and the results show that while CO2 per capita emissions have a negative relationship with FDI, other factors such as government efficacy, GDP per capita growth, trade openness, the Financial Development Index, and the price level ratio have a positive relationship with FDI Meanwhile, HDI seems to have no relationship with FDI attraction in developing countries in Asia Although the study was conducted in a short time and the number of factors selected was limited, it successfully revealed the impact of each variable on FDI and suggested that further studies should expand both on the period and number of determinants in the relationship between ESG and FDI

TABLE OF CONTENTS

ACKNOWLEDGEMENT iv

ABSTRACT v

TABLE OF CONTENTS vi

LIST OF ABBREVIATIONS viii

LIST OF TABLES ix

LIST OF FIGURES x

CHAPTER 1: INTRODUCTION 1

1.1 The importance of the topic 1

1.2 Research objectives 2

1.2.1 General objectives 2

1.2.2 Specific objectives 3

1.3 Research question 3

1.4 Object and scope of research 3

1.5 Research Methods 4

1.6 Thesis structure 4

CHAPTER 2 LITERATURE REVIEW 5

2.1 Foreign direct investment overview 5

2.1.1 Concepts and definition 5

2.1.2 The role of FDI in economic development 8

2.2 Overview of environmental, social and governance (ESG) 12

2.2.1 Fundamentals of ESG 12

2.2.2 The rationale for investing in ESG 18

2.3 The relationship between FDI and ESG 22

2.3.1 Theoretical background 22

2.3.2 Empirical researches 25

2.3.3 Proposed research framework 30

CHAPTER 3 DATA AND RESEARCH METHODS 32

3.1 Database 32

3.2 Description of research variables 33

3.2.1 Dependent variable 33

3.2.2 Independent variables 33

3.3 Research methodology 36

3.4 Research model and research hypothesis 38

CHAPTER 4 CURRENT SITUATION, RESEARCH RESULTS AND DISCUSSION

43

4.1 Overview of FDI and ESG in Asian countries 43

4.1.1 Global FDI and FDI in Asian countries 43

4.1.2 Implementing ESG in Asian countries 48

4.2 Empirical results 50

4.2.1 Description statistics 50

4.2.2 Correlative analysis 53

4.2.3 Multicollinearity 53

4.2.4 Test the regression method selection 55

4.2.5 Diagnostic test for FEM estimations 58

4.3 Regression results 60

4.4 Analyze and evaluate research results 62

CHAPTER 5 RECOMMENDATION AND CONCLUSION 67

5.1 Recommendation 67

5.1.1 Policies proposed for Asian countries 67

5.1.2 Recommendation on policies of Vietnam 70

5.2 Conclusion 71

APPENDICES 74

REFERENCES 86

LIST OF ABBREVIATIONS

APAC Asia-Pacific

CSR Corporate Social Responsibility

EBA European Banking Authority

ESG Environmental, Social and Governance

FD/ FIND Financial Development Index

FDI Foreign Direct Investment

FEM Fixed Effects Model

FTA Free Trade Agreements

GDP Gross Domestic Product

HDI Human Development Index

IFC International Finance Corporation

MNE Multinational Enterprises

OLS Ordinary Least Squares

PRI Principles for Responsible Investment

REM Random Effects Model

SDG Sustainable Development Goals

SME Small and Medium Enterprises

UAE United Arab Emirates

UN The United Nations

USD The United States Dollar

LIST OF TABLES

Table 1: Institutional sector (IMF) and Industry sector (OECD) 8

Table 2: Frameworks addressing ESG 14

Table 3: ESG framework (International frameworks) 16

Table 4: Description statistics 51

Table 5: Correlation coefficient between variables in the research model 53

Table 6: Variance inflation factor (VIF) of the model 55

Table 7: Multivariate regression results on the influence of ESG on FDI 56

Table 8: Summary of test results 63

LIST OF FIGURES

Figure 1: Commonalities of ESG factors 17

Figure 2: Outperformance of top ESG-rated companies and bottom ESG-rated companies within the MSCI World Index 20

Figure 3: Research framework on the influence of ESG on FDI of countries in Asia 31

Figure 4: Financial Development Index framework 35

Figure 5: FDI by subregion 2021, 2022 (USD billions) 44

Figure 6: FDI in the world and FDI in Asian countries (2010-2022) 44

Figure 7: FDI inflows in developing Asia, by subregion, 2021-2022 45

Figure 8: Top 10 developing economies by international investment in renewable energy (2015–2022) Billions of US dollars and percent 46

