thesis investment efficiency

• Help & FAQ

Corporate investment efficiency, disclosure practices and governance : a systematic literature review and empirical evidence

• Noha Said Elberry

Student thesis : Doctoral Thesis

File : application/pdf, 5.02 MB

Type : Thesis

Thank you for visiting nature.com. You are using a browser version with limited support for CSS. To obtain the best experience, we recommend you use a more up to date browser (or turn off compatibility mode in Internet Explorer). In the meantime, to ensure continued support, we are displaying the site without styles and JavaScript.

• View all journals
• My Account Login
• Explore content
• About the journal
• Publish with us
• Sign up for alerts
• Open access
• Published: 18 September 2023

The power influence of executives and corporate investment efficiency: empirical evidence from Chinese state-owned enterprises

• Yewei Huang   ORCID: orcid.org/0009-0002-7661-145X 1 &
• Junqin Qiu 1  

Humanities and Social Sciences Communications volume  10 , Article number:  586 ( 2023 ) Cite this article

719 Accesses

1 Citations

1 Altmetric

Metrics details

• Business and management

Previous literature has explored investment efficiency in terms of executive incentives, supervisory mechanisms, information disclosure, agency conflicts, and managerial capabilities. This study focuses on analysing the power influence of executives in the context of Chinese State-Owned Enterprises (SOEs) from the two hypotheses of “economic man” and “social man”, aiming to improve the research between the power influence of executives and investment efficiency. This study adopts principal component analysis to comprehensively evaluate the power influence of executives in Chinese SOEs from four dimensions, namely, organisational position influence, personal competence influence, industry influence, and prestige influence. Using the analytical tool STATA15 to establish a regression model, the mechanism of executive power influence on investment efficiency is explored from the logic of “financing constraints” and “diversification”. It then explores the moderating effects of equity concentration and independent director oversight. The empirical results show that the greater the power influence of the executive, the lower the investment efficiency. The intermediary mechanisms of this study find that executives of Chinese SOEs can use their power influence to reduce financing constraints, obtain more resources, and make diversified investments, thus generating inefficient investments. This study also finds that equity concentration and oversight by independent directors have a positive moderating effect on executive power and investment efficiency. The results of this study are robust due to the use of the instrumental variables approach. The innovation of this study integrates the measurement of executive power influence in the particular context of SOEs and analyzes its impact on investment efficiency. It enriches the study of factors influencing executive power and corporate investment efficiency.

Similar content being viewed by others

The nexus of top executives’ attributes, firm strategies, and outcomes: Large firms versus SMEs

Jun Xie, Wataru Nozawa & Shunsuke Managi

Achieving stability and prosperity: The Chinese way

Quan Cheng & Alex Ng

CEOs’ early famine experience, managerial discretion and corporate social responsibility

Zhaocheng Xu

Introduction

In the Fortune 500 list for 2022, there are ninety-nine Chinese SOEs, of which four are ranked in the top ten. Only eighty Chinese SOEs in the Fortune 500 list by 2020. Showing an increasing trend year on year. Chinese SOEs are important carriers of Chinese state-owned assets and important pillars of Chinese economic development, contributing indispensable strength to Chinese transformation from a state subject to a social subject. In 2022, at the 20th National Congress of the Communist Party of China, General Secretary Xi Jinping emphasised “deepening the reform of state-owned capital and SOEs, accelerating the optimisation of the layout and restructuring, promoting state-owned capital and SOEs to become stronger, better and larger, and enhancing the core competitiveness of enterprises.” Improving the efficiency of capital investment in SOEs is at the heart of deepening the reform of SOEs. However, because of diversified target systems, soft budget constraints, managerial appointment mechanisms, and rigid pay controls, SOEs have experienced an “efficiency paradox” of increasing operational efficiency but decreasing profitability (Lu and Peng 2015 ).

The role of executives in business largely depends on their performance of power (Na et al. 2022 ). Executive power determines the ability of enterprises to obtain and allocate resources. It is well known that executive power comes not only from within the enterprise, but also from its voice in the industry, personal prestige and the ability to obtain preferential policies and resource elements from the government (Zhai et al. 2023 ). Executive power is comprehensive. SOE executives in China have the status of quasi-government officials, and SOE leaders and government departments can often be interchanged. As decision-makers and senior managers of SOEs, executives decide the direction of development and investment decisions, directly impacting their investment efficiency. Existing research findings are not sufficient to reflect the power of SOE executives in the Chinese institutional context. Therefore, understanding the internal rules of the executive power’s influence on SOEs and studying their impact on corporate performance in this paper is very valuable at both theoretical and practical circles.

In modern corporate context, the relationship between executive power and investment efficiency has been studied from these two perspectives, namely, the principal-agent problem and personal characteristics of executives.

The first is the relationship between executive power and investment efficiency, based on the principal-agent problem. Executive power may increase corporate efficiency (Guo et al. 2020 ) or may generate non-efficient investment behaviour due to personal promotion, opportunism, etc. Lu et al. ( 2016 ) found that political promotion incentives can cause SOE executives to cater to the performance needs of local governments and implement over-investment at the expense of long-term corporate interests. Xie et al. ( 2023 ) found that due to strict performance requirements, less regulation, and less negative information interference, SOE management subject to equity incentives will increase corporate tax avoidance and improve performance. Dong and Li ( 2014 ) argues that, for personal reputation reasons, executives may tend to increase investments that enhance the short-term performance of the firm and reduce long-term investment projects that are risky and slow to yield results, leading to under-investment. For managerial defence purposes, Sia and Chen et al. ( 2011 ) argue that executives may choose projects that are good at maintaining a strong position for themselves irrespective of poor business performance, leading to under-investment.

The second is the relationship between executive power and investment efficiency, based on the personal characteristics of executives. Zhang and Jiang ( 2015 ) found that the stronger the personal ability of executives, the more they can alleviate the act of blindly following the investment decisions of other companies in the industry, reduce under-investment and over-investment, and improve capital allocation efficiency. Ullah et al. ( 2021 ) analysis from a gender perspective revealed that FCEO is more focused on curbing over-investment when making investment decisions and plays no role in improving the investment efficiency of SOEs. Studies of SOE executives found that they are civil servants dispatched by the state and government and have higher decision-making power, which can easily breed corruption and affect corporate performance. Executives of SOEs in China are civil servants dispatched by the state and government and have higher decision-making power, which can easily breed corruption and affect the performance of enterprises (Zhang et al. 2021 ; Zhang and Song 2021 ). Some scholars oppose the view that the participation of party organisations in corporate governance is an important feature of corporate governance of SOEs, and that party political governance has a restraining effect on management power and reduces the possibility of over-investment in enterprises.(Shu and Huang 2021 ; Yin et al. 2020 ).

A literature review of executive power and its relationship with investment efficiency reveals that most studies analyse the impact of executive abuse of power on corporate decision-making and firm value from the perspective of self-interest, such as executive private gains, professional reputation, and risk avoidance. However, some studies also analyse the impact of executive power on investment efficiency from the perspective of corporate free cash flow. The existing literature defines a single dimension of executive power, considering only purely executive power, without considering it in terms of the ability to deploy external resources, and without taking into account the special situation of the quasi-official status of executives of Chinese SOEs. Meanwhile, existing research mainly focused on SOE executive power itself, and the indicators measured are usually positions held, executive tenure, board independence, shareholding structure, and capital structure.

For our research, this is a central motivation, as we believe that the influence of executive power not only takes into account the administrative authority itself, but also considers the influence of executive power. The research questions addressed in the present study are as follows: (1) What is the power influence of executives in SOEs? (2)How does the power influence of executives in SOEs affect their investment efficiency? (3) Will the role of the power influence of the executive be affected by other factors?

To achieve this goal, we take the Shanghai and Shenzhen A share-listed companies as samples from 2010 to 2018. To the best of our knowledge, this study is the first attempt to explore the association between the power influence of SOE executives and corporate investment efficiency from the perspective that SOE executives have the status of quasi-officials in the context of the Chinese system. We measure the power influence of SOE executives in four aspects: organisational position influence, personal ability influence, industry influence, and prestige influence. The power influence of executives discussed in this study can more accurately reflect the ability of executives to allocate resources in investment. In addition, it more truly reflects the impact of executives on investment efficiency, and is more in line with China’s institutional background. This study also adds scientific value by revealing the impact and mechanism of executives’ power influence on investment efficiency from the perspective of SOEs. Numerous studies have been conducted to understand investment efficiency in terms of executive incentives, monitoring mechanisms, information disclosure, agency conflicts, and managerial competence. This study contributes to that body of knowledge.

The core findings of this paper are the following. First, the power influence of SOE executives can inhibit investment efficiency. Second, SOE executives can use their power to obtain more financing resources. Third, executives tend to diversify their investment operations when there are too many resources, resulting in inefficient investment. Fourth, the equity concentration of SOEs and the supervision of independent directors have a positive moderating effect on the positive relationship between the power influence of SOE executives and investment efficiency.

The remainder of this paper is organised as follows: Section 2 discusses the theory and hypotheses in the purview of extant literature; Section 3 presents the data and methodology; Section 4 illuminates the empirical results; and Section 5 concludes the findings of the research study.

Theoretical analysis and hypothesis development

Theoretical analysis: power influence of executive and investment efficiency.

Based on the special holding structure of SOEs in China, the positions of SOE executives are usually tinged with administrative appointments, with some central enterprises’ chairmen, party committee (party group) secretaries, and general managers appointed by the Central Organisation Department of the Communist Party of China (CPC) and local organisation departments, similar to appointment and removal procedures for general cadres. Administrative interference by the government in corporate executives has led to a high level of non-market-based behaviour in SOEs, such as direct appointments, dismissals, and pay incentives. Therefore, combined with the special nature of property rights of SOEs, the special nature of SOEs as subjects of state-owned capital rights and the administrative overtones of management positions, SOEs take into account social benefits in addition to the pursuit of economic interests, and SOE executives are both “economic man” and “social man”.

Based on the assumption of “economic man”, the separation of ownership and management of an enterprise will give rise to a principal-agent problem. As an agent, the utility function of executives is not consistent with that of the principal, and there is a principal-agent conflict. Therefore, it is inevitable that executives of SOEs, who hold specific control and residual control of the enterprise, will take advantage of information asymmetry to seek control and private gains in business decisions. Because of principal-agent conflict and information asymmetry, SOE executives seek to maximise their personal interests, which manifests itself as inefficient investment at the expense of shareholders’ interests by extracting private profits.

Based on the assumption of “social man”, SOE executives are motivated by the desire to achieve personal fulfilment due to their special status as quasi-officials. They do so by dealing with uncertainty, assuming responsibility, establishing authority, or gaining promotion in executive rank. When the government examines candidates, performance is easily quantifiable and is the main basis for cadre promotion and selection. Corporate performance is positively related to SOE executives’ political promotion. SOE executives are not utilitarians in economics; their pursuit of social and personal motives, such as their dignity and self-worth realisation, makes them dedicated and enhances their collectivist tendencies. Driven by the motivation of collective interests, SOE executives will maximise organisational interests, tend to serve altruistically in their business decisions, exhibiting the stewardship behaviour of investing in efficiency to maximise organisational interests (Yi et al. 2022 ), which can simultaneously achieve personal benefits and satisfy a sense of personal achievement.

Based on agency theory, stewardship theory, and the quasi-official status characteristics of SOE executives, this study proposes competing hypotheses H1.

H1a: Other things being equal, the power influence of SOE executives is positively related to the efficiency of corporate investment, i.e. the greater the power influence of SOE executives, the greater the incentive for firms to choose efficient investment.

H1b: Other things being equal, the power influence of SOE executives is negatively related to the efficiency of firms’ investment, i.e. the greater the power influence of SOE executives, the greater the incentive for firms to make inefficient investments for personal gain.

Intermediary mechanism: financing constraints and investment diversification

The first intermediary mechanism is the financing constraints. SOEs tend to enjoy preferential interest rates and lower financing costs. The China Private Enterprise Finance Environment Report (2020) shows that private companies accounted for only 12% of SOEs in the 2018 average financing size data. From the perspective of securing external resources, SOE executives have a quasi-official status. The higher the level of SOEs executives, the more power influence they have, and the more beneficial it is for companies to seek more government grants, bank loans, and so on. In the current situation where banks in China are suspicious of small-scale enterprises and love the big-scale ones. The government is keen to create leading enterprises. The more powerful and influential the SOE executives in and out of the industry, the easier it is for companies to obtain preferential bank loans and government grants. Therefore, the more powerful and influential the executives of SOEs, the more government subsidies they can obtain, and face fewer financing constraints.

The second intermediary mechanism is diversification of investments. SOEs tend to enjoy more preferential interest rates and lower financing costs. According to Wind database and Evergrande Research Institute, the total financing scale of listed SOEs, private enterprises and public enterprises in China is 14.7 trillion, 8 trillion and 1.4 trillion respectively, with SOEs occupying the dominant position. The financing advantages created by the power influence of SOE executives and the SOE soft budget constraints provide conditions for SOE executives to diversify investments. SOE executives may be inclined to implement diversification strategies (Wu et al. 2008 ). Usually, SOEs, especially large SOE groups, are tasked with the important mission of “getting bigger and stronger” and improving international competitiveness. Thus, given the small financing constraints and soft budget constraints, SOE executives have the urge to diversify their investments to grow their enterprises. On the one hand, diversification can reduce investment risks and improve investment efficiency; however, on the other hand, diversification may be a speculation that deviates from the main business and is a means to expand the scale of operations, build a “corporate empire” and seek more personal gains. Excessive diversification can lead to a large organisational size and inefficient information transfer, resulting in inefficient investments that can undermine corporate value or performance (Yao et al. 2004 ). Therefore, in the case of SOEs with small financing constraints and soft budget constraints, the greater the power influence of SOE executives, the more funds can be mobilised and allocated for diversification, and the more serious the inefficient investment.

Based on the above analysis, hypothesis H2 is proposed.

H2a: Other things being equal, the greater the power influence of SOE executives, the smaller the financing constraints.

H2b: Other things being equal, fewer financing constraints incentivizes SOE executives’ to diversify stronger, generating more inefficient investment.

Regulating mechanisms: equity concentration and independent director oversight

High levels of equity concentration are common in both SOEs and non-SOEs. A relatively concentrated shareholding structure provides a check on senior management’s power. As equity concentration increases, the less likely it is that major shareholders will want to get out and sell their stakes, and they will monitor the operators more vigorously and rationally for their own benefit and the enterprise’s benefit, thereby improving investment efficiency (Wang et al. 2021 ). State-owned Assets Supervision and Administration Commissions (SASACs) act at all levels as the de facto controllers of SOEs. The higher the concentration of equity in SASACs, the greater the power influence of executives, the stronger the influence of executives on corporate investment, and the more likely they are to make inefficient investments. Based on this, hypothesis H3 is proposed.

H3: The concentration of equity in effective control of SOEs has a moderating effect on the relationship between executive power influence and investment efficiency in SOEs.