Figure 9: Structure of FDI in Vietnam by industry 47

Figure 10: ESG Performance Comparison 49

Figure 11: Distribution of variables 52

Figure 12: F-test 57

Figure 13: Lagrange multiplier test 57

Figure 14: Hausman test 58

Figure 15: Breusch-Pagan test 59

Figure 16: Breusch-Godfrey test 59

Figure 17: FEM model results 60

CHAPTER 1: INTRODUCTION

1.1 The importance of the topic

Foreign direct investment (FDI) has shaped the global economy for years and is important for emerging and developed nations Investment in transnational commercial activity is primarily done by multinational firms through FDI Nations seek investment opportunities abroad to capitalize on comparative advantages in raw material pricing, natural resources, labor, science and technology, infrastructure, and tariffs to achieve economic gains However, numerous nations seek FDI to create jobs, boost economic growth, and utilise foreign science and technology to accelerate their development Developing Asia receives 50% of global FDI and maintains its $662 billion flow (UNCTAD, 2023) Asian countries have great economic development potential due to their dynamic development, dense population, affordable labor, educated population, constant interest in investment, labor skill development, and infrastructural improvement

By identifying the elements that make FDI inflows attractive, policymakers may adapt solutions for each feature Improved information helps firms and investors make educated judgments and contribute to the decision-making process

However, rapid expansion has destroyed habitat and the ecosystem Larger economic output and more intensive resource use are needed to expand economic activity This increases carbon dioxide emissions, which may harm human health Developing countries must balance FDI with environmental preservation, while host countries must decide if ESG aspects assist in attracting FDI Many studies have examined the

Latin America, and others Previous research has found unclear results and has not examined the relationship between ESG aspects, FDI, and macroeconomic variables without focusing on Asian countries increasing and disaggregated by income FDI and ESG research is scarce despite being a sustainable management pillar

Furthermore, because it focuses on Asian countries at the forefront of environmental deterioration and sustainable development, the research is extremely useful The necessity for research into sustainable development and economic growth in Asian economies, on the other hand, is highlighted by the possibility of a rapid economic recovery in the post-COVID era To the author's knowledge, there is a study gap in the analysis of the connection between sustainable FDI, ESG, financial development, and HDI, especially in the case of Asian economies trying to tackle environmental pollution

by strengthening green financing tools These economies are looking for ways to restart their economic operations due to the negative consequences of the pandemic Therefore,

the author chooses the topic “The relationship between foreign direct investment and environmental, social and governance (ESG)”, as the object of research in this thesis

required The recommendations of the thesis hope to contribute to promoting FDI attraction and moving towards sustainable investment in developing countries - one of the important factors contributing to sustainable development goals

1.2.2 Specific objectives

- Research the relationship between FDI and ESG parameters for a sample of 31 Asian countries from 2010 to 2020 using empirical data and running econometric models

- Determine the impact of these factors on attracting FDI capital flows

- Propose and recommend policies to attract FDI capital flows into Asian countries based

- Do the researched factors have a positive or negative effect on FDI capital flows?

- For the Asian countries, how does this result change and how does it affect the application of the policy?

1.4 Object and scope of research

The study examines the association between FDI and ESG factors over the 2010 – 2020 period for a sample of 31 Asian countries The panel data comprises 18 high and upper-middle-income and 13 low and lower-middle-income Asian countries as classified

by the World Bank Group 1 is a group of 18 high and upper-middle-income Asian countries including Armenia, Azerbaijan, Bahrain, Brunei, China, Indonesia, Iran, Japan, Jordan, Kazakhstan, Korea, Malaysia, Oman, Qatar, Saudi Arabia, Singapore, Thailand, and UAE Group 2 is a group of 13 low and lower-middle-income Asian countries including Bangladesh, Bhutan, Cambodia, India, Kyrgyz Republic, Lao PDR, Myanmar, Nepal, Pakistan, Philippines, Sri Lanka, Uzbekistan, and Vietnam

1.5 Research Methods

The author used quantitative research methods, and regression sample data as mentioned above This study used the pooled ordinary least squares (Pooled OLS), the fixed effects models (FEM), and the random effects models (REM) as the baseline models

R and R Studio software were used to find regression estimators using secondary panel data obtained between 2010 and 2020 To ensure efficient and reliable regression estimates, the author has carried out tests to select the model, the correlative analysis, multicollinearity, and heteroskedasticity

1.6 Thesis structure

CHAPTER 1 INTRODUCTION

CHAPTER 2 LITERATURE REVIEW

CHAPTER 3 DATA AND RESEARCH METHODS

CHAPTER 4 CURRENT SITUATION, RESEARCH RESULTS AND DISCUSSION CHAPTER 5 RECOMMENDATION ON POLICIES AND CONCLUSION

CHAPTER 2 LITERATURE REVIEW

2.1 Foreign direct investment overview

2.1.1 Concepts and definition

According to the United Nations Conference on Trade and Development (UNCTAD) (2023), FDI is an investment consisting of long-term relationships, reflecting the control and interest of an entity in an economy (foreign parent company or foreign investor) (UNCTAD, 2023) According to the International Monetary Fund (IMF) (2004), FDI is defined as foreign investment aimed at securing lasting benefits in a foreign economy, with a focus on gaining management control and emphasizing the permanence

of the investment (Galeza and Chan, 2015) In the fifth edition of the IMF's Balance of Payment Manual, a direct investor is defined as someone who owns 10% or more of a company's capital While this isn't a strict rule, it acknowledges that control can be exerted with a smaller stake and may not be guaranteed with over 10% Nonetheless, the IMF suggests using this 10% threshold as the key distinction between direct investment and portfolio investment through shareholdings (Duce and España, 2003)