Effective corporate governance mechanisms can constrain the motivation and behaviour of SOE executives in pursuit of personal interests (Zhang 2015 ; Zheng et al. 2019 ). Among the governance structures of SOEs in China, the most characteristic is the governance of party organisations. As the subject of this study is SOEs, all samples have party governance, which is undifferentiated. The number of independent directors and their share of the board of directors are differentiated. Thus, this study focuses on whether the monitoring role of independent directors affects the relationship between the executives’ power influence and investment efficiency of SOEs. Based on this, hypothesis H4 is proposed.

H4: The monitoring role of independent directors moderates the relationship between executives’ power influence and investment efficiency in SOEs.

Data, measurement, and research methodology

Sample selection.

This study uses state-owned listed companies whose actual controllers in Shanghai and Shenzhen A-shares are SASACs at all levels. The research sample is from 2010 to 2018. The reason for the sample selection from 2010 is that the Law of the People’s Republic of China on Enterprise State-owned Assets was officially implemented on 1 May 2009. The law clarified the subject position of the SASACs system among the institutions performing capitalist duties. It regulated the legal relationship between the institutions performing the duties of capital contributors and state-funded enterprises. According to the Letter of the National Bureau of Statistics on the Opinions on the Identification of State-owned Corporate Enterprises, this study distinguishes between state-owned listed companies and non-state-owned listed companies according to the nature of the actual controller. The state-owned listed companies analysed in this study are purely SOEs and state-controlled enterprises. As of 31 December 2018 there were 833 state-owned listed companies in Shanghai and Shenzhen A-shares, and to exclude the effect of outliers, the sample was processed as follows: ① excluding ST, *ST, and PT type enterprises among SOEs; ② deleting data of enterprises in the financial sector due to its own special characteristics which are significantly different from other industries; ③ excluding the data of enterprises in the financial sector during the study period where the auditor issued a rejection or negative opinions; ④ in the matching process, there were certain missing values in the databases of listed companies, so the missing values were deleted. Taking into account the impact that extreme values may have on the results of the study, this study applies a top and bottom 1% winsorizing to the main continuous variables, and 3654 company annual data of 451 state-owned listed companies were obtained. The financial data and executive information of the listed companies were obtained from the CSMAR and Wind databases, and company executives’ information was supplemented and checked through company annual reports and relevant online information.

Variable measures

Explanatory variable: power influence of soes executive.

In the Chinese context, the power influence of SOE executive includes not only their ability to control the company internally but also their influence on the outside, such as influencing the industry, society, and government. Based on the special characteristics of SOEs and the synthesis of the existing literature, this study constructs indicators of the power influence of SOEs executive from four dimensions, as shown in Table 1 .

First, the power influence of organisational position. (1) Administrative level: The power to appoint SOEs executives is largely controlled by the government. Because the roles of government officials and SOEs managers are often interchangeable in both directions, some government officials can be reappointed or promoted to SOEs executive, and SOEs executives can be promoted or reappointed to government officials(Prakash 2003 ). As a result, administrative levels still exist in SOEs. (2) Holding multiple positions: In the case of chief executive officer (CEO) duality, SOEs executives have a stronger ability to deploy resources within the enterprise, resulting in a greater influence of power. (3) Length of tenure: Tenure length is a measure of executive power in terms of time. The longer the tenure, the higher the prestige accumulated and the greater the influence of the executive’s personal power (Cash 2018 ; Kragt and Day 2020 ).

The second is the influence of power on personal competence. (1) Technical title: According to the existing literature, the higher the technical title of an executive, the more prominent the expertise and influence of the executive (Liu and Peng 2018 ). (2) Political capital: Executives with political capital can obtain policy, institutional support, and tilt by virtue of their good relationships with the government. Executive politics can lobby the government to develop and implement policies and institutions conducive to business operations, such as interest-free loans and land tenure, through their good relations with the government. Thus, political connections provide firms with more institutional and resource support and freedom to make decisions. At this point, executives with political resources have increased their power and influence. (3) Internal promotion: Due to years of accumulation, internally promoted executives have formed a mature network of power relations within the enterprise. Compared to executives parachuted into the company from outside, internally promoted executives have obvious advantages in terms of knowledge, information, experience, and internal contacts, which can enhance their power influence.

The third factor is industry influence. (1) Industry title: Executive influence represents a firm’s recognition in the industry and that society’s understanding of a firm’s business begins primarily with the perception of the executive (Graham et al. 2015 ). Executives who are leaders of industry associations have higher prestige and greater voice in the industry, are better able to coordinate the relationship between the company and other companies in the industry, coordinate disputes within the industry, and secure favourable policies from the government for the development of the industry. (2) Social influence: Weng and Chen ( 2016 ) found that both corporate reputation and executive reputation are beneficial to a company’s financial performance, and that the impact of executive reputation is more lasting and comprehensive. Wang et al. ( 2016 ) concluded that receiving honorary awards from professional bodies (e.g., Labour Medal, Outstanding Entrepreneur) would increase executive reputation, which has a positive effect on firm performance. Thus, the stronger the social influence of executives, the greater their power influence.

The fourth factor is the influence of prestige. The ability of executives to gain the support of their subordinates and staff internally depends not only on the power of their organisational position but also on their personal reputation. The higher the reputation of an individual, the more convincing he or she can be, and therefore, the higher the power influence(Jia et al. 2022 ). From an “economic human” rational point of view, the more a company’s employees earn than other companies in the same industry, the more the employees have a sense of belonging and pride in the company, and they will embrace corporate executives more often. On the contrary, the lower the income of employees in the same industry, the more frustrated the employees will be, and the more dissatisfied they will be with the management of the company. Therefore, this study selects the degree of employee support to measure the influence of executive prestige.

This study uses principal component analysis to comprehensively evaluate the power influence of SOEs executives. The weights of the four level indicators and nine secondary indicators, as shown in Table 1 , in the prediction function of the power influence of SOEs executives are determined based on the contribution of each principal component. The power influence of SOEs executives can be calculated based on the weights of each indicator and the data collected for measurement. The contributions of each level and the secondary indicators are shown in Table 2 .

That is, the measure of power influence of SOEs executives( Score ) is expressed as:

Based on the weights of each indicator in Tables 1 and 2 and using Eq. ( 1 ), this study measured the power influence of 451 state-owned listed companies in Shanghai and Shenzhen A-shares from 2010 to 2018. Owing to space constraints, Table 3 lists only some of the measurements for 2018.

Explained variable: investment efficiency

With reference to Chen et al. ( 2011 ) and Chen and Huang ( 2019 ), we construct an expectation investment regression model to measure investment efficiency in terms of the difference between the actual investment expenditure value and the expected value obtained from the regression equation, and express the level of investment efficiency in terms of the regression residuals, as follows:

where the explained variables Invest is investment efficiency, Growth is firm growth, and NEG is a dummy variable that introduces an interaction term between NEG and sales revenue growth. The variables are listed in Table 4 . The regression of Eq. ( 2 ) is estimated by year and industry, and the absolute value of the residuals is obtained and used to measure investment efficiency. Larger absolute values of the residuals indicate lower investment efficiency, whereas smaller absolute values of the residuals indicate higher investment efficiency.

Intermediate variables: diversified investments and financing constraints

The degree of diversification ( Dhy ) is measured by referring to Park and Kim ( 2016 ), and the Herfindel Index (HHI) for each firm’s business is chosen (Table 5 ). Specifically, this is the dispersion of firm size in the market, with a larger value indicating less diversification.

There are many ways to measure financing constraints ( Fc ), but most rely on financial indicators that are endogenous rather than directly related to financing constraints, potentially making the study’s findings biased. To avoid this shortcoming, this study refers to the method of Lu and Chen ( 2017 ), which use the absolute value of the SA index and take the logarithm to measure it. The larger the value, the greater the degree of financing constraint.

Moderating variables: equity concentration and independent director oversight

Referring to the study by Ling ( 2014 ), the sum of shareholdings of the second-largest shareholder to the tenth-largest shareholder of a company is used to measure equity concentration. The larger the indicator, the stronger the inhibitory effect of large shareholders on the influence of executive power. Independent director oversight ( Sid ) is measured as the ratio of the number of independent directors to the total number of board members.

Control variables

To control for the effects of other factors on investment efficiency, we select the gearing ratio ( Lev ), return on total assets ( ROA ), and cash holding level ( Cash ). This study controls for industry fixed effects ( Industry ) and time fixed effects ( Year ) because there may be unobservable factors that vary over time, such as policy changes.

The specific variables are defined as shown in Table 5 below.

Estimating model

Based on the theoretical analysis above, to test hypothesis H1, drawing on the study of Liu et al. ( 2018 ), and to avoid the time-varying nature of firm investment efficiency and firm heterogeneity, this study uses a control year and industry dual fixed effects model for empirical analysis and constructs the following mode.

where k is the number of control variables, ε denotes the random disturbance term, i denotes the firm, and t denotes the time.

Descriptive statistics

Table 6 presents the results of the descriptive statistics for the main variables. The mean Score was −0.008, the maximum value was 3.838, the minimum value was −0.742, and the standard deviation was 0.47, indicating that power influence varies significantly between SOE executives. Financing constraint ( Fc ) has a maximum value of 1.497 and a minimum value of 0.940, indicating that the degree of constraint in accessing financing varies widely across SOEs. The degree of diversification ( Dyh ) has a minimum value of 0.159, indicating a high degree of operational diversification, and a maximum value of 1.724 with a standard deviation of 0.469, which indicates a large variation in the way different SOEs operate and manage their businesses.

Empirical regression results

To test H1, the greater the power influence of SOEs executives, the lower/higher the investment efficiency, regressions were conducted using model (1), and the results are shown in Table 7 .

Analysis of intermediary mechanisms

A previous study shows that the greater the power influence of SOE executives, the lower the efficiency of corporate investment. To further analyse the mechanism of the power influence of SOE executives on enterprise investment efficiency and to test hypothesis H2a, models (4) and (5) are constructed based on model (3).

where Fc denotes the intensity of the firm’s financing constraint.

Columns (1) and (2) of Table 8 show the empirical results of the influence mechanism of financing constraints. The power influence of SOE executives ( Score ) is significantly and negatively related to the firm’s financing constraint ( Fc ) at the 1% level, indicating that SOE executives’ power influence reduces the firm’s financing constraint. The regression results in column (2) of Table 8 show that the coefficients of the regressions of financing constraints ( Fc ) and firms’ investment efficiency (Invest) are both significantly negative at the 10% level, indicating that the greater the power influence of SOE executives, the lower the financing constraints, and the more resources SOE executives can allocate using their power influence, which reduces firms’ investment efficiency. The H2a hypothesis in this study that the intermediary mechanism of financing constraints holds.

To further test the mediating mechanism of diversification in hypothesis H2b, i.e. SOE executives use their power and influence to diversify their investments, thus reducing the efficiency of corporate investments we construct models (6) and (7) based on model (3).

where Dyh denotes the degree of diversified investments.

The regression results in Column (3) of Table 8 indicate that the power influence of SOE executives ( Score ) is significant and positively related to the degree of diversification ( Dyh ), suggesting that the greater the power influence of SOE executives, the greater their investment in diversification ( Dyh ). Column (4) of Table 8 shows that the degree of diversification ( Dyh ) is significant and negatively related to the efficiency of the firm’s investment ( Invest ), indicating that the higher the degree of diversification, the less efficient is the firm’s investment. Therefore, the greater the power influence of SOE executives, the more inclined they are to adopt diversification, which reduces the investment efficiency of the firm. Thus, the hypothesis H2b regarding the intermediary mechanism of the degree of diversification holds true.

Analysis of regulating mechanisms

To further analyse the moderating effect of SOE equity concentration on the relationship between the power influence of SOE executives and investment efficiency, i.e. to test hypothesis H3, this study incorporates SOE equity concentration (Shr) and its interaction term with executive power influence (Score×Shr) on the basis of model (3). The regression results are presented in Column (1) of Table 9 , which show that the regression coefficient of the interaction term between SOE equity concentration and power influence (Score×Shr) is significantly positive. This indicates that SOE equity concentration mitigates the positive relationship between the influence of SOE executives’ power and corporate investment efficiency. Thus, hypothesis H3 holds true.

In order to test hypothesis H4, this paper adds independent directors’ supervision (Sid) and its interaction term with executive power influence (Score×Sid) to model (3) to verify the moderating effect of independent directors’ supervision on the relationship between executive power influence and corporate investment efficiency. The regression results are shown in Column (2) of Table 9 . The regression coefficient of the interaction term between independent directors’ supervision and the power influence of SOE executives (Score×Sid) is significantly positive, indicating that the higher the degree of independent directors’ supervision, the greater the influence of executive power on corporate investment efficiency in SOEs. This suggests that the relationship between independent director supervision and the power influence of SOEs executives and corporate investment efficiency has a positive moderating effect. Hypothesis H4 of this study holds true.

Robustness tests

To ensure the reliability of the results of this study, the following robustness tests were conducted:

First, we replaced the measure of enterprises’ investment efficiency. In the previous empirical analysis, this study used the difference between the actual investment expenditure value and the expected value obtained from the regression equation to portray investment efficiency. To further reflect the robustness of this result, this study uses a regression model of corporate investment on growth opportunities to estimate firms’ investment efficiency by referring to Dai and Kong ( 2017 ). The regression results show that executive power influence in SOEs is significantly and positively related to overinvestment, i.e. the greater the executive power influence, the higher the likelihood that firms will produce inefficient outcomes of overinvestment, and the previous results do not change substantially.

The second is the lagged period treatment of the key variables. This study uses a regression analysis of the current period’s executive power influence of SOEs on the investment efficiency of the next period, which is now rerun using the current period’s investment efficiency.

Third, we consider endogeneity treatment. The findings of this study suffer from some endogeneity problems because there is likely to be reverse causality in the impact of executive power influence on the investment efficiency of SOEs, i.e. SOEs with higher investment efficiency may themselves have higher executive power influence. Although this study takes the approach of using the dependent variable (firm investment efficiency) one period ahead to overcome the endogeneity problem, it may still not be able to fully overcome this problem. Given that there is no good instrumental variable to replace the power influence of SOE executives in the existing literature, in order to mitigate the endogeneity problem, this study adopts a two-stage least squares (2SLS) approach to parameter estimation of the instrumental variables, using the explanatory variables of the previous period and the mean values of the variables of other firms in the same industry and year as the instrumental variables, showing that Corollary 1’s findings remain unchanged.

The results of the above robustness tests indicate that the main findings of the previous study have not changed; therefore, the previous findings are reliable (results omitted and retained for information).

Conclusions and perspectives

Conclusion and policy implications.

This study theoretically analyses the relationship between the power influence of SOE executives on corporate investment efficiency and constructs an indicator system to measure the power influence of SOE executives. To measure the power influence of SOE executives, we use a sample of state-owned listed companies in Shanghai and Shenzhen A-shares from 2010 to 2018 to empirically analyse the double fixed-effect model of the relationship between the power influence of SOE executives and investment efficiency. As a starting technique, STATA15 was used to test pooled ordinary least squares (OLS) regression on a sample of Chinese listed companies, and the panel data set was obtained from the Wind Information database and the China Stock Market and Accounting Research (CSMAR) database. Data on executive positions and awards were manually compiled. This study found that the power influence of SOE executives had a dampening effect on investment efficiency. Further analysis of the mechanism of influence found that SOE executives can use their power and influence to alleviate financing constraints and diversify their investments, thereby generating inefficient investments. Moderating effect analysis found that the concentration of equity in SOEs and the supervision of independent directors can mitigate the positive relationship between the power influence of SOE executives and efficient investment.