The definition of FDI that is the most generally used is the IMF/OECD benchmark definition since it was created by a collaborative effort of these two international organizations to give national statistical offices guidelines for producing FDI statistics The definition's main idea is that FDI is an international business venture in which an investor who lives in the home economy gains a long-term influence over the direction

of a subsidiary company in the host economy Both the host economy, which records FDI flows as inbound FDI along with other liabilities in the balance of payments, and the

home economy, which records FDI flows as outward FDI, a category of assets, can be used to observe FDI flows (OECD, 2008)

Therefore, from the point of view mentioned above, FDI can be understood as a form of foreign investors transferring technology, money, management skills, etc from one country to another, from one region to another at the same time, taking control and management to obtain economic benefits from the host countries It is important to note that only capital that is provided by the direct investor either directly or through other

enterprises related to the investor should be classified as FDI (Auzairy et al., 2018)

FDI is classified based on three factors: first, the direction of investment; second, the investment instrument used; and third, the sector breakdown (Duce and España, 2003)

First, the direction can be viewed from both the host's and the home's perspectives

From the domestic perspective, any form of funding provided by the parent firm that is a resident to its nonresident associates would be considered a direct investment abroad As opposed to being considered a foreign direct investment, money of any kind provided by non-resident subsidiaries, affiliates, or branches to their resident parent business is instead counted as a decrease in foreign direct investment The financing provided by non-resident parent companies to their resident subsidiaries, associates, or branches would be classified as a decrease in foreign direct investment rather than a direct investment abroad from the perspective of the host one and would be recorded in the country of residence of the affiliated companies under foreign direct investment If there is a cross-holding of more than 10% in the share capital of the parent firm and any subsidiaries, affiliates, or branches, then this directional principle does not apply (Duce and España, 2003)

Second, for instruments, direct investment capital includes capital contributed

(either directly or through other linked firms) by a direct investor to a direct investment enterprise and capital received from a direct investor Direct investment capital transactions have three parts: (i) Equity capital includes branch equity, all subsidiary and affiliate shares (except non-participating preferred shares that are debt securities and included under other direct investment capital), and machinery (ii) Reinvested earnings: the direct investor's share (in proportion to direct equity participation) of non-disbursed earnings, such as subsidiary or associate dividends and branch earnings If unidentified, branch profits are allocated traditionally (iii) Other direct investment capital (or inter-company debt transactions): borrowing and lending cash, including debt securities and trade credits, between direct investors and direct investment firms and between two direct investment enterprises with the same investor Deposits and loans from associated deposit

institutions are represented as other investments, not direct investments.(Auzairy et al.,

2018)

Finally, FDI flows are further broken down by several sectors According to the

resident party's sector, the IMF has split into four institutional sectors However, the Fifth IMF Manual does not require sector-split reporting National statistics in certain countries offer FDI data with this split In practice, only the Banks and Other sector matters, and even then, national banks sometimes finance foreign enterprises through local non-banking holding companies (IMF, 2004a) As a result, both categories would be distorted because such transactions would be recorded as being carried out by other sectors rather than by banks (IMF, 2004b; Eurostat, 2002) Instead of classifying by institutional sector, the OECD Benchmark definition uses an “industrial” split, which covers nine economic

company by the parent company's industrial sector When the parent firm is a bank, FDI transactions by a non-banking holding company are ascribed to the bank (Golub, Kauffmann and Yeres, 2011; OECD, 2008)

Table 1: Institutional sector (IMF) and Industry sector (OECD)

Source: (OECD, 2008; IMF, 2004a)

2.1.2 The role of FDI in economic development

Economists encourage cross-border capital flow because it lets capital seek the maximum return Feldstein (2000) suggests the potential benefits of unrestricted capital movements First, international money flows allow capital owners to diversify their lending and investment, reducing risk Second, global capital market integration can spread company governance, accounting, and legal best practices Third, global capital mobility limits harmful policies by governments (Feldstein, 2000) Host nations might benefit in various ways from FDI, in addition to these advantages, which apply to all

Institutional sector (IMF) Economic or industry sector (OECD)

General government

Central bank

Other depository corporations

Other sectors

- Other financial corporations

+ Insurance corporations and pension funds

+ Other financial corporations

Financial auxiliaries

- Nonfinancial corporations

- Households

- Nonprofit institutions serving households

1 Agriculture, hunting, forestry and fishing

2 Mining and quarrying

7 Transport, storage and communications

8 Financing, real state and business services

9 Community, social and personal services

private capital inflows Financial transactions cannot transfer technology, including new capital inputs like FDI, in commodities and services The benefits of FDI include increased competition in domestic input markets, increased human capital in the host country, and increased corporate tax revenues from FDI earnings Countries may forsake some of this money while lowering corporate tax rates to attract FDI In certain OECD countries, competition may explain the sharp drop in company tax receipts