The relationship and impact of SOE executive both personal and social influence on performance of company is well explained as well analysed with empirical data. Based on this study’s findings, we propose the following policy recommendations.

First, we should continue to deepen the market-oriented reform of SOEs and improve the supervision and discipline mechanisms for senior executives of state-owned enterprises. The reform of SOEs is the focus and central part of the current reform of China’s economic system, and its important goal is to solve the problems of inefficient management and weak market competitiveness by resolving the problem of inactive internal mechanisms. In addition to streamlining the organisational structure, decentralisation, and empowerment of SOEs, it is necessary to strengthen the supervision system of SOE executives and establish a sound mechanism for linking the work of the expatriate supervisory board with the internal supervision force of the enterprises.

Second, the administrative level of SOEs should be completely abolished, and the influence of SOE executives’ power should be weakened from an organisational point of view. Until now, many provinces, municipalities directly under the Central Government, and autonomous regions have abolished the administrative level of SOEs, but out of inertia, the influence of executive officers and administrative level of state-owned enterprises is still very strong. For this reason, a market-oriented system of “market-based selection and recruitment” of senior executives of SOEs should be implemented. The general manager and other executives along with the chairman of the board of directors should be selected and hired through the internal market of all SOEs belonging to the same level as SASACs.

Third, we should strengthen the focus of SOEs on their main businesses and prevent blind diversification that may lead to inefficient investments. Promote the divestment of SOEs from non-main businesses and non-advantageous businesses, and prevent inefficient investments resulting from blind greed for more comprehensive and haphazard spreads.

Limitations and future research

This study has some limitations and provides additional opportunities for future research.

First, owing to data limitations, our research results may be limited to state-owned listed companies. The degree of marketisation of SOEs differs somewhat from that of non-SOEs, the selection of executives is influenced by the government management system, and their overall competence is subject to scrutiny by government departments, which may limit the generalisability of our findings. Future research could focus on the performance of SOE executives after market transformation, and on a broader group of executives.

Second, this study is confined to the Chen model to assess the investment efficiency of a firm. To find the connection between the investment results and the power influence of SOE executives, the upcoming enquiry should add better investment performance metrics.

Finally, this study examines the intermediary mechanism of diversification and financing constraints. However, we believe that there may be other ways to influence the relationship between SOE executives power influence and investment efficiency, which need to be explored in the future.

Data availability

The raw data supporting the conclusions of this article will be made available by the authors, without undue reservation, to any qualified researcher.

Cash JT (2018) George mason and the ambiguity of executive power. Pres Stud Q 48:741–767. https://doi.org/10.1111/psq.12483

Article   ADS   Google Scholar  

Chen F, Hope OK, Li Q, Wang X (2011) Financial reporting quality and investment efficiency of private firms in emerging markets. Account Rev 86:1255–1288. https://doi.org/10.2308/accr-10040

Article   Google Scholar  

Chen YS, Huang JQ (2019) Stock market liberalization and corporate investment efficiency: evidence from Shanghai-Hong Kong stock connect. J Finan Res 8:151–170. https://doi.org/10.13587/j.cnki.jieem.2020.02.008

Dai YH, Kong DM (2017) Can executives with overseas experience improve corporate investment efficiency? J World Econ 1:168–192. https://doi.org/10.19985/j.cnki.cassjwe.2017.01.009

Dong HY, Li XR (2014) The executive power of state-owned enterprise and overinvestment. Econ Manage J 10:75–87. https://doi.org/10.19616/j.cnki.bmj.2014.10.010

Graham KA, Ziegert JC, Capitano J (2015) The effect of leadership style, framing, and promotion regulatory focus on unethical pro-organizational behavior. J Bus Ethics 126:423–436. https://doi.org/10.1007/s10551-013-1952-3

Guo H, Li WL, Gao WW (2020) Political governance, managerial power and over-investment of state-owned enterprises. J Ind Eng 2:71–83. https://doi.org/10.13587/j.cnki.jieem.2020.02.008

Jia XP, Liao SD, Van der Heijden B, Li WQ (2022) Power and responsibility: How different sources of CEO power affect firms’ corporate social responsibility practices. Journal of the Florida Medical Association. Bus Ethics Environ Responsib 31:682–701. https://doi.org/10.1111/beer.12438

Kragt D, Day DV (2020) Predicting leadership competency development and promotion among high-potential executives: the role of leader identity. Front Psychol 11:1816. https://doi.org/10.3389/fpsyg.2020.01816

Article   PubMed   PubMed Central   Google Scholar  

Ling ZH (2014) Empirical study on equity concentration, balance and operating performance. Commun Finan Account 24:44–46. https://doi.org/10.16144/j.cnki.issn1002-8072.2014.24.046

Liu GJ, Peng SB (2018) CEO power intensity, equity incentive plan and CEO explicit corruption. Collect Essays Finan Econ 6:87–95. https://doi.org/10.13762/j.cnki.cjlc.2018.06.008

Lu J, Peng X (2015) Multidimensional evaluation of Chinese SOEs’ efficiency. Res Econ Manage 6:27–36. https://doi.org/10.13502/j.cnki.issn1000-7636.2015.06.005

Lu SF, Chen SX (2017) Does governmental favoritism reduce financing constraintsof firms:a quasi-natural experiment from China. Manage World 5:51–65. https://doi.org/10.19744/j.cnki.11-1235/f.2017.05.006

Lu X, He YQ, Wu T (2016) Is SOE executives’ political promotion incentive a long-term solution? Econ Manage J 7:94–106. https://doi.org/10.19616/j.cnki.bmj.2016.07.009

Na C, Tian G, Rauf F, Naveed K (2022) Do financial performance and firm’s value affect the quality of corporate social responsibility disclosure: moderating role of chief executive officer’s power in China. Front Psychol 13: https://doi.org/10.3389/fpsyg.2022.925323

Park S, Kim S (2016) Can nonprofit enterprises lead to better revenue conditions in local government. Am Rev Publ Adm 46:700–712. https://doi.org/10.1177/0275074015573832

Prakash S (2003) The essential meaning of executive power. U Illinois Law Rev 2:701–820. https://doi.org/10.2139/SSRN.223757

Shu JP, Huang L (2021) The problem of executive compensation of state-owned enterprises and its governance under the perspective of power allocation. Manage Eng 26:13–19. https://doi.org/10.19327/j.cnki.zuaxb.1007-1199.2021.01.002

Ullah I, Majeed MA, Fang HX (2021) Female CEOs and corporate investment efficiency: evidence from China. Borsa Istanbul Rev. 21:161–174. https://doi.org/10.1016/j.bir.2020.09.010

Wang JY, Wang H, Wang D (2021) Equity concentration and investment efficiency of energy companies in China: evidence based on the shock of deregulation of QFIIs. Energy Econ 93:80–88. https://doi.org/10.1016/j.eneco.2020.105032

Wang S, Xu N, Jiang NN (2016) Intensity, effectiveness and mechanism of executive reputation incentive contract: an empirical study in the Chinese context. Theory Pract Finan Econ 3:69–76. https://doi.org/10.16339/j.cnki.hdxbcjb.2016.03.011

Weng PS, Cchen WY (2016) Doing good or choosing well? Corporate reputation, CEO reputation, and corporate financial performance. North Am J Econ Finan 39:223–240. https://doi.org/10.1016/j.najef.2016.10.008

Wu JF, He DJ, Lin W, Wang Y (2008) Political network of top managers and corporate diversification strategy: from the perspective of social capital: an empirical analysis based on panel data of listed companies in China. Manage World 8:107–118. https://doi.org/10.19744/j.cnki.11-1235/f.2008.08.012

Xie WW, Khurram MU, Qing L, Rafiq A (2023) Management equity incentives and corporate tax avoidance: moderating role of the internal control. Front. Psychol 1:14. https://doi.org/10.3389/fpsyg.2023.1096674

Yao J, Lv Y, Lan HL (2004) An empirical study on the relationship between diversification and economic performance of listed companies in China. Manage World 11:119–125+135. https://doi.org/10.19744/j.cnki.11-1235/f.2004.11.016

Yi LQ, Li T, Zhang XY, Huang QY, Ma YZ, Wang P (2022) Power and corporate green governance from the perspective of input-output efficiency. Emerging Mark Finan Trade 59:836–847. https://doi.org/10.1080/1540496X.2022.2108318

Yin LQ, Li T, Zhang T, Li A (2020) Executive power, internal control and social responsibility in state-owned enterprises. Soft Sci 34::25–29. https://doi.org/10.13956/j.ss.1001-8409.2020.08.05

Zhai D, Zhao X, Bai Y, Wu D (2023) A study of the impact of executive power and employee stock ownership plans on corporate cost stickiness: evidence from China a-share non-financial listed companies. Systems 11:238. https://doi.org/10.3390/systems11050238

Zhang DL, Jiang XF (2015) Managerial ability and the herd behavior of corporate investment:considering the moderating effect of compensation fairness. Account Res 8:41–48+96. https://doi.org/10.3969/j.issn.1003-2886.2015.08.006

Zhang LL, Liu F, Cai GL (2015) Regulatory independence, market-oriented process and the implementation of executives promotion mechanism in SOEs — based on the SOE executives turnover data from 2003 to 2012. Manage World 10:117–131. https://doi.org/10.19744/j.cnki.11-1235/f.2015.10.011

Article   CAS   Google Scholar  

Zhang WJ, Gu FJ, Liu L (2021) Research on the effect of executive compensation incentive on enterprise performance in state-owned enterprises. Res Finan Econ Issues 10:122–129. https://doi.org/10.19654/j.cnki.cjwtyj.2021.10.013

Zhang YF, Song XY (2021) Study on the function of economic responsibility audit accountability in the governance of corruption of state-owned enterprises’ executives. Auditing Finan. 6:41–44. https://doi.org/10.19419/j.cnki.36-1264/f.2021.06.020

Zheng ZG (2019) Ways to strengthen corporate control in the era of decentralized equity. Tsinghua Finan Rev 9:41–44. https://doi.org/10.19409/j.cnki.thf-review.2019.09.010

Download references

Acknowledgements

We are grateful to Prof. Changnan Wu for his guidance on the manuscript and to the foundations for their support.

This research was supported by Science and Technology Research Project of Jiangxi Provincial Department of Education(No. GJJ2204104) and Humanities and Social Sciences Research Project of Colleges and Universities in Jiangxi Province(No. JJ22207).

Author information

Authors and affiliations.

College of Modern Economics and Management of Jiangxi University of Finance and Economics, Jiujiang, China

Yewei Huang & Junqin Qiu

You can also search for this author in PubMed   Google Scholar

Contributions

All authors listed have made a substantial, direct, and intellectual contribution to the work, and approved the final manuscript. YH: research ideas, concept and design, statistical analysis, and writing up. JQ: investigation, data curation, and obtaining funding.

Corresponding author

Correspondence to Junqin Qiu .

Ethics declarations

Competing interests.

The authors declare no competing interests.

Ethical approval

This article does not contain any studies with human participants performed by any of the authors.

Informed consent

Additional information.

Publisher’s note Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Supplementary information

Rights and permissions.

Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made. The images or other third party material in this article are included in the article’s Creative Commons license, unless indicated otherwise in a credit line to the material. If material is not included in the article’s Creative Commons license and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this license, visit http://creativecommons.org/licenses/by/4.0/ .

Reprints and permissions

About this article

Cite this article.

Huang, Y., Qiu, J. The power influence of executives and corporate investment efficiency: empirical evidence from Chinese state-owned enterprises. Humanit Soc Sci Commun 10 , 586 (2023). https://doi.org/10.1057/s41599-023-02107-w

Download citation

Received : 17 March 2023

Accepted : 07 September 2023

Published : 18 September 2023

DOI : https://doi.org/10.1057/s41599-023-02107-w

Share this article

Anyone you share the following link with will be able to read this content:

Sorry, a shareable link is not currently available for this article.

Provided by the Springer Nature SharedIt content-sharing initiative

Quick links

• Explore articles by subject
• Guide to authors
• Editorial policies

Investment efficiency and compensation committee expertise

Campus location, principal supervisor, additional supervisor 1, year of award, department, school or centre, degree type, usage metrics.

ORIGINAL RESEARCH article

Esg performance, auditing quality, and investment efficiency: empirical evidence from china.

• 1 School of Accountancy, Anhui University of Finance and Economics, Bengbu, Anhui, China
• 2 School of Accountancy, Shandong Technology and Business University, Yantai, Shandong, China

Dramatic changes in the business environment have created demands for additional information such as management discussions, governance information, and financial statement notes that go beyond the coverage of traditional financial reporting. Environmental, social, and governance (ESG) information can help gain stakeholder trust, reduce transaction costs, and improve investment efficiency. Taking Chinese A-share listed companies from 2011 to 2020 as a sample, we run fixed effect regressions to test the effect of ESG performance on investment efficiency. ESG performance is measured with the ESG score from the Bloomberg database. The results show that (a) good ESG performance significantly improves investment efficiency, (b) auditing quality partially mediates the relationship between ESG performance and investment efficiency, and (c) the role of ESG performance is stronger in non-state-owned enterprises, undeveloped regions, and firms with low accounting information quality. This paper contributes to the literature on ESG performance and provides references for ESG practice and sustainable corporate development in emerging countries.

Introduction

ESG is the acronym for environmental, social, and governance. ESG information is an important part of nonfinancial information disclosure and complements traditional financial disclosure. ESG disclosure is valued because it helps stakeholders make better quality decisions ( Zhang et al., 2020 ). Investors from developed countries have a higher level of ESG recognition. With the increasing foreign investment in China, foreign investors are driving Chinese companies to place greater emphasis on ESG practice and reporting ( Cheng et al., 2014 ). In 2016, China’s seven ministries and commissions issued “ Guidelines for Establishing the Green Financial System” to encourage green investments, curb pollution investments, build a green financial system, accelerate the green economy transformation, and promote efficient economic growth. In 2019, the Assets Management Association of China issued “the Research Report on ESG Evaluation System of Listed Companies in China” to highlight the concept of green development, emphasize the protection of the balance of interests among stakeholders, and promote modern corporate governance. In December 2020, “ the White Paper on ESG Development in China” was issued to promote responsible investment and improve the ESG evaluation system of Chinese firms. Although the concept of ESG has attracted much attention, most scholars are committed to the research on ESG performance and enterprise value ( Malik, 2015 ; Qureshi et al., 2019 ), and there is no relatively unified conclusion on the relationship between ESG performance and investment efficiency. Therefore, research on the effect of ESG performance on investment efficiency can both contribute to ESG literature and provide theoretical references for firms in China to improve investment efficiency.

The research theme of this paper is that good ESG performance will improve investment efficiency, and audit quality partially mediates the relationship between ESG performance and investment efficiency. First, good ESG performance may ease financing constraints and be more conducive to the external financing of enterprises ( Lambert et al., 2007 ; Liu et al., 2021 ); Second, good ESG performance may reduce agency costs and effectively constrain management behavior ( Lee and Kim, 2020 ). Third, social responsibility activities can integrate stakeholders into enterprise investment decisions and alleviate information asymmetry ( Cui et al., 2018 ), thereby improving investment efficiency ( Samet and Jarboui, 2017 ). In addition, in hypothesis 2, this paper discusses the impact of audit quality on investment efficiency, which paves the way for confirming the intermediary role of audit quality in the relationship between ESG performance and investment efficiency. The study found that high audit quality can reduce the quality of corporate earnings, improve the credibility of accounting information, and thus improve the efficiency of enterprise investment ( Cheong and Zurbruegg, 2016 ; Palazuelos et al., 2018 ). Enterprises with good ESG performance tend to choose high-quality auditing to send positive signals to the outside world and reduce enterprise information asymmetry ( Kim and Song, 2011 ). High audit quality can improve investment efficiency, which further confirms the intermediary role of audit quality in the relationship between ESG performance and investment efficiency.

There are three reasons why this paper chooses Chinese A-share listed companies as the research sample: first, emerging countries are relatively late in taking on ESG. Taking the Chinese market as the research sample enriches the research of ESG theory in emerging countries. Second, the organizational structure of Chinese enterprises is mostly pyramidal, which is complex and prone to agency problems, which makes us more interested in the relationship between ESG performance and the investment efficiency of Chinese enterprises ( Hai et al., 2022 ). Third, the rapid development of the social economy makes the market competition increasingly intense, which greatly increases the complexity of the business environment of Chinese listed companies. The sustainable development of Chinese listed companies has become an important topic of academic research, which has led us to pay more attention to the research of Chinese listed companies ( Xu and Bai, 2019 ).

We run regressions using a sample of Chinese A-share listed companies from 2011 to 2020. ESG performance is measured by the ESG score from the Bloomberg database. Our results show that good ESG performance can improve enterprise investment efficiency and that auditing quality mediates the relationship between ESG performance and investment efficiency. Further research shows that the positive relationship between ESG performance and investment efficiency is moderated by the nature of property rights, institutional environment, and accounting information quality. For non-state-owned enterprises (non-SOEs), firms in less-developed regions, and firms with low accounting information quality, ESG performance plays a stronger role in promoting investment efficiency. The results indicate that ESG practices promote Chinese firms’ sustainable development.

This paper makes the following contributions to the extant literature. First, most extant studies focus on a single ESG dimension, such as the environment, social responsibility, and corporate governance, and few studies take the three dimensions as a unit. This paper integrates the environmental, social, and governance dimensions into the same analytical framework to investigate the impact of Chinese firms’ ESG performance on investment efficiency, highlighting the overall effect of ESG in improving investment efficiency. Second, most extant ESG literature focuses on firm value/financial performance rather than investment efficiency. This paper contributes to the extant literature by highlighting the relationship between ESG and investment efficiency. Third, this paper enriches the extant ESG literature by investigating the mediating role of auditing quality in the relationship between ESG performance and investment efficiency.

The rest of this paper is organized as follows. Section 2 states the theoretical analysis and research assumptions and mainly analyzes the relationship between ESG performance, audit quality, and investment efficiency. Section 3 describes the variables and data used in this study and establishes a regression model. Section 4 is an empirical test and reports the regression results. Section 5 analyzes the heterogeneity. Section 6 mainly discusses the contribution of this study, the limitations and future directions.

Theoretical analysis and research hypothesis

Esg performance and investment efficiency.

According to stakeholder theory, ESG practices help increase stakeholder trust, obtain stakeholder support, obtain strategic resources for corporate development, and improve investment efficiency ( Liu et al., 2021 ). ESG performance improves investment efficiency in the following three ways. First, ESG practice reduces agency costs. Good ESG performance indicates that firms have a well-established corporate governance mechanism that can effectively constrain managers and mitigate agency problems ( Lee and Kim, 2020 ). Positive ESG information reduces the negative influence of media coverage, buffers external pressures, reduces agency costs, and improves investment efficiency ( Matten and Moon, 2008 ). ESG investments reduce corporate free cash flow and curb managerial short-sightedness, thereby mitigating agency costs and improving corporate investment efficiency ( Samet and Jarboui, 2017 ).

Second, ESG performance can improve investment efficiency by mitigating financing constraints. ESG disclosure transmits nonfinancial information to investors and facilitates external financing ( El Ghoul et al., 2011 ). ESG disclosure also increases external supervision and attention, helps uninformed investors obtain more information, and reduces the synchronization of stock prices ( Kim et al., 2012 ). In addition, social responsibility performance is directly related to the approval of corporate refinancing in heavily polluting industries ( Goss and Roberts, 2011 ).

Finally, ESG disclosure sends a positive signal to the market. Firms usually spend a certain amount to transmit nonfinancial information to society, which can reduce information asymmetry and facilitate investors in identifying quality companies ( Spence, 1973 ). Good ESG performance reduces the information asymmetry between firms and investors and provides more information for stakeholders to make decisions, thereby decreasing the decision-making risk for investors and improving investment efficiency ( Lins et al., 2017 ). Consequently, we propose the following hypothesis.

H1 : ESG performance is positively associated with investment efficiency.

Auditing quality and investment efficiency

Rapid economic growth and improving capital markets do not mean high investment efficiency. Chinese listed companies face serious problems of inefficient investment, including overinvestment and underinvestment ( Qin and Song, 2009 ; Chen S. et al., 2011 ). According to the principal-agent theory, too much power of managers may breed short-sighted behavior, lead to the neglect of the long-term interests of the enterprise, generate excessive investment, cause uneven and unreasonable distribution of resources, and finally cause waste of enterprise resources and increase the risk of enterprise operation ( Li, 2009 ; Chen et al., 2017 ). In contrast, if the management power is too constrained by other factors, it is easy to produce conservative investment behavior, resulting in insufficient investment. Insufficient investment can contribute to idle resources, increase the opportunity cost of enterprises, and damages the rights and interests of stakeholders ( Stulz, 1990 ; Bertrand and Mullainathan, 2003 ). Improving investment efficiency has become an urgent problem to be solved.

Low investment efficiency is generally due to information asymmetry and principal-agent problems. High-quality accounting information can improve information transparency ( Biddle and Hilary, 2006 ; Biddle et al., 2009 ). Auditing provides a guarantee for the quality of accounting information and has important reference value for stakeholders. Auditing quality affects investment efficiency in the following three ways. First, auditing can effectively alleviate information asymmetry, reduce investors’ decision-making risk, and improve investment efficiency through the signal transmission mechanism ( Copley and Douthett, 2002 ). Second, high auditing quality reduces financing costs ( Mansi et al., 2004 ; Lambert et al., 2007 ). High auditing quality enhances investors’ trust in financial information, alleviates information asymmetry, avoids insufficient investment caused by high financing costs, and thus improves investment efficiency ( Bushman and Smith, 2001 ; Biddle et al., 2009 ). Third, auditing has the function of insurance and supervision ( Chen H. et al., 2011 ). High auditing quality restricts the behavior of managers, improves the efficiency of corporate resource allocation, and inhibits inefficient investment ( Bushman and Smith, 2001 ). High-quality auditing restrains the insufficient investment of firms and effectively solves investment problems ( Copley and Douthett, 2002 ). The impact of auditing quality on investment efficiency varies with the nature of equity ( Khurana and Raman, 2004 ; Chen H. et al., 2011 ). Consequently, we propose the following hypothesis.

H2 : High auditing quality can improve the investment efficiency of firms.

The mediating effect of auditing quality in the relationship between ESG performance and investment efficiency

By disclosing ESG information, firms transmit nonfinancial information to the outsiders, reduce information asymmetry, and improve investment efficiency ( Lins et al., 2017 ). It is important to take effective measures to increase stakeholders’ trust in corporate disclosures. High-quality disclosure can improve corporate information transparency, reduce corporate information asymmetry, and alleviate agency problems ( Mitton, 2002 ; Elaoud and Jarboui, 2017 ). External auditing is a guarantee of accounting information quality. The independence and objectivity of auditing can provide a guarantee for the quality of ESG disclosure. Auditing supervision has played a positive role in the development of ESG ( Iatridis, 2011 ). Auditing standards require certified public accountants (CPAs) to check both the financial and nonfinancial information and measure firms’ sustainable operation ability more accurately. As important nonfinancial information, corporate social responsibility (CSR) reports are bound to be included in the auditing and constitute an important reference content for auditing risk assessment ( Kolk and Margineantu, 2009 ).

As intermediaries, accounting firms use auditing standards to certify the ESG reports. The process ensures the authenticity and reliability of the information disclosed by companies, thus promoting the overall consistency between ESG information and financial information. The quality of accounting information quality audited by high-quality accounting firms is generally higher than that of small accounting firms ( Becker et al., 1998 ; Francis and Yu, 2009 ). Therefore, to send a positive signal to the outside world, firms prefer to choose high-quality auditing, which further alleviates firms’ financing constraints, reduces their agency cost, and improves their investment efficiency ( Jones and Raghunandan, 1998 ; Francis and Wang, 2008 ). High-quality auditing improves the efficiency of investor confidence by identifying accounting quality and thus improving the efficiency of capital allocation ( Elaoud and Jarboui, 2017 ). Firms with good ESG performance are motivated to choose high-quality accounting firms to ensure the authenticity of accounting information and increase the trust of stakeholders in ESG information ( Fan and Wong, 2005 ). Consequently, auditing quality plays a positive role in promoting investment efficiency ( Bushman and Smith, 2001 ), and we propose the following hypothesis.

H3 : Auditing quality plays a mediating role in the relationship between ESG performance and investment efficiency.

Research design

Data and sample.

This paper uses China’s A-share listed companies from 2011 to 2020 as the research sample. The data are updated to 2020, which makes the research for this paper timely. The research period is the 10 years from 2011 to 2020, which makes the conclusions of the research persuasive. ESG performance data are from the Bloomberg database, other financial data are from the CSMAR and Wind databases, and the marketization degree data are from the “ Report on China’s Marketization Index by Province (2018).” The data are processed as follows. First, due to the particularity of the financial statement calculation of the financial industry, we have excluded the samples from the financial industry and the real estate industry. Second, we exclude samples such as ST or * ST to reduce the impact of outliers on the empirical results. Third, we exclude the samples with missing values. Our final full sample consists of 915 companies, corresponding to 7,933 firm-year observations. The data structure in this paper is an unbalanced panel (pooled cross-sectional and time series data). All continuous variables are winsorized at the 1 and 99% levels to reduce the influence of outliers.

Dependent variable

Following Biddle et al. (2009) , We use the residual obtained from model (1) to measure the efficient investment level of firms. the model is as follows:

Inv represents the investment efficiency of firm i in year t . The investment level in year t  = (cash paid for the purchase and construction of fixed assets, intangible assets, and other long-term assets + cash paid for the acquisition of subsidiaries and other business units + cash paid for investment–net cash recovered from the disposal of fixed assets, intangible assets and other long-term assets–net cash received from the disposal of subsidiaries and other business units–cash received from the recovery of investment)/total assets at the beginning of the period. Salesgrowth is the growth rate of operating revenue. v i , t is the regression residual of the Model (1). Through the industry and annual estimation model (1), the fitting value of the optimal investment level of the enterprise and the residual deviation from the optimal investment level of the enterprise are obtained. The residual part represents the deviation from the optimal investment level of the enterprise. The larger the absolute value of the residual is, the lower the investment efficiency.

Independent variable

Following Minutolo et al. (2019) , we use the ESG score of the Bloomberg database to measure ESG performance. The Bloomberg database publicly publishes the level of CSR reporting to investors, including the ESG comprehensive index score and the E, S, and G single index scores. The score is based on the quality of ESG disclosure. The scoring range is 0–100. The more information a firm discloses, the higher the ESG score. Investors can access each company’s ESG score, scoring methodology, and score report data. The reasons for selecting the Bloomberg database are as follows. First, Bloomberg’s ESG data are obtained from company CSR/sustainability reports or other public sources, and the scores are more objective. Second, compared to other ESG ratings, Bloomberg’s ESG data cover a wider range and are more convincing.

Mediating variables

Auditing has a supervisory function, and external auditing is an assurance of accounting information quality. Following Teoh and Wong (1993) , Hackenbrack and Hogan (2002) , and Balsam et al. (2003) , the size of an accounting firm determines auditing quality. In this paper, Big4 is selected to measure auditing quality. Big4 equals 1 if a firm selects the top four international accounting firms for auditing, and 0 otherwise.

Control variables

Following Bates (2005) , we control firm size (Size), financial leverage (Lev), asset tangibility (Tang), financial performance (ROA), firm age (Age), market value to book ratio (MB), cash level (Cash), property right nature (SOE), free cash flow of enterprise (FCF), proportion of fixed assets (PPE), institutional environment (MKT), board size (Board) and industry and year dummy variables. The variables are defined as follows in Table 1 .

Table 1 . Definitions of variables.

Model construction

We build fixed effect models (2) and (3) to test H1 and H2, respectively; Industry FE represents industry fixed effects; Year FE represents year fixed effects; Province FE represents Province fixed effects.

Referring to the mediation effect test procedure proposed by Baron and Kenny (1986) , we build fixed effect models (4) and (5) to test H3.

We conducted all our analyses in Stata 16.

Descriptive statistics

Table 2 shows the descriptive statistical results of the main variables. The average investment efficiency of the sample firms is 0.0389 indicating that the investment efficiency of China’s A-share listed companies is generally low. The minimum value of investment efficiency is 0.0006 and the maximum value is 0.2282, indicating that the investment efficiency of different firms varies greatly. The average ESG performance is 0.2090, the minimum value is 0.0909, and the maximum value is 0.4421, indicating that there is a wide variation in the ESG performance of Chinese firms. The mean value of auditing quality is 0.1083 and the standard deviation is 0.3108, indicating that the importance attached to audit quality varies widely among firms. The average tangible value of assets is 0.9482, the lowest is 0.6841, and the highest is 1. It shows that most of the enterprises are tangible assets and less intangible assets. The average ROA of the company’s profitability is 0.0433, the minimum value is −0.2934, and the maximum value is 0.2027, indicating that the overall profitability of the enterprise is low, and the profitability gap between different enterprises is large. The descriptive statistical results of other variables such as Lev and SOE are similar to the conclusions of existing research ( Hai et al., 2022 ), so they will not be repeated.

Table 2 . Descriptive statistics.

It can be seen from Table 3 that industry and public utilities account for the highest proportion, with 6,013 observed values in the industry, accounting for 75.80%. There are 1,135 observed values in public utilities, accounting for 14.31%. It can be seen from Table 4 that the overall investment level of the four industries is 0.0389. The average ESG of the four industries is 0.2090, of which the industrial ESG performs well, with an average of 0.2122, and the comprehensive ESG performs poorly, with an average of 0.1825.

Table 3 . Sample distribution across sectors.

Table 4 . Descriptive statistics (Mean).