According to growth and trade theory, capital inflows may boost GDP per capita

in the capital-importing country Technological spillovers, linkage effects, and

competitive impacts have been extensively studied in the literature on host country

consequences of FDI (Kind, 2003)

Firstly, affiliates abroad usually have technological advantages that help them

compete with local enterprises Thus, host country enterprises may learn from international affiliates Technological spillovers, which should boost local business factor productivity and incentives, should not be ignored, according to empirical studies The least developed countries may not have the human capital to employ foreign technology (Blomström and Kokko, 2001) This is supported by Blomstrom, M and Wolff (1994), who found that FDI inflows boost income growth in advanced developing nations but not

in the least developed In addition, governments that restrict inward FDI and force foreign enterprises to collaborate with local firms have few spillovers The headquarters of multinational corporations may be less inclined to bring innovative and advanced technology to countries where they have less control over their proprietary information (Blomstrom, M and Wolff, 1994) In the current period of very strong globalization, the

that country, but always with the participation of other factors abroad to supplement and support Foreign investors will participate in projects that require large investment capital that the host country does not have enough resources for or projects where the host country has little priority on capital but gives priority to foreign investors' capital investment in these areas (Kind, 2003)

Secondly, related to spillovers is whether foreign enterprises join up with local

firms Strong links suggest FDI may have a big employment impact Interaction between local intermediate suppliers and the foreign affiliate may also facilitate learning For instance, international corporations may demand greater intermediate quality and prompt delivery, forcing local suppliers to improve efficiency Increasingly efficient local intermediate suppliers will assist locally owned downstream enterprises In a survey of the empirical literature, Lall (1978, 1992) shows substantial links between import substitution MNEs and local enterprises in large economies, especially in nations with tight local content requirements MNEs that gradually switch from import-replacing to export-oriented production, especially those using reliable and simple technology, are the same However, export-focused MNEs lack local industry links Labor and travel costs seem to influence these companies' localization decisions more than the availability of locally created intermediate goods, according to Lall Efficiency restrictions diminish local links in emerging nations to essentially nothing for export-oriented MNEs in complex electronics sectors (LALL, 1978, 1992) As multinational corporations, their activities, and goods circulate in various nations, FDI enterprises have several cases FDI companies contact domestic companies for raw materials and other production services

to decrease input costs and use local sources Domestic enterprises can join their

production chain, creating jobs and revenue for host nation companies and people.(Bissoon, 2012; Kind, 2003)

Finally, foreign entry may reduce the concentration of firms in a market, and

thereby increase competition This is likely to lead to lower prices, and perhaps a wider choice of goods Tougher competition may also force firms to reduce organizational inefficiencies, so-called X-inefficiencies, to stay competitive (Blomström and Kokko, 2001; Blomstrom, M and Wolff, 1994) As a point of departure, one may expect the pro-competitive effect to be strongest in the sectors that are otherwise relatively protected from foreign competition However, as noted by Graham and Krugman (1995), there is likely to be a sectoral bias in trade protection, in the sense that countries tend to protect those sectors where the domestic industry has a comparative disadvantage (Krugman, 1995) Local firms argue that allowing FDI into these sectors may crowd out their competitiveness due to demanding customers, giving foreign firms market power and pure profits without increasing competitive pressure (Michael E Porter, 1990) In severe cases, local enterprises are eliminated, giving the foreign newcomer a monopoly Studies show that foreign investments are more profitable in sectors with low trade barriers or competitive local enterprises (Blomström and Kokko, 2001) However, the higher consumer surplus created by foreign entrance must be evaluated against the loss of domestic producer surplus when local firms lose market shares This is especially detrimental in industries with dynamic learning-by-doing This is one reason many developing countries have utilized the infant industry policy before and after Local firms would become less competitive after foreign entry, hurting the host economy in addition

to static consequences like transferring earnings (Lee and Rajan, 2011; Kind, 2003)

2.2 Overview of environmental, social and governance (ESG)

2.2.1 Fundamentals of ESG

In the early 1960s, the environmental movement forced huge firms to take responsibility for their actions, raising the question of environment, society, and governance to the environment and human health owing to company business activity The United Nations Brundtland Commission (WCED) met in 1987 to set global sustainable development goals The gathering encouraged environmental pollution and economic growth Thus, WCED defines sustainable development as meeting the needs of the present without compromising the ability of future generations to meet their own needs (Visser and Brundtland, 1987) In 1992, UNEP released the Financial Institutions Declaration of Commitment to Sustainable Development This Declaration constituted the foundation of the UNEP Finance Initiative after the 1992 Earth Summit in Rio The financial services sector contributes to a sustainable economy and lifestyle by integrating environmental and social issues into all operations Due to public expectations and environmental concerns regarding company activity, the European Commission (2001) published seven reports Promoting the European Framework for Corporate Social Responsibility The first plan to include corporate social responsibility (CSR) is this one The plan emphasizes that corporations are responsible for their societal repercussions and outlines how they should be socially responsible However, CSR is a business strategy for individual companies without a standard performance measurement system ESG is a term coined in the UN report Who Cares Wins (2004) The report is the result of a joint initiative of financial institutions to develop guidance and recommendations on how to integrate environmental, social, and corporate governance issues in asset management and services related stockbrokers (Hagart and Knoepfel, 2004)