Correlation analysis

The correlation coefficient between the main variables is shown in Table 5 . It can be seen from the table that the correlation coefficient between ESG performance ( ESG ) and investment efficiency ( Inv ) is negative and significant at the 1% level. It is preliminarily proven that ESG performance can restrict the behavior of management, reduce enterprise agency costs, and improve enterprise investment efficiency. The correlation coefficient between auditing quality ( Big4 ) and investment efficiency ( Inv ) is significantly negative, indicating that auditing quality can alleviate the inefficient investment of firms. The higher the quality of accounting firms, the more rigorous the implementation of auditing, which can better give play to the function of external supervision and improve the investment efficiency of firms. In addition, the correlation coefficient between other variables is small, indicating that there is no serious multicollinearity problem between variables.

Table 5 . Correlations.

Regression results

Model (2) tests the impact of ESG performance on investment efficiency. Column (1) of Table 6 shows that the coefficient of ESG is −0.0220 and significant at the 1% level. Consistent with H1, the results indicate that ESG performance can effectively improve investment efficiency. Model (3) tests the relationship between auditing quality and investment efficiency. Column (2) of Table 6 shows that the regression coefficient of Big4 is −0.0054 and significant at the 1% level, indicating that higher-quality accounting firms improve investment efficiency. The regression results are consistent with H2.

Table 6 . The effect of ESG performance on investment efficiency.

According to the stepwise method of Baron and Kenny (1986) , if the independent variable X affects the dependent variable Y by influencing variable M , M is called an intermediary variable. In this paper, ESG performance is the independent variable X , investment efficiency is the dependent variable Y , and auditing quality is the mediating variable M . First, we test the significance of coefficient c of model (6). In the second step, we test the significance of coefficient a of model (7) and coefficient b of model (8). If both a and b are significant, there is an intermediary effect. The third step is to test whether there is a full mediating effect or a partial mediating effect. If c ’ is significant, it is a partial mediating effect. If c ’ is not significant, it is a complete mediating effect. Column (3) of Table 6 shows that the coefficient of ESG is 1.2103 and significant at the 1% level, indicating that firms with good ESG performance are more likely to choose high-quality accounting services to obtain stakeholders’ trust. In column (4) of Table 6 , the coefficient of ESG is −0.0164 and significant at the 5% level, indicating that good ESG performance can improve enterprise investment efficiency. The coefficient of Big4 is −0.0046 and significant at the 1% level, indicating that high auditing quality can improve investment efficiency. The coefficient of ESG increased from −0.0220 to −0.0164, representing an increase of 25.45%, and the model passed the Sobel test. Therefore, auditing quality plays a partial mediating role in the relationship between ESG performance and investment efficiency. Because the coefficient of ESG increases after adding the auditing quality variable Big4 to Model (2), the mediating effect is positive. The regression results are consistent with H3.

Robustness tests

First, we replace the independent variable to run regressions. In Model (2), we use the Huazheng ESG rating to measure ESG performance ( ESG2 ). The higher the Huazheng ESG rating is, the better the ESG performance. The Huazheng ESG ratings CCC-AAA are assigned as 1–9 in order, i.e., ESG performance rating C is 1, CC is 2, CCC is 3, and so on. Table 7 column (1) shows the results of the regression with ESG2. The coefficient of ESG2 is −0.0005 and significantly negative at the 5% level. The results show that ESG2 can also improve investment efficiency, which further proves the H1 hypothesis that ESG performance can improve investment efficiency, and that this result is robust.

Table 7 . Robust tests.

Second, this paper uses a more direct method to measure ESG performance (ESG3). We assign a Huazheng ESG rating CCC-AAA of 1–3 in order. The ESG performance rating C is 1, B is 2, and A is 3. Column (2) of Table 7 shows the regression results with ESG3 . The coefficient of ESG3 is −0.0015 and significantly negative at the 5% level, indicating that the regression results are robust. The results show that ESG3 can also improve investment efficiency, which shows that replacing independent variables will not change the conclusion of H1; that is, the conclusion of our H1 hypothesis is robust.

Third, we replace the dependent variable to run regressions. Following Richardson (2006) , this paper measures the level of efficiency investment by the residual of Model (9). The greater the absolute value of the residual is, the lower the investment efficiency level.

G r o w t h i , t − 1 represents the growth rate of prime operating revenue, R e t i , t − 1 represents the annual return of stocks, and I n v i , t − 1 is the investment efficiency level of the previous year. v i . t is the regression residual, and its absolute value shows the level of investment efficiency. Column (3) of Table 7 reports the regression results. The coefficient of ESG is −0.0310 and significantly negative at the 1% level, indicating that good ESG performance can improve investment efficiency. The results show that changing the measurement method of dependent variables can also lead to the conclusion that good ESG performance can improve investment efficiency, which further proves the credibility of the conclusion of H1; that is, the conclusion of our H1 is robust.

Audit quality and investment efficiency

First, we run regression with a new independent variable: Audit1. In Model (3), we use audit opinion to measure audit quality (Audit1). An unqualified opinion is assigned a value of 1 and a nonunqualified opinion is assigned a value of 0. Table 8 column (1) shows the results of the regression with the Audit1. The coefficient of Audit1 is −0.0036 and significantly negative at the 5% level. The results still show that high audit quality can improve investment efficiency, that is, changing the measurement method of audit quality does not change the conclusion of hypothesis 2, indicating that the conclusion of H2 is robust.

Table 8 . Robust tests.

Second, this paper uses a more direct method to measure audit quality (Audit2) by using the natural logarithm of audit fees as a substitute variable for audit quality. The higher the audit cost is, the higher the audit quality. Table 8 column (2) shows the results of the regression with the Audit2. The coefficient of Audit2 is −0.0031 and significantly negative at the 1% level, indicating that good audit quality can improve investment efficiency. That is, changing the measurement method of audit quality does not change the conclusion of hypothesis 2, which shows that the conclusion of H2 is robust.

Third, following Richardson (2006) , this paper measures the level of efficiency investment by the residual of Model (6). The greater the absolute value of the residual is, the lower the investment efficiency level. Column (3) of Table 8 reports the regression results. The coefficient of audit quality ( Big4 ) is −0.0023 and significantly negative at the 5% level, indicating that good audit quality can improve investment efficiency. The results show that by changing the measurement method of dependent variables, the conclusion is still consistent with H2, which further proves the credibility of H2.

Endogeneity

First, we add control variables to address the influence of the missing variables. For the unobservable missing variables that may exist in the model, which may affect the conclusion, we adopt adding control variables to solve the problem of endogeneity caused by missing variables. Given that the ownership concentration ( fhold ) and the proportion of independent directors ( indep ) will also affect investment efficiency, we add the two variables to Model (2). Column (1) of Table 9 shows the regression results. The coefficient of ESG is −0.0222 and significantly negative at the 1% level, which shows that the addition of control variables does not affect the conclusion of H1; that is, there is no influence of omitted variables on endogeneity, and our result is still robust.

Table 9 . Endogeneity test with additional control variables.

Second, we run regressions to alleviate the influence of two-way causality. We lag the independent variables by one-, two-, and three- periods for regressions, respectively. The results are shown in Table 10 . The coefficient of 1 year lagged ESG is −0.0243 and significant at the 1% level, the coefficient of two-years lagged ESG is −0.0247 and significant at the 1% level, and the coefficient of three-years lagged ESG is −0.0247 and significant at the 1% level. This shows that good ESG performance can improve investment efficiency; that is, there is no problem of endogeneity caused by two-way causality, and our conclusion is robust.

Table 10 . Endogeneity test with hysteretic variables.

Third, we run the two-stage least squares (2SLS) regressions. Following Benlemlih and Bitar (2018) , we use the average ESG score of other firms in the same province as an instrumental variable (IV1). Additionally, considering that the firm’s earliest ESG score has an impact on current ESG performance but is not related to the current model disturbance, we use the firm’s earliest ESG performance as the instrumental variable (IV2). We run the 2SLS regressions for endogenous tests. The results are shown in Table 11 . In the first-stage regression, the coefficients of instrumental variables IV1 and IV2 are significantly positive, and the F value is far greater than 10, indicating that there is no problem with weak instrumental variables, and the tool variables we selected are valid. We also conduct an overidentification test on the instrumental variables. The p value of the Sargan test is 0.2225, which is greater than 0.1, rejecting the assumption that the instrumental variable is endogenous and indicating that the two instrumental variables are effective. In the second-stage regression, the ESG coefficient is −0.0602 and significant at the 1% level, which shows that good ESG performance can improve investment efficiency, indicating that our result is robust.

Table 11 . Results of two-stage least squares regression.

Additional analyses

Heterogeneous impacts of esg performance on the investment efficiency of soes and non-soes.

First, SOEs and non-SOEs have different motivations for ESG disclosure. SOEs have a dual identity as both a political entity and a market entity. They consider national policies and social impacts first and economic returns second. Non-SOEs have only one identity as market participants, and the main purpose of their ESG disclosure is to obtain higher economic returns. Second, SOEs and non-SOEs have different ESG disclosure focuses. SOEs first respond to national policies and conduct ESG practices following national development directions. However, non-SOEs focus more on stakeholders’ needs to obtain more economic returns. As shown in columns (1) and (2) of Table 12 , the coefficient of ESG of the non-SOE group is −0.0625 and significant at the 1% level, but the coefficient of ESG of the SOE group is not significant. The results show that ESG performance is positively associated with the investment efficiency of non-SOEs. However, the relationship does not exist in SOEs. Non-SOEs are mainly driven by market competition to engage in CSR activities and good ESG performance can improve investment efficiency and financial performance ( Sun et al., 2019 , 2020 ). In contrast, SOEs are mainly driven by institutional pressures to be socially responsible, so the ESG performance in SOEs does not significantly affect investment efficiency.

Table 12 . Results of grouped regressions.

Grouped regressions by marketization

China’s economy has grown rapidly in recent years, but as a large emerging market country, it also suffers from serious economic development imbalances. In China’s more market-oriented regions, investment is less affected by economic instability and is more efficient and stable. Developed regions have more intense competition, higher market fairness, and better levels of information communication. The pressure on companies in developed regions is also relatively high. Good communication mechanisms in developed regions can strengthen external monitoring, and shareholders are more efficient in “voting with their feet.” Companies with a better external environment have more access to information, which improves the efficiency of resource allocation ( Pinkowitz et al., 2006 ). The role of external governance is better in developed regions, and the role of ESG disclosure is weakened. In contrast, the marginal utility of ESG performance is greater in less developed regions, which can better alleviate the problems caused by information asymmetry and improve investment efficiency.

We define firms with less than the median marketization level of all A-share listed companies as low marketization and firms with greater than the median marketization of all A-share listed companies as high marketization. As shown in columns (3) and (4) of Table 12 , the coefficient of ESG of the low marketization group is −0.0489 and significant at the 1% level, and the coefficient of ESG of the high marketization group is not significant. This is consistent with our expectations. The marginal effect of practicing ESG in underdeveloped regions is greater; that is, good ESG performance in underdeveloped regions can better improve investment efficiency. Developed regions have better external governance, and the relationship between ESG performance and investment efficiency is not obvious.

Grouped regressions by accounting information quality

As mentioned above, ESG performance can alleviate information asymmetry and improve investment efficiency. However, ESG performance has a “ceiling effect” on the mitigation of information asymmetry; that is, when the information asymmetry between enterprises and stakeholders is effectively filled by other information, the impact of ESG information disclosure on investment efficiency is significantly reduced. Stakeholders in the capital market obtain important information about a company mainly from financial reports. Therefore, if the quality of accounting information of a company is relatively high, the marginal utility of ESG disclosure will be greatly reduced when the financial information can better meet the needs of stakeholders.

This paper argues that ESG performance can only have a significant impact on investment efficiency in firms with low accounting information quality. We refer to the Jones model modified by Dechow et al. (1995) to measure accounting information quality. The greater the absolute value of manipulation accrued profit, the lower the quality of accounting information. We take the median of the absolute value of all A-share listed companies’ manipulation of accrued profits as the standard to measure the quality of accounting information. Enterprises greater than the median are allocated to the low accounting information quality group, and enterprises less than the median absolute value are allocated to the high accounting information quality group. Columns (5) and (6) of Table 12 show the results of grouped regressions by accounting information quality. The coefficient of ESG of the group with low accounting information quality is −0.0374 and significant at the 1% level, and the coefficient of ESG of the group with high accounting information quality is not significant. The results show that good ESG performance can improve investment efficiency in samples with low accounting information quality, but this effect is not obvious in samples with high accounting information quality. This is consistent with our expectations. In areas with low-quality accounting information, ESG information disclosure can alleviate information asymmetry and improve investment efficiency. In areas with high-quality accounting information, the marginal utility of ESG information disclosure is greatly reduced.

This paper empirically examines the impact of ESG performance on investment efficiency using a sample of Chinese A-share listed companies from 2011 to 2020. The results show that ESG performance can significantly improve investment efficiency. Audit quality plays a partial mediating role in the relationship between ESG performance and investment efficiency. Further tests show that the impacts of ESG performance on investment efficiency are influenced by the nature of property rights, institutional environment, and accounting information quality. The promotion effect of ESG performance on investment efficiency is stronger for non-SOEs, firms in less developed regions, and firms with low-quality accounting information.

This study makes several contributions to the current literature. First, this paper highlights the overall effect of ESG in improving investment efficiency. Most extant studies focus on the single ESG dimension, such as the environment, social responsibility, and corporate governance ( Bostian et al., 2016 ; Chen et al., 2018 ; Castelló-Taliani et al., 2021 ). Few studies have taken these three dimensions as a unit. Integrating environmental, social, and governance dimensions into one analytical framework, this paper highlights the overall role of ESG in improving investment efficiency.

Second, this paper contributes to the extant literature by highlighting the relationship between ESG and investment efficiency. Most extant ESG literature focuses on company value and financial performance ( Yoon et al., 2018 ; Taliento et al., 2019 ; Broadstock et al., 2020 ), but little attention is given to investment efficiency. ESG reports provide mainly nonfinancial information that makes up for traditional financial information disclosure deficiencies, which may improve the reasonability of investment decisions and help firms with sustainable development. Our empirical results provide a new understanding of ESG performance outcomes by highlighting the positive relationship between ESG performance and investment efficiency.

Third, this paper enriches the existing ESG literature by investigating the mediating role of auditing quality in the relationship between ESG performance and investment efficiency. We find that audit quality plays a partially mediating role in the relationship between ESG performance and investment efficiency. External audits can provide a certain degree of assurance on the quality of ESG information by their independence and objectivity. Accounting firms use auditing standards to verify the ESG reporting, ensuring the truthfulness and reliability of ESG information. Top accounting firms signal higher quality of ESG information of audited companies. Firms are more willing to choose high-quality audits to send positive signals to outsiders, which alleviates financing constraints, reduces agency costs, and improves investment efficiency ( Zeng et al., 2019 ). With these results, this paper sheds new light on studies related to the outcomes of ESG performance.