The ESG principle is a framework that takes governance (G), social (S), and environmental (E) aspects into account ESG is a byproduct of responsible investing, described as a strategy and practice to incorporate ESG factors in investment decisions and active ownership by the principles for responsible investment (PRI) As a result, investors typically utilize ESG as a benchmark and technique to assess corporate behavior and potential future financial success The three fundamental elements of ESG are the most important criteria to take into account when conducting investment analysis and making investment decisions

Table 2: Frameworks addressing ESG

Source: (EBA, 2021; Lee and Eastman, 2021)

MSCI (2007) defines ESG investment as the consideration of environmental,

social and corporate governance factors in addition to financial factors in the investment

decision-making process (Marina Brogi, 2018) ESG is an investing concept for assessing the sustainable growth of businesses (EBA, 2021) The sustainability and social impact

of corporate operations are also measured with the aid of ESG considerations ESG issues are defined as environmental, social, or governance matters that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign, or individual by the European Banking Authority (EBA) Therefore, ESG is an investment philosophy that seeks long-term value growth and is a comprehensive, practical, and practical governance strategy It is a value of sustainable and coordinated development

that takes into account economic, environmental, social, and governance benefits (Li et

al., 2021) The majority of international frameworks and standards avoid singly defining

ESG criteria Despite widespread agreement that ESG elements are one of the three basic pillars of sustainability, it is difficult to consistently comprehend and manage ESG factors because there is no standard definition for them An ESG factor exhibits one or more of the intrinsic properties listed below, which are given in non-hierarchical order in Table 4 and may potentially be connected based on the similarities of the various frameworks that

refer to ESG factors (EBA, 2021; Li et al., 2021)

Table 3: ESG framework (International frameworks)

Source: (EBA, 2021)

ESG factors are often of the nature of non-financial factors, such as greenhouse gas emissions, environmental footprint, social welfare, poverty, equal rights and ethics, a few can also be financial factors such as profits, capital and costs In addition, ESG variables can also have short-, medium-, or long-term effects and can manifest at any time, making their impact unpredictable It is critical to avoid the assumption that ESG issues only matter in the medium and/or longer-term because they can also result in immediate problems, such as immediate environmental policy implementation and acute

environmental risks (Schanzenbach and Sitkoff, 2020) Moreover, the public is particularly concerned about ESG issues like greenhouse gas emissions, pollution, social welfare, and poverty because of harmful economic externalities They represent the combined effect of many individual actions, but because they are not included in financial statements, costs are borne by third parties or society as a whole, and market mechanisms

do not fully account for them Besides, ESG is also quite responsive to shifts in societal preferences and objectives Regulation reform and other uncertain structural adjustments may be necessary to limit climate change and other environmental concerns (EBA, 2021) Finally, the consequences of an entity's actions and interactions with stakeholders in its upstream and downstream value chains are referred to as ESG A firm may meet different ESG variables in these activities through its debtors and creditors

Figure 1: Commonalities of ESG factors

Source: (EBA, 2021)

2.2.2 The rationale for investing in ESG

Influential is Friedman's (1970) perspective on the social obligations of business

A business's only goal is to boost profits while engaging in fair and honest competition Managing shareholder profitability while adhering to legal and ethical standards is a challenge for corporate leaders (Carson, n.d.) Corporations should not be involved in social or environmental issues ESG investments and activities use up corporate funds and take managers' focus away from their operational duties Investor wealth is ultimately harmed by this (Friedman, 1970) In addition, agency interactions are also agreements between the primary (shareholders or other individuals who award tasks or authority) and the agent (management or other parties who accept responsibilities and authority), according to Jensen and Meckling's agency theory (1976) The agency dilemma, which occurs when an agent (the person accepting levers and authority) acts contrary to the principle (the one providing the lever or authority), is a topic that agency theory frequently tackles When an agent declines to share earnings after performing a task, management is faced with the agency problem Actions taken by agents against the principal might take a variety of shapes Not all company's stakeholders strive to increase the company's value The interests of managers and business owners could collide (Mccolgan, 2001; Jensen and Meckling, 1976)

Contrary to this, Freman (1984) initiated the stakeholder theory point of view According to this theory, an organization must treat its stakeholders equally and, in the event of a conflict of interest, must find a balance that is best for all parties involved The organization will concentrate on addressing the needs of stakeholders who have a significant and direct interest and make the assumption that the interests of the other parties are also fulfilled because the demands of stakeholders vary and change over time

By the organization's pursuit of a business strategy and the reporting of data in line with social norms and values, happiness can be attained In response to the rising demand for environmental information from other stakeholders, governmental organizations, credit institutions, investors, consumers, and the community, this theory is used to explain the motivations of organizations to choose and voluntarily apply ESG standards (Freeman, 1984)

According to the author's assessment, there are some important justifications for investing in ESG standards for sustainable development The main advantage of ESG investing is that it adds value over the long term by incorporating sustainable company practices These include the broader repercussions for society, the environment, and stakeholder investments in addition to just adhering to legislation By limiting exposure

to significant sustainability risks and providing possibilities to profit from future growth from sustainable investments, ESG builds a more resilient portfolio that is better suited

to market volatility Additionally, it gives investors a way to match their values with investable assets, enhancing the sense of purpose behind their choice of investments and producing numerous financial gains Last but not least, numerous studies have shown that businesses with high ESG performance typically perform better financially over the long run, suggesting that making investments in ESG may have advantages beyond only ethical ones

Figure 2: Outperformance of top ESG-rated companies and bottom ESG-rated

companies within the MSCI World Index

Source: MSCI World Index (Bank, n.d.)

Businesses that excel in ESG concerns usually beat their competitors in terms of competitiveness by optimizing internal resources, managing human capital, and strengthening supply chains Importantly, ESG leaders will be forward-thinking in their capital allocation as they work to manage the market, regulatory, reputational, and physical risks and build sustainable businesses with a long-term perspective Bottom line: ESG leaders frequently experience stronger profitability and above-average returns, creating opportunities for longer-term increases in the amount paid to shareholders Companies with higher ESG ratings outperformed those with lower ratings, as evidenced

by the performance chart

Risk-adjusted return is the determination of an investment's return by measuring the level of risk involved in generating that return, usually expressed as a number or rating Risk-adjusted return applies to individual securities, mutual funds, and portfolios Some

common risk measures include the Alpha coefficient, Beta coefficient, R-Squared coefficient, standard deviation, and Sharpe ratio (Schanzenbach and Sitkoff, 2020) ESG investing places a focus on ESG elements that could reduce risk and boost risk-adjusted returns Compared to traditional investing, ESG investments can increase risk-adjusted returns, alpha, and volatility Investors can locate companies with strong management, positive corporate cultures, and financial and social congruence with the help of ESG investments Key ESG indicators and firm performance have a relationship that is supported theoretically Some empirical data backs up these ideas, albeit the specifics depend on the research methodology and the setting Companies with high environmental and social scores often make more money while taking on fewer risks than companies with low environmental and social scores, according to research on business performance (Mozaffar Khan, 2016) Furthermore, there is evidence that firms can promote goodwill through socially conscious initiatives, which can protect their reputation from negative events (Paul C Godfrey, n.d.)

Investing in ESG elements is expected to increase despite the recent abrupt change

in the financial landscape and an increasingly difficult macroeconomic environment The ESG principle has been widely adopted in Europe, America, and other industrialized nations since 2004 ESG evaluation, disclosure, and index systems mature environmental, social, and governance components and ESG These constants sustain growth patterns ESG was studied, adopted, and popularized worldwide, drawing scholars (Wu, 2022)

2.3 The relationship between FDI and ESG

2.3.1 Theoretical background

The theory of capital mobility is the earliest explanation for FDI, seen as part of portfolio investing Hymer's (1976) pioneering contribution was the first explanation of FDI in traditional industries Hymer argues that MNCs are willing to open their wallets for FDI only if they gain advantages over local firms through intangible assets such as well-known trademarks, public copyrights, etc technology, management skills and other special factors FDI can come about because it is difficult to sell or lease these intangible assets even though multinationals want to It affirms that a business decides to invest abroad based on its desire to take advantage of specific strengths that the business owns and that are not shared by local (competing) businesses that are present in the host nation These competitive advantages could impact a company's decision to relocate abroad and include operating financing, technical expertise, managerial, and/or marketing benefits in the foreign country (W.Hymer, 1976)

Compared with the theory of industrial organization, the in-house approach of firms emphasizes that firms undertake FDI because the market for factors of production

is imperfect and as a result, firms try to replace market transactions with transactions of

an internal enterprise nature They do it because it saves them certain marketing costs The advantage of internalizing the properties of the business is that it avoids lengthy delays, bargaining, and buyer uncertainty (Raible, 2013) In contrast, the FDI location theory explains that the main cause of FDI is the difference in some factors of production such as natural resources and labor across countries This leads to a difference in costs associated with the investment location (Denisia, 2010)

Dunning (1973, 1980, 1988) proposed the theory of the structure of FDI inflows The eclectic theory developed by professor Dunning is a mix of three different theories

of FDI Ownership - Location – Internalization (O-L-I) It presents the interweaving of three distinct theories of FDI, focusing on the advantages of ownership, the advantages

of the place of investment and the advantages of the internalization of enterprise characteristics (Brouthers, Brouthers and Werner, 1988) Eclectic paradigm OLI demonstrates that OLI parameters vary from business to business, rely on context, and represent the economic, political, and social traits of the host nation As a result, the goals and plans of the companies, as well as the volume and pattern of production, will be influenced by the opportunities and difficulties presented by various types of nations (Thi Kim Anh and Hong Ngoc, 2016)