There are some important changes that need to be made. At the firm level, firms should actively engage in ESG practices. First, firms should integrate ESG philosophy into their culture to build a good business image, enhance the trust of investors, and alleviate financing constraints. Second, firms should incorporate ESG practices into management systems and specific businesses, such as product development, employee training, social charity, etc. Through these measures, the degree of information asymmetry between firms and external investors can be reduced and corporate investment efficiency can be improved. At the market level, investors should incorporate ESG performance into investment decisions. First, while considering financial information, investors should also include nonfinancial information, such as environmental information, social responsibility information, and corporate governance information, in the decision-making framework to integrate ESG with investors’ strategic objectives, thus making more scientific decisions and reducing investment risks. Second, investors should play an external governance role to actively promote corporate ESG practices and sustainable development and improve the efficiency of capital allocation. At the institutional level, the government should play a regulatory role in promoting corporate ESG practices. First, the ESG information disclosure system in China is not perfect at present, and the quality of ESG information disclosure of many firms is poor. The government should work on improving the ESG information disclosure system and promote firms to continuously improve the ESG information quality. Second, the government should intervene less in the market and establish a good institutional environment for corporate ESG practices, thus improving the efficiency of market capital allocation. Finally, the government should advance the regulatory system for ESG disclosure and strengthen the penalties for false ESG information.

The generalizability of these results is subject to certain limitations. First, we examine the impact of ESG performance on investment efficiency only for Chinese listed firms but do not cover other emerging countries. The sample size should be expanded to include firms from all emerging countries in future studies. Second, this paper quantifies ESG performance with ESG reporting scores. The quality of ESG ratings may be undermined by imperfect and noncomparable ESG reporting rules.

Data availability statement

The raw data supporting the conclusions of this article will be made available by the authors, without undue reservation.

Author contributions

WW, YY, and XL completed the research design together. WW provided research assistance and support. YY and XL collected and analyzed the data and wrote the manuscript all up. All authors contributed to the article and approved the submitted version.

This work is supported by the National Office for Philosophy and Social Sciences under grant number 21BGL097.

Conflict of interest

The authors declare that the research was conducted in the absence of any commercial or financial relationships that could be construed as a potential conflict of interest.

Publisher’s note

All claims expressed in this article are solely those of the authors and do not necessarily represent those of their affiliated organizations, or those of the publisher, the editors and the reviewers. Any product that may be evaluated in this article, or claim that may be made by its manufacturer, is not guaranteed or endorsed by the publisher.

Balsam, S., Krishnan, J., and Yang, J. S. (2003). Auditor industry specialization and earnings quality. Audit. J. Pract. Theory 22, 71–97. doi: 10.2308/aud.2003.22.2.71

CrossRef Full Text | Google Scholar

Baron, R. M., and Kenny, D. A. (1986). The moderator-mediator variable distinction in social psychological research: conceptual, strategic, and statistical considerations. J. Pers. Soc. Psychol. 51, 1173–1182. doi: 10.1037/0022-3514.51.6.1173

PubMed Abstract | CrossRef Full Text | Google Scholar

Bates, T. W. (2005). Asset sales, investment opportunities, and the use of proceeds. J. Finance 60, 105–135. doi: 10.1111/j.1540-6261.2005.00726.x

Becker, C. L., Defond, M. L., Jiambalvo, J. J., and Subramanyam, K. R. (1998). The effect of audit quality on earnings management. Contemp. Account. Res. 15, 1–24. doi: 10.1111/j.1911-3846.1998.tb00547.x

Benlemlih, M., and Bitar, M. (2018). Corporate social responsibility and investment efficiency. J. Bus. Ethics 148, 647–671. doi: 10.1007/s10551-016-3020-2

Bertrand, M., and Mullainathan, S. (2003). Enjoying the quiet life? Corporate governance and managerial preferences. J. Polit. Econ. 111, 1043–1075. doi: 10.1086/376950

Biddle, G. C., and Hilary, G. (2006). Accounting quality and firm-level capital investment. Account. Rev. 81, 963–982. doi: 10.2308/accr.2006.81.5.963

Biddle, G. C., Hilary, G., and Verdi, R. S. (2009). How does financial reporting quality relate to investment efficiency? J. Acc. Econ. 48, 112–131. doi: 10.1016/j.jacceco.2009.09.001

Bostian, M., Fare, R., Grosskopf, S., and Lundgren, T. (2016). Environmental investment and firm performance: A network approach. Energy Econ. 57, 243–255. doi: 10.1016/j.eneco.2016.05.013

Broadstock, D. C., Chan, K., Cheng, L., and Wang, X. (2020). The role of ESG performance during times of financial crisis: evidence from COVID-19 in China. Finance Res. Lett. 38:101716. doi: 10.2139/ssrn.3627439

Bushman, R. M., and Smith, A. J. (2001). Financial accounting information and corporate governance. J. Account. Econ. 32, 237–333. doi: 10.1016/S0165-4101(01)00027-1

Castelló-Taliani, E., Giralt Escobar, S., and da Rosa, F. S. (2021). Environmental disclosure: study on efficiency and alignment with environmental priorities of Spanish ports. Sustainability 13:1791. doi: 10.3390/su13041791

Chen, H., Chen, J. Z., Lobo, G. J., and Wang, Y. (2011). Effects of audit quality on earnings management and cost of equity capital: evidence from China. Contemp. Account. Res. 28, 892–925. doi: 10.1111/j.1911-3846.2011.01088.x

Chen, J., Dong, W., Tong, J. Y., and Zhang, F. (2018). Corporate philanthropy and investment efficiency: empirical evidence from China. Pac. Basin Finance J. 51, 392–409. doi: 10.1016/j.pacfin.2018.08.008

Chen, T., Xie, L., and Zhang, Y. (2017). How does Analysts' forecast quality relate to corporate investment efficiency? J. Corp. Finan. 43, 217–240. doi: 10.1016/j.jcorpfin.2016.12.010

Chen, S., Zheng, S., Song, T., and Wu, D. (2011). Government intervention and investment efficiency: evidence from China. J. Corp. Finance 17, 259–271. doi: 10.1016/j.jcorpfin.2010.08.004

Cheng, B., Ioannou, I., and Serafeim, G. (2014). Corporate social responsibility and access to finance. J. Strat. Manage. 35, 1–23. doi: 10.1002/smj.2131

Cheong, C. S., and Zurbruegg, R. (2016). Analyst forecasts and stock price informativeness: some international evidence on the role of audit quality. J. Contemp. Account. Econ. 12, 257–273. doi: 10.1016/j.jcae.2016.09.002

Copley, P. A., and Douthett, E. B. (2002). The association between auditor choice, ownership retained, and earnings disclosure by firms making initial public offerings. Contemp. Account. Res. 19, 49–76. doi: 10.1506/U1Y4-CCXT-BPVE-QH58

Cui, J., Jo, H., and Na, H. (2018). Does corporate social responsibility affect information asymmetry? J. Bus. Ethics 148, 549–572. doi: 10.1007/s10551-015-3003-8

Dechow, P. M., Sloan, R. G., and Hutton, A. P. (1995). Detecting earnings management. Account. Rev. 70, 193–225.

Google Scholar

El Ghoul, S., Guedhami, O., Kwok, C. C. Y., and Mishra, D. R. (2011). Does corporate social responsibility affect the cost of capital? J. Bank. Finance 35, 2388–2406. doi: 10.1016/j.jbankfin.2011.02.007

Elaoud, A., and Jarboui, A. (2017). Auditor specialization, accounting information quality and investment efficiency. Res. Int. Bus. Finance 42, 616–629. doi: 10.1016/j.ribaf.2017.07.006

Fan, J. P. H., and Wong, T. J. (2005). Do external auditors perform a corporate governance role in emerging markets? Evidence from East Asia. J. Account. Res. 43, 35–72. doi: 10.1111/j.1475-679x.2004.00162.x

Francis, J. R., and Wang, D. (2008). The joint effect of investor protection and Big4 audits on earnings quality around the world. Contemp. Account. Res. 25, 157–191. doi: 10.1506/car.25.1.6

Francis, J. R., and Yu, M. D. (2009). Big 4 office size and audit quality. Account. Rev. 84, 1521–1552. doi: 10.2308/accr.2009.84.5.1521

Goss, A., and Roberts, G. S. (2011). The impact of corporate social responsibility on the cost of Bank loans. J. Bank. Finance 35, 1794–1810. doi: 10.1016/j.jbankfin.2010.12.002

Hackenbrack, K. E., and Hogan, C. E. (2002). Market response to earnings surprises conditional on reasons for an auditor change. Contemp. Account. Res. 19, 195–223. doi: 10.1506/5XW7-9CY6-LLJY-BA2F

Hai, M., Fang, Z., and Li, Z. (2022). Does business Group's conscious of social responsibility enhance its investment efficiency? Evidence from ESG disclosure of China's listed companies. Sustainability 14:4817. doi: 10.3390/su14084817

Iatridis, G. E. (2011). Accounting disclosures, accounting quality and conditional and unconditional conservatism. Int. Rev. Finance Anal. 20, 88–102. doi: 10.1016/j.irfa.2011.02.013

Jones, F. L., and Raghunandan, K. (1998). Client risk and recent changes in the market for audit services. J. Account. Public Policy 17, 169–181. doi: 10.1016/S0278-4254(97)10002-3

Khurana, I. K., and Raman, K. K. (2004). Litigation risk and the financial reporting credibility of big 4 versus non-big 4 audits: evidence from Anglo-American countries. Account. Rev. 79, 473–495. doi: 10.2308/accr.2004.79.2.473

Kim, Y., Park, M. S., and Wier, B. (2012). Is earnings quality associated with corporate social responsibility? Account. Rev. 87, 761–796. doi: 10.2308/accr-10209

Kim, J. B., and Song, B. Y. (2011). Auditor quality and loan syndicate structure. Audit. J. Prac. Theory 30, 71–99. doi: 10.2308/ajpt-10144

Kolk, A., and Margineantu, A. (2009). Globalization regionalization of accounting firms and their sustainability services. Int. Mark. Rev. 26, 396–410. doi: 10.1108/02651330910971959

Lambert, R., Leuz, C., and Verrecchia, R. E. (2007). Accounting information, disclosure, and the cost of capital. J. Account. Res. 45, 385–420. doi: 10.1111/j.1475-679X.2007.00238.x

Lee, J., and Kim, E. (2020). The influence of corporate environmental responsibility on over Investment behavior: evidence from South Korea. Sustainability 12:1901. doi: 10.3390/su12051901

Li, X. T. (2009). Managerial entrenchment with strategic information technology: a dynamic perspective. J. Manage. Inf. Syst. 25, 183–204. doi: 10.2753/MIS0742-1222250406

Lins, K. V., Servaes, H., and Tamayo, A. (2017). Social capital, trust, and firm performance: the value of corporate social responsibility during the financial crisis. J. Finance 72, 1785–1824. doi: 10.1111/jofi.12505

Liu, Z., Li, W., Hao, C., and Liu, H. (2021). Corporate environmental performance and financing constraints: An empirical study in the Chinese context. Corp. Soc. Responsib. Environ. Manage. 28, 616–629. doi: 10.1002/csr.2073

Malik, M. (2015). Value-enhancing capabilities of CSR: a brief review of contemporary literature. J. Bus. Ethics 127, 419–438. doi: 10.1007/s10551-014-2051-9

Mansi, S. A., Maxwell, W. F., and Miller, D. P. (2004). Does auditor quality and tenure matter to investors? Evidence from the bond market. J. Account. Res. 42, 755–793. doi: 10.1111/j.1475-679X.2004.00156.x

Matten, D., and Moon, J. (2008). “Implicit” and “explicit” CSR: a conceptual framework for a comparative understanding of corporate social responsibility. Acad. Manage. Rev. 33, 404–424. doi: 10.5465/amr.2008.31193458

Minutolo, M. C., Kristjanpoller, W. D., and Stakeley, J. (2019). Exploring environmental, social, and governance disclosure effects on the S&P 500 financial performance. Bus. Strategy Environ. 28, 1083–1095. doi: 10.1002/bse.2303

Mitton, T. (2002). A cross-firm analysis of the impact of corporate governance on the east Asian financial crisis. J. Finance Econ. 64, 215–241. doi: 10.1016/S0304-405X(02)00076-4

Palazuelos, E., Crespo, A. H., and del Corte, J. M. (2018). Accounting information quality and trust as determinants of credit granting to SMEs: the role of external audit. Small Bus. Econ. 51, 861–877. doi: 10.1007/s11187-017-9966-3

Pinkowitz, L., Stulz, R., and Williamson, R. (2006). Does the contribution of corporate cash holdings and dividends to firm value depend on governance? Across-country analysis. J. Finance 61, 2725–2751. doi: 10.1111/j.1540-6261.2006.01003.x

Qin, D., and Song, H. (2009). Sources of investment inefficiency: the case of fixed-asset Investment in China. J. Dev. Econ. 90, 94–105. doi: 10.1016/j.jdeveco.2008.06.001

Qureshi, M. A., Kirkerud, S., Theresa, K., and Ahsan, T. (2019). The impact of sustainability (environmental, social, and governance) disclosure and board diversity on firm value: the moderating role of industry sensitivity. Bus. Strategy Environ. 29, 1199–1214. doi: 10.1002/bse.2427

Richardson, S. (2006). Over-investment of free cash flow. Rev. Acc. Stud. 11, 159–189. doi: 10.1007/s11142-006-9012-1

Samet, M., and Jarboui, A. (2017). How does corporate social responsibility contribute to investment efficiency? J. Multinatl. Finance Manage. 40, 33–46. doi: 10.1016/j.mulfin.2017.05.007

Spence, M. (1973). Job Market Signaling. Q. J. Econ. 87, 355–374. doi: 10.2307/1882010

Stulz, R. M. (1990). Managerial discretion and optimal financing policies. J. Finance Econ. 26, 3–27. doi: 10.1016/0304-405X(90)90011-N

Sun, W., Li, X., Geng, Y., Yang, J., and Zhang, Y. (2020). Board interlocks and the diffusion of CSR reporting practices: the role of market development. Corp. Soc. Responsibility Environ. Manage 27, 1333–1343. doi: 10.1002/csr.1887

Sun, W., Zhao, C., and Cho, C. H. (2019). Institutional transitions and the role of financial performance in CSR reporting. Corp. Soc. Responsibility Environ. Manage. 26, 367–376. doi: 10.1002/csr.1688

Taliento, M., Favino, C., and Netti, A. (2019). Impact of environmental, social, and governance information on economic performance: evidence of a corporate ‘sustainability advantage’ from Europe. Sustainability 11:1738. doi: 10.3390/su11061738

Teoh, S. H., and Wong, T. J. (1993). Perceived auditor quality and the earnings response coefficient. Account. Rev. 68, 346–366.

Xu, P., and Bai, G. (2019). Board governance, sustainable innovation capability and corporate expansion: empirical data from private listed companies in China. Sustainability 11:3529. doi: 10.3390/su11133529

Yoon, B., Lee, J., and Byun, R. (2018). Does ESG performance enhance firm value? Evidence from Korea. Sustainability 10:3635. doi: 10.3390/su10103635

Zeng, S., Qin, Y., and Zeng, G. (2019). Impact of corporate environmental responsibility on investment efficiency: the moderating roles of the institutional environment and consumer environmental awareness. Sustainabilityss 11:4512. doi: 10.3390/su11174512

Zhang, Q., Loh, L., and Wu, W. (2020). How do environmental, social and governance initiatives affect innovative performance for corporate sustainability? Sustainability 12:3380. doi: 10.3390/su12083380

Keywords: ESG performance, auditing quality, investment efficiency, emerging countries, China

Citation: Wang W, Yu Y and Li X (2022) ESG performance, auditing quality, and investment efficiency: Empirical evidence from China. Front. Psychol . 13:948674. doi: 10.3389/fpsyg.2022.948674

Received: 08 June 2022; Accepted: 01 September 2022; Published: 12 October 2022.

Reviewed by:

Copyright © 2022 Wang, Yu and Li. This is an open-access article distributed under the terms of the Creative Commons Attribution License (CC BY) . The use, distribution or reproduction in other forums is permitted, provided the original author(s) and the copyright owner(s) are credited and that the original publication in this journal is cited, in accordance with accepted academic practice. No use, distribution or reproduction is permitted which does not comply with these terms.

*Correspondence: Xuan Li, [email protected]

Disclaimer: All claims expressed in this article are solely those of the authors and do not necessarily represent those of their affiliated organizations, or those of the publisher, the editors and the reviewers. Any product that may be evaluated in this article or claim that may be made by its manufacturer is not guaranteed or endorsed by the publisher.

• Search Search Please fill out this field.

What Is an Investment Thesis?

• Understanding the Thesis

Special Considerations

• What's Included?

The Bottom Line

• Portfolio Management

Investment Thesis: An Argument in Support of Investing Decisions

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

The term investment thesis refers to a reasoned argument for a particular investment strategy, backed up by research and analysis. Investment theses are commonly prepared by (and for) individual investors and businesses. These formal written documents may be prepared by analysts or other financial professionals for presentation to their clients.

Key Takeaways

• An investment thesis is a written document that recommends a new investment, based on research and analysis of its potential for profit.
• Individual investors can use this technique to investigate and select investments that meet their goals.
• Financial professionals use the investment thesis to pitch their ideas.

Understanding the Investment Thesis

As noted above, an investment thesis is a written document that provides information about a potential investment. It is a research- and analysis-based proposal that is usually drafted by an investment or financial professional to provide insight into investments and to pitch investment ideas. In some cases, the investor will draft their own investment thesis, as is the case with venture capitalists and private equity firms.

This thesis can be used as a strategic decision-making tool. Investors and companies can use a thesis to decide whether or not to pursue a particular investment, such as a stock or acquiring another company. Or it can be used as a way to look back and analyze why a particular decision was made in the first place—and whether it was the right one. Putting things in writing can have a huge impact on the direction of a potential investment.

Let's say an investor purchases a stock based on the investment thesis that the stock is undervalued . The thesis states that the investor plans to hold the stock for three years, during which its price will rise to reflect its true worth. At that point, the stock will be sold at a profit. A year later, the stock market crashes, and the investor's pick crashes with it. The investor recalls the investment thesis, relies on the integrity of its conclusions, and continues to hold the stock.

That is a sound strategy unless some event that is totally unexpected and entirely absent from the investment thesis occurs. Examples of these might include the 2007-2008 financial crisis or the Brexit vote that forced the United Kingdom out of the European Union (EU) in 2016. These were highly unexpected events, and they might affect someone's investment thesis.

If you think your investment thesis holds up, stick with it through thick and thin.

An investment thesis is generally formally documented, but there are no universal standards for the contents. Some require fast action and are not elaborate compositions. When a thesis concerns a big trend, such as a global macro perspective, the investment thesis may be well documented and might even include a fair amount of promotional materials for presentation to potential investing partners.

Portfolio management is now a science-based discipline, not unlike engineering or medicine. As in those fields, breakthroughs in basic theory, technology, and market structures continuously translate into improvements in products and in professional practices. The investment thesis has been strengthened with qualitative and quantitative methods that are now widely accepted.

As with any thesis, an idea may surface but it is methodical research that takes it from an abstract concept to a recommendation for action. In the world of investments, the thesis serves as a game plan.

What's Included in an Investment Thesis?

Although there's no industry standard, there are usually some common components to this document. Remember, an investment thesis is generally a proposal that is based on research and analysis. As such, it is meant to be a guide about the viability of a particular investment.

Most investment theses include (but aren't limited to) the following information:

• The investment in question
• The investment goal(s)
• Viability of the investment, including any trends that support the investment
• Potential downsides and risks that may be associated with the investment
• Costs and potential returns as well as any losses that may result

Some theses also try to answer some key questions, including:

• Does the investment align with the intended goal(s)?
• What could go wrong?
• What do the financial statements say?
• What is the growth potential of this investment?

Putting everything in writing can help investors make more informed decisions. For instance, a company's management team can use a thesis to decide whether or not to pursue the acquisition of a rival. The thesis may highlight whether the target's vision aligns with the acquirer or it may identify opportunities for growth in the market.

Keep in mind that the complexity of an investment thesis depends on the type of investor involved and the nature of the investment. So the investment thesis for a corporation looking to acquire a rival may be more in-depth and complicated compared to that of an individual investor who wants to develop an investment portfolio.

Examples of an Investment Thesis

Portfolio managers and investment companies often post information about their investment theses on their websites. The following are just two examples.

Morgan Stanley

Morgan Stanley ( MS ) is one of the world's leading financial services firms. It offers investment management services, investment banking, securities, and wealth management services. According to the company, it has five steps that make up its investment process, including idea generation, quality assessment, valuation, risk management , and portfolio construction.

When it comes to developing its investment thesis, the company tries to answer three questions as part of its quality assessment step:

• "Is the company a disruptor or is it insulated from disruptive change? 
• Does the company demonstrate financial strength with high returns on invested capital, high margins, strong cash conversion, low capital intensity and low leverage? 
• Are there environmental or social externalities not borne by the company, or governance and accounting risks that may alter the investment thesis?"

Connetic Ventures

Connetic Adventures is a venture capital firm that invests in early-stage companies. The company uses data to develop its investment thesis, which is made up of three pillars. According to its blog, there were three pillars or principles that contributed to Connetic's venture capital investment strategy. These included diversification, value, and follow-on—each of which comes with a pro and con.

Why Is an Investment Thesis Important?

An investment thesis is a written proposal or research-based analysis of why investors or companies should pursue an investment. In some cases, it may also serve as a historical guide as to whether the investment was a good move or not. Whatever the reason, an investment thesis allows investors to make better, more informed decisions about whether to put their money into a specific investment. This written document provides insight into what the investment is, the goals of the investment, any associated costs, the potential for returns, as well as any possible risks and losses that may result.

Who Should Have an Investment Thesis?

An investment thesis is important for anyone who wants to invest their money. Individual investors can use a thesis to decide whether to purchase stock in a particular company and what strategy they should use, whether it's a buy-and-hold strategy or one where they only have the stock for a short period of time. A company can craft its own investment thesis to help weigh out whether an acquisition or growth strategy is worthwhile.

How Do You Create an Investment Thesis?

It's important to put your investment thesis in writing. Seeing your proposal in print can help you make a better decision. When you're writing your investment thesis, be sure to be clear and concise. Make sure you do your research and include any facts and figures that can help you make your decision. Be sure to include your goals, the potential for upside, and any risks that you may come across. Try to ask and answer some key questions, including whether the investment meets your investment goals and what could go wrong if you go ahead with the deal.

It's always important to have a plan, especially when it comes to investing. After all, you are putting your money at risk. Having an investment thesis can help you make more informed decisions about whether a potential investment is worth your while. Make sure you put your thesis in writing and answer some key questions about your goals, costs, and potential outcomes. Having a concrete proposal in place can spell the difference between earning returns and losing all your money. And that's if your thesis supports the investment in the first place.

Harvard Business School. " Writing a Credible Investment Thesis ."

Lanturn. " What is an Investment Thesis and 3 Tips to Make One ."

Morgan Stanley. " Global Opportunity ."

Medium. " The Data That Built Our Fund's Investment Thesis ."

• Terms of Service
• Editorial Policy
• Privacy Policy
• Your Privacy Choices

• Job Seekers

Investment Thesis: An Argument in Support of Investing Decisions

October 29, 2023 by Abi Tyas Tunggal

An investment thesis is a well-reasoned argument that supports a specific investment decision, playing a vital role in the strategic planning process for individual investors and businesses alike. It comprises detailed research and analysis to evaluate an investment's potential profitability. A good investment thesis serves multiple purposes, including helping in the decision-making process, providing a comprehensive framework for monitoring and assessment, and offering a structured approach to identifying potential opportunities.

There are different types of investment strategies, such as venture capital , private equity, and long-term value investments. The core of an investment thesis involves identifying key parameters for evaluating an investment, understanding the unique market dynamics and competitive landscape, and realizing how to create value through strategic planning. To ensure a comprehensive and detailed investment thesis, it is crucial to involve thorough research, considering emerging trends and opportunities, and incorporating industry case studies for better understanding. Ultimately, financial statements and valuation metrics play a significant role in determining a well-suited investment decision.

Key Takeaways

• An investment thesis is a well-reasoned, research-based argument supporting a specific investment decision
• There are several types of investment strategies, and a well-structured investment thesis addresses market dynamics and competition to create value
• Research, valuation metrics, and understanding emerging trends are crucial in crafting a compelling investment ideas

Defining an Investment Thesis

An investment thesis is a well-structured, logical argument that justifies a particular investment decision, based on thorough research and analysis. It is essential for investors, as well as financial professionals in the domains of investment banking, private equity, hedge funds, and venture capital funds . A confident and knowledgeable investor will build out clear investment criteria to successfully navigate the investment landscape.

The primary purpose of an investment thesis is to outline the reasons and expected outcomes of a proposed investment, often focusing on the potential for growth and profit. This document offers a roadmap for investors, guiding them through their decision-making process, and helping to ensure that they arrive at rational and informed conclusions. A comprehensive investment thesis should consider various aspects, such as market conditions, competitive landscape, and financial performance of the targeted asset or company.

A strong investment thesis is built on rigorous market research and analysis. This involves evaluating historical and current financial information, as well as scrutinizing industry trends and the overall economic environment. Skilled investors will also incorporate their expertise in the industry to better assess the merits of an investment opportunity. This level of thoroughness creates a confidently expressed thesis, allowing investors to remain steadfast in their investment decisions, even amid market volatility.

In summary, an investment thesis plays a pivotal role in the investing process. It presents a well-reasoned argument, grounded in extensive research and clear analysis, that supports an investment decision. Crafting a robust investment thesis is crucial for both individual and institutional investors as it provides a solid foundation for investment choices and ensures the alignment of investment strategies with long-term objectives.

Importance of Research in Crafting an Investment Thesis

Thorough research is a crucial aspect of creating a solid investment thesis. It allows investors to gather vital information and insights that will help guide their investment decisions. There are several elements to consider while conducting this research, with data analysis, understanding risks, and returns being essential components.

Data Analysis

Data analysis forms the backbone of any research conducted for crafting an investment thesis. It involves collecting, organizing, and interpreting various types of data, such as financial statements, market trends, and industry forecasts, to identify patterns and make informed predictions about a potential investment opportunity. A comprehensive data analysis can help investors make confident choices based on reliable information, which is essential for a successful investment strategy.

Some key data analysis techniques used in crafting an investment thesis include:

• Comparative analysis: Comparing the performance of different companies within the same industry to identify investment opportunities.
• Trend analysis: Monitoring historical data to determine patterns and potential future developments.
• Financial statement analysis: Examining the financial health of a company through its balance sheets, income statements, and cash flow statements.

Understanding Risks and Returns

One of the primary goals of research in developing an investment thesis is to assess the risk/reward profile of a potential investment. This involves evaluating the potential risks associated with the investment and weighing them against the expected returns. A sound investment thesis should demonstrate a clear understanding of these risks and offer a rationale for why the investment’s potential returns make it a worthwhile addition to a portfolio.

Some common risks to consider when crafting an investment thesis include:

• Market risk: The risk of an investment losing value due to fluctuations in the market.
• Credit risk: The risk that a company or issuer of a financial instrument may default on its obligations.
• Operational risk: The risk of losses arising from failed internal processes, systems, or personnel within a business.

Evaluating these risks requires investors to develop a deep understanding of the investment opportunity, its industry, and the factors that may impact its performance. A diligent and systematic approach to research can help investors identify potential risks and gains, leading to informed and confident decision-making in crafting a strong investment thesis.

Types of Investment Strategy

When it comes to crafting an investment thesis, selecting an appropriate investment strategy is crucial. In this section, we will discuss two popular strategies: Value Investing and Growth Investing.

Value Investing

Value investing is a strategy that focuses on identifying undervalued stocks or assets in the market. These investments typically have lower valuations, which are reflected in their price-to-earnings ratios or book values. The central idea behind value investing is that the market may sometimes undervalue a company or asset, presenting an opportunity for investors willing to do thorough research and analysis.

The process of value investing involves:

• Fundamental analysis : Evaluating a company's financial health, management, and competitive advantages
• Value metrics : Identifying various valuation metrics, such as price-to-earnings, price-to-book, and dividend yield
• Margin of safety : Discovering investment opportunities with a built-in cushion to reduce the risk of loss

Famous investors, such as Warren Buffett and Benjamin Graham, have implemented value investing strategies to achieve long-term success.

Growth Investing

On the other hand, growth investing centers on companies that are expected to grow at an above-average rate compared to their industry. Growth investors seek opportunities in businesses they believe will offer substantial capital appreciation through rapid expansion or market-share gains. They prioritize the potential for future profit over the stock's valuation.

Features of growth investing include:

• High expectations : Companies targeted by growth investors typically have a history of robust revenue and profit growth
• Momentum : Investors seek stocks with upward price momentum, as increasing demand for these stocks may drive prices even higher
• Risk tolerance : Growth stocks can be volatile, and investors must be prepared to weather price swings

Renowned growth investors like Peter Lynch and Phil Fisher have demonstrated the effectiveness of growth investing throughout their careers.

Both value and growth investing strategies have their unique advantages and require different levels of risk tolerance. Investors should carefully consider their investment thesis and select a strategy that aligns with their objectives and risk appetite.

Venture Capital and Private Equity Investment Theses

When considering investments in private companies, venture capital (VC) and private equity (PE) firms each have their own unique strategies encapsulated within their respective investment theses. These theses provide guidance on the focus of investments, the sectors or geographies of interest, and the stage of the target companies.

Learn more about the differences between private equity and venture capital .

Venture Capital Investment Thesis

A venture capital investment thesis outlines how a VC fund aims to make money for its investors, typically referred to as Limited Partners (LPs). This strategy identifies crucial factors such as the stage of companies the fund will invest in, commonly early-stage companies, the targeted geography, and specific sectors of focus.

The thesis may vary depending on a venture capitalist's unique specialization, with some firms concentrating on a specific vertical and stage, while others invest more broadly without a core thesis driving their decisions. The underlying objective of a VC investment thesis is to outline how the firm will achieve high returns on investment by supporting and nurturing the growth of portfolio companies.

Private Equity Investment Thesis

In contrast, a private equity investment thesis is an evidence-based case in support of a particular investment opportunity. It usually begins with a concise argument illustrating how the potential deal supports the fund's general investment strategy. The thesis then provides details that substantiate this preliminary conclusion.