FDI theories related to international trade Smith (1776), followed by Ricardo (1817), pioneered the theory that provided explanations of trade flows between nations Smith established his theory based on an absolute cost difference Trade will occur if one nation has an absolute advantage in one commodity’s manufacturing and a disadvantage

in another commodity’s manufacturing There is no single, coherent theoretical explanation for FDI, according to all empirical findings, and its current appearance seems extremely implausible

The relationship between ESG criteria and global transfers has primarily been researched at the corporate level and in the context of portfolio investments According

to the corporate social responsibility thesis, businesses must adopt socially responsible

strategies and practices (Chang et al., 2017) According to Caroll's theory, it is in the

long-social structures will negatively affect those businesses' economic success (Archie B Carroll, 1979) As reported by the stakeholder theory, businesses must take into account the interests of all stakeholders - including the environment and other non-social stakeholders - when making decisions There is evidence that all stakeholders are interested in ESG measures when it comes to firm investments, thus businesses must adapt to stakeholder expectations (Freeman, 1984) According to the legitimacy theory, making investment decisions based on ESG factors and disclosing CSR data are both essential components of the social compact that businesses have with society (Pfeffer, 1975) From a business perspective, it can be seen that ESG criteria have a positive impact

on sustainable investment but can increase the costs of the business leading to a decrease

in profits and shareholder benefits

Underlying the interest in FDI and ESG at the country level is the emphasis currently placed on multilateralism in the literature related to FDI and its impact on the sustainability of countries International direct investment is that while investment protection and liberalization are particularly crucial to MNEs, governments should pay close attention to the implications of all of these concerns for sustainable growth and development (UNCTAD, 1996) Groups like trade unions and consumer advocacy organizations are primarily concerned with social policy issues FDI will assist skills development and the expansion of human capital in several significant ways, including boosting market access, foreign exchange, technical innovation, and escalating local market competitiveness (Chipalkatti, Le and Rishi, 2021)

2.3.2 Empirical researches

Sample ESG quantitative data that may be used in the valuation model must be related to investigate the relationship between FDI and ESG towards FDI The economic literature places a lot of emphasis on factors that influence climate change, like CO2 emissions The HDI, a factor, has been the subject of some investigations The WB Governance Index was studied by others However, no researcher has attempted to conduct a joint empirical investigation on the FDI drivers The purpose of the following

is to close this gap by conducting a literature review to first identify the FDI indicators and then the ESG indicators

The world development indicators from 1986 to 2020 and Sustainable Development Goals (SDG) reports were used as secondary sources for the current study

of Sadiq et al (2022) The Panel Autoregressive Distributed Lag (ARDL) was employed

in the current study to examine the relationship between the variables The findings showed that the SDGs of the ASEAN member states were favorably correlated with the environmental score, social score, governance score, and economic growth score The current article offers assistance to new researchers as they study attaining SDGs and offers guidance to decision-makers as they develop policies about achieving the SDGs through

ESG (Sadiq et al., 2022)

Chipalkatti, Le, and Rishi (2021) examine how ESG factors affect FDI and SDGs Sustainable investing distributes investments by ESG characteristics The UN SDGs are also influencing national environmental policy and sustainable development The reporters econometrically study ESG and FDI inflows in 161 counties, focusing on

struggle to secure SDG funding and promote sustainable economic growth The data suggest that good governance in a target country encourages FDI in all nations The article indicates that emerging markets with high HDI scores discourage FDI and that higher FDI flows increase carbon emissions Sustainability attracts FDI to commodity exporters (Chipalkatti, Le and Rishi, 2021)

Irandoust (2021) does an empirical analysis of the relationship between FDI and the financial development of the host nation The multidimensional FD index is a shift from past research on the function of FD in luring FDI Therefore, this study examines the causes of FDI and FD in eight postcommunist nations The direction of causality is determined using the bootstrap panel Granger causality technique The results demonstrate that, in six of the eight nations under examination, there is only a unidirectional causality connecting FD to FDI The findings' policy consequence is that nations seeking to increase their FDI should take steps to increase their access to foreign financing, which should be complemented by a financially sound and properly regulated system (Irandoust, 2021)

The goal of research by Ciobanu and colleagues in 2020 was to figure out how FDI affects GDP growth and show if the COVID-19 crisis can affect the growth prospects

of CEE countries even more than it does now The study reveals that foreign cash boosts

an economy, even though some worry it would undermine the local market Foreign companies help the host country develop by adopting new technologies and management ideas that use human capital, bringing foreign capital into the economy, growing banking activities to meet market financing needs, changing laws, and improving foreign trade A panel data regression model on Central and Eastern European nations showed that FDI

flows considerably affect GDP growth Due to the FDI decline, all CEE countries can anticipate their economies to shrink more (Ciobanu, R., Șova, R.-A., & Popa, 2020)

The goal of Ng et al (2020) study is to close a knowledge gap by investigating the relationship between financial development and ESG performance in Asia Country-level data for the years 2013 to 2017 were used in this analysis Financial development is positively correlated with ESG success, according to assessments based on the pooled ordinary least squares approach, the fixed effects regression model, the two-stage least squares method, and the system Generalised Method of Moments estimator The finding

is consistent and robust under various model parameters, according to additional experiments including the financial markets and financial institutions, which are subcomponents of the development of the financial sector When considered collectively, financial development plays a significant role in fostering ESG performance in Asia (Ng

et al., 2020)

The time lag between a cause and its effect in economics and finance is a frequently overlooked link that is examined in the research of Ausloos et al in 2019 The relationship between economic growth measured by a nation's GDP and FDI The relevant data spans 43 nations between 1970 and 2015, totaling 4278 observations The Inequality-Adjusted Human Development Index (IHDI) is used to categorize countries, and it is discovered that there is a temporal lag dependence impact on the correlations between FDI and GDP A time-dependent Pearson's product-moment correlation coefficient matrix

is used to prove this (Ausloos et al., 2019)

Auzairy et al (2018) investigate the relationship and impact of ESG factors - key

resources, human capital, population, infrastructure, trade openness, and corruption are some examples of the environmental, social, and governance elements These annual time series data were examined using Granger causality analyses and ordinary least squares regression The results demonstrate a substantial link between the majority of those key changes and FDI inflows Except for trade openness, which has a negative link with FDI, many of the factors are favorably associated with FDI Changes in infrastructure and natural resources, however, are not significantly related to FDI inflows The outcome indicates that a developing nation like Malaysia needs to keep improving its social, environmental, and governance systems to attract sustainable FDI and build a sustainable

economy (Auzairy et al., 2018)

This study by Abdouli and Hammami (2018) looks into the connection between FDI inflows, economic expansion, and environmental deterioration The findings utilizing the GMM method for the years 1990–2012 show that, for the global panel and the Middle East, except North Africa, there is evidence of a bidirectional causal relationship between economic growth and FDI inflows, between economic growth and CO2 emissions, and between FDI inflows and CO2 emissions There is a one-way causal relationship between FDI inflows and CO2 emissions According to the study, foreign and environmental policies both support economic growth when there is minimal pollution and substantial investment (Abdouli and Hammami, 2018)

Sirag, SidAhmed, and Ali (2018) examine how financial development and FDI affect Sudanese economic growth using annual data from 1970 to 2014 Time series data

is evaluated using unit root and cointegration tests with/without structural discontinuities since most macroeconomic variables are sensitive to the unit root problem The paper

also estimates the long-run model using fully modified and dynamic ordinary least squares Even after accounting for the structural break, cointegration tests show a long-term relationship between variables The data suggest that FDI and financial development explain Sudan's economic growth Financial development is better for economic growth than FDI Additional data suggest that FDI increases economic performance through financial development The study found that FDI boosts financial development's economic growth effect (Sirag, SidAhmed and Ali, 2018)

Generalized Least Squares (GLS) estimation and a substantially balanced panel data set from 10 ASEAN nations collected between 1997 and 2014 were both used in the article of Cuong, Thu and Trang (2018) This is done to determine what causes FDI to come into the region The estimated findings differ between the categories of participating countries The Real GDP Growth, Low Inflation, High Trade Openness Ratio, Improvement of Infrastructure, and Political Stability are the Deterministic Factors of FDI for the ASEAN 10 This is in line with the determinant of the FDI theoretical model Unexpectedly, the region's FDI flows have been negatively impacted by the region's labor productivity and exchange rate regime (Cuong, Thu and Trang, 2018)

Ridzuan, Ismail, and Hamat (2017) assess FDI inflows on Singapore's economic growth, income distribution, and environmental quality, the three pillars of sustainable development The analysis uses Autoregressive Distributed Lag estimation Sample data

is based on annual data from 1970 to 2013 The expected long-run elasticity demonstrated that FDI inflows boost economic growth, environmental quality, and income disparities

in this country, compromising its commitment to sustainable development Other

financial development Trade openness has increased economic growth and reduced environmental degradation This variable has little effect on Singapore's income distribution Financial development has been shown to boost economic growth and reduce income inequality CO2 emissions, however, reveal that this variable does not affect the environmental quality (Ridzuan, Ismail and Hamat, 2017)

2.3.3 Proposed research framework

Several quantitative ESG factors have an impact on FDI in developing nations, as determined by worldwide research and the current situation in several Asian countries The complete assessment approach was utilized to determine the association between ESG and FDI, and the panel regression method was employed to uncover the relationship between these components and FDI Make recommendations for governments, firms, and investors to pay attention to ESG factors, as well as for regulators to develop rules and regulations to attract appropriate FDI

In this study, the author tries to determine how ESG criteria are related to the FDI attraction of developing countries, and whether ESG indicators or macroeconomic factors have an impact different in attracting FDI or not The author uses a sample of 32 countries

in Asia The panel data comprises 19 high- and upper-middle-income Asian countries and

13 low- and lower-middle-income Asian countries as classified by the World Bank This

is a group of developing countries with great potential in attracting FDI

The study considers country-level data year by year to assess the impact of ESG

on attracting FDI inflows to Asian countries and is based on countries' strategic visions for the environment, society, and governance by the UN SDGs Furthermore, to demonstrate the perspectives of ESG, the author relies on past studies to refer to and pick