Private equity firms often target more established companies compared to venture capital firms, focusing on businesses with a proven track record. The PE investment thesis may identify areas where operational improvements, strategic mergers, or better capital structures could enhance value, ultimately generating a good return for the firm and its investors.

Overall, both venture capital and private equity investment theses serve as critical frameworks guiding investment decisions. They not only help align these decisions with a firm's specialized strategy but also provide a basis for evaluating potential deals to ensure they contribute to the firm's goals and long-term value creation.

Key Parameters for Evaluating an Investment

When assessing the viability of an investment, it is essential to examine various key parameters to make informed decisions. By analyzing these factors, investors can gain a deeper understanding of a company's financial health and its potential for growth.

One vital metric to consider is earnings per share (EPS) , which represents the portion of a company's profit attributed to each outstanding share of its common stock. A higher EPS indicates higher earnings and suggests that the company may be a lucrative investment opportunity.

Another fundamental metric is the return on assets (ROA) , which measures the effectiveness of a company in using its assets to generate profit. The higher the ROA, the better the company is at utilizing its assets to generate earnings. Similarly, return on equity (ROE) is a measure of financial performance that calculates the proportion of net income generated by a company's equity. A higher ROE demonstrates the efficient usage of shareholders' investments.

Conducting a thorough analysis of the company's financial statements is crucial. This includes reviewing income statements, balance sheets, and cash flow statements. By doing so, investors can gain insights into the company's profitability, liquidity, and solvency.

Another important factor to consider is a company's cash position. Adequate cash reserves enable a company to meet its short-term obligations and invest in growth opportunities. On the other hand, a lack of cash can leave a company vulnerable to market fluctuations and financial stress.

It is also essential to evaluate a company's capital structure, which refers to the proportion of debt and equity financing it uses to fund its operations. A balanced capital structure ensures financial stability, while excessive debt may lead to financial distress.

Examining a company's debt level is crucial, as it can directly impact the company's financial flexibility and risk profile. A high level of debt can hinder a company's ability to grow and adapt to changes in the market, making it a less attractive investment option.

Assessing a company's assets and how they're managed plays a significant role in evaluating an investment opportunity. This includes tangible assets, such as property and equipment, and intangible assets, such as patents and trademarks. Effective asset management contributes to a company's ability to generate profit.

Finally, it is important to scrutinize a company's costs associated with its operations, such as production costs and overhead expenses. A company that efficiently manages its costs will likely generate higher profitability and provide better returns for investors.

Creating Value through Strategic Planning

Strategic planning plays a crucial role in creating value for investors and businesses. It serves as the foundation for effective decision-making and guides companies towards achieving their goals. Through strategic planning, management teams can identify and focus on core competencies that contribute to a company's competitive advantage.

One way to create value is to prioritize revenue growth. By identifying key growth drivers, such as product innovation or market expansion, companies can allocate resources accordingly to boost earnings. Such targeted investments in growth engines allow firms to capture a larger market share and drive long-term profitability.

Another aspect of strategic planning involves optimizing a company's holdings. By assessing the existing portfolio, management can decide whether to divest underperforming assets or make strategic acquisitions that align with their investment thesis. The right combinations and adjustments can significantly enhance a company's overall performance and shareholder value.

Risk management is also an essential aspect of strategic planning. Companies must assess potential risks and incorporate suitable mitigation measures in their plans. This ensures that organizations are prepared for unforeseen circumstances, which can safeguard profits and protect the company's assets.

Furthermore, creating value requires continuous improvement and adaptation to market trends. Companies should routinely reevaluate their strategies to identify both internal and external factors that may impact their current position. By setting clearly defined objectives and quantifiable financial targets, management teams can measure their progress effectively and adjust their strategic plans as needed.

In summary , creating value through strategic planning involves a combination of focusing on core competencies, prioritizing revenue growth, optimizing holdings, managing risk, and continuously reassessing the company's strategic direction. This holistic approach can help businesses enhance their profitability, strengthen their market position, and ultimately deliver strong value creation to investors.

Understanding the Market and Competition

Before developing an investment thesis, it is crucial to have a deep understanding of the market and its competition. The stock market is influenced by various factors such as economic supercycles, bear markets, and secular trends. Analyzing these elements will provide a solid foundation to recognize potential investment opportunities.

An economic supercycle is a long-term pattern that occurs over several decades, during which the economy undergoes periods of growth and contraction. Investors need to be aware of the current phase and how it may impact their investment decisions. For instance, during a growth period, certain industries tend to outperform, while others may underperform during a contraction phase.

In addition to analyzing these market conditions, investors must also pay heed to the competitive landscape of the sector in which they plan to invest. Examining the competitors within the industry enables one to identify companies with competitive advantages, which may lead to superior performance. These advantages can stem from factors such as lower costs, innovation, or a dominant market share.

A bear market occurs when the stock market experiences a prolonged decline, typically characterized by a decrease of 20% or more from recent highs. In such environments, it becomes even more crucial for investors to understand the competitive dynamics within an industry to identify resilient companies that can withstand market downturns.

A secular trend is a long-term movement in a particular direction that can last for several years or even decades. Identifying secular trends within industries is essential to spotting opportunities for long-term growth. For example, investors may capitalize on sectors benefiting from a shift towards clean energy usage or the increasing importance of artificial intelligence.

In summary, understanding the market and competition requires a deep analysis of the stock market, economic supercycles, bear markets, and secular trends. By researching industry trends, evaluating market opportunities, and assessing the strengths and weaknesses of competitors, investors can develop a robust investment thesis that increases the likelihood of achieving long-term returns.

Industry Case Studies

In the investment world, the importance of an investment thesis cannot be overstated. By examining various industry case studies, we can gain insight into how businesses make strategic investments to enhance their value. In this section, we'll discuss notable examples from companies such as DuPont, General Motors, Rexam PLC, and Clear Channel Communications.

DuPont is a leading science and innovation company with a focus on agriculture, advanced materials, and industrial biosciences. During its acquisition of Dow Chemical, DuPont developed a robust investment thesis to justify the merger. Their investment case relied on the belief that the combined entity would benefit from increased operational efficiencies, new market opportunities, and enhanced innovation capabilities. This approach provided a strong rationale for the deal, which has created a more competitive company in the global market.

General Motors (GM) , a multinational automobile manufacturer, crafted its investment thesis in response to evolving trends in the automotive industry, such as the increasing importance of emissions reduction, electrification, and autonomous technology. GM's investment case centered on embracing these trends, focusing on innovation, and expanding its product offerings through strategic M&A, investments, and partnerships. For example, GM has made significant investments in electric vehicles and autonomous driving technology, positioning the company for future growth in these areas.

Next, we have Rexam PLC , a former British packaging manufacturer that was a leading producer of beverage cans globally. When Ball Corporation sought to acquire Rexam, they developed an investment thesis based on the value derived from combining the two companies' strengths. This thesis outlined the strategic fit between both companies, synergies from combining production capabilities, and projected growth, particularly in developing markets. The successful acquisition helped Ball Corporation consolidate its position as a global leader in the packaging industry.

Lastly, Clear Channel Communications is a media company specializing in outdoor advertising. As the company sought to expand its presence in this sector, it created an investment thesis centered around leveraging its core competence in outdoor advertising and acquiring strategic assets. One example is Clear Channel's acquisition of crucial billboard locations to solidify its competitive edge in the outdoor advertising market. This targeted growth strategy has allowed Clear Channel to remain a dominant player in the industry.

In conclusion, these industry case studies demonstrate the value of a well-crafted investment thesis. Effective investment theses provide a roadmap for companies to pursue strategic acquisitions and investments that create long-term value, while also helping investors evaluate the viability of proposed deals. By understanding how companies like DuPont, General Motors, Rexam PLC, and Clear Channel Communications have strategically invested in the market, we can better appreciate the importance of a well-structured investment thesis.

Long-Term Investment Strategies

A long-term investment strategy refers to an approach where investors hold onto their investments for an extended period, typically more than one year. This type of strategy aims to achieve the investment goal by allowing assets to grow through market fluctuations and capitalizing on the power of compounding interest. Diversification and patience play pivotal roles in ensuring the success of a long-term investment strategy.

Portfolio managers often use various techniques and methods to craft long-term investment portfolios. Some of these techniques include targeting undervalued sectors or stocks, dividend reinvestment plans, dollar-cost averaging, and asset allocation. By employing these strategies, portfolio managers increase chances of achieving their clients' investment goals over time.

In order to develop long-term investment strategies, investors should first define their investment goal . This could include objectives such as saving for retirement, funding a child's college education, or purchasing a home. Clear investment goals help in designing an appropriate investment strategy, taking into account factors like the investor's risk tolerance, time horizon, and available capital.

One key aspect of a successful long-term strategy is diversification . Diversifying across asset classes and industries allows investors to spread risks and potentially achieve higher risk-adjusted returns. A well-diversified portfolio will typically consist of a mix of stocks, bonds, and other asset types, with variations in investment size, industry sector, and geographical location. This diversified approach minimizes the impact of underperforming investments on the overall portfolio.

Another crucial element in long-term investing is patience . Market fluctuations can be tempting for investors to react to their emotions and make impulsive decisions, which could derail a well-thought-out investment strategy. Maintaining a disciplined approach and sticking to one's investment plan, even during periods of market volatility, is paramount to achieving long-term success.

In conclusion, long-term investment strategies require investors to define clear goals, diversify their portfolio, and exercise patience in the face of market fluctuations. By adhering to these principles, investors and portfolio managers can steer a course towards achieving their investment objectives.

Emerging Trends and Opportunities

In recent years, various emerging trends have presented attractive opportunities for investors. Among these trends, renewable energy, megatrends, and the coffee shop market stand out as sectors with significant potential for growth.

Renewable energy has gained considerable attention and investment as a response to the global push for addressing climate change and reducing emissions. Solar, wind, and hydroelectric power are some of the most prominent technologies in this sector. With an increased interest in clean energy from both governments and consumers, companies in this space are poised to experience substantial growth.

Megatrends such as urbanization, aging populations, and technological advancements are also influencing investment opportunities. These large-scale shifts provide a backdrop for businesses to tap into new markets and adjust their strategies to capitalize on these changes. For instance, companies working in healthcare and biotechnology may benefit from catering to the needs of an aging population, while businesses focused on artificial intelligence (AI) and automation may find increased demand due to technological advancements.

The coffee shop market, too, presents investment opportunities. This industry has experienced robust growth in recent years as consumers increasingly seek out unique, high-quality coffee experiences. Independent and specialty coffee shops are at the forefront of this trend. Niche coffee shops that offer novel and authentic experiences have seen success by catering to the specialized preferences of today's consumers. As the demand for artisanal and premium beverages continues to rise, businesses operating in this space can expect to have ample opportunities for growth.

In conclusion, current emerging trends such as renewable energy, megatrends, and the coffee shop market offer a wealth of investment opportunities. As these sectors continue to develop and evolve, investors with well-informed investment theses stand to benefit from the potential rewards in these growing industries.

Role of Financial Statements and Valuation Metrics

Financial statements play a vital role in the investment thesis by providing crucial information about a company's financial health and performance. They consist of the balance sheet, income statement, and cash flow statement, which offer insights into the company's assets, liabilities, revenues, expenses, and cash flows. Investors use these statements to assess the company's past performance, current financial condition, and potential for future growth.

Valuation metrics, on the other hand, are vital yardsticks that investors use to compare different investment opportunities and make informed decisions. These metrics include price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, price-to-book (P/B) ratio, dividend yield, and return on equity (ROE), among others. By analyzing these ratios, investors can gauge a company's value relative to its peers and make better investment choices.

Analysts and investors scrutinize financial statements to identify growth trends, profitability, and financial stability. For instance, they may calculate the gross margin, operating margin, and net profit margin to determine the company's profitability across different stages of its operations. Additionally, they examine liquidity ratios, such as the current ratio and quick ratio, to assess the company's ability to meet its short-term obligations.

Valuation metrics provide a quantitative basis for comparing investment opportunities within the same industry or across different sectors. For example, a lower P/E ratio may indicate that a stock is undervalued, while a high P/E ratio might suggest overvaluation. Moreover, the P/B ratio can help investors determine if a stock is undervalued by comparing its market price to its book value.

Another key valuation metric is the dividend yield, which measures the annual dividend income per share relative to the stock's price. A higher dividend yield may attract income-oriented investors, while a lower yield might be more appealing to growth-focused investors. Furthermore, the ROE ratio, which measures a company's profitability in relation to its equity base, is an essential metric for evaluating the efficiency of management in creating shareholder value.

In conclusion, financial statements and valuation metrics are indispensable tools for investors to evaluate a company's financial health and investment attractiveness. By analyzing these data points, investors can make well-informed investment decisions that align with their risk tolerance and investment objectives.

Concluding Thoughts on Crafting a Compelling Investment Thesis

Crafting a compelling investment thesis is crucial for informed investing decisions, as it helps investors thoroughly analyze a potential opportunity. A well-researched investment thesis demonstrates the investor's conviction level and reinforces their confidence in the investment choice. This process involves a deep understanding of the business, its value drivers, and its potential growth trajectories.

A strong investment thesis should be definitive, clearly articulating the reasoning behind the opportunity and the expected returns. This allows investors to stay focused on their goals and maintain their conviction, even when the stock's price movement does not align with their expectations.

By adopting a confident, knowledgeable, and neutral tone, investors can effectively communicate their investment thesis to others. Clarity in presenting the investment case is essential for persuading potential partners or stakeholders to support the opportunity. Utilizing formatting tools such as tables and bullet points can aid in conveying essential information efficiently and ensuring the investment thesis is easy to understand.

In summary, crafting a compelling investment thesis enables investors to make well-informed decisions that align with their financial goals. By developing a thorough understanding of the investment opportunity and maintaining a strong conviction level, investors can better navigate the market and achieve long-term success.

Frequently Asked Questions

How do you develop a strong investment thesis.

A strong investment thesis begins with thorough research on the company or asset in question. This may include looking at the financials, competitive position, management team, industry trends, and future prospects. It's essential to critically analyze the available information, identify potential risks and rewards, and establish a clear rationale for the investment based on this analysis. Staying focused on the long-term outlook and maintaining a disciplined approach to the investment process can also contribute to developing a robust investment thesis.

What are the key elements to include in an investment thesis?

An investment thesis should include the following key elements:

• Overview of the company or asset: Provide a brief background of the company or asset, including its market, size, and competitive positioning.
• Investment rationale: Detail the reasons for investing, such as attractive valuation, strong revenue growth, or a unique business model.
• Risk assessment: Identify potential risks and how they could impact the investment returns.
• Expected return: Estimate the potential financial return based on the identified growth drivers or catalysts.
• Time horizon: Indicate the investment period, typically long-term, during which the thesis is expected to play out.
• Fund size: Specify the amount of invested capital that will be allocated to this particular investment, considering its impact on portfolio construction, liquidity, and potential returns within the overall portfolio strategy

How can one evaluate the success of an investment thesis?

Evaluating the success of an investment thesis involves tracking the progress of the company or asset against its initial expectations and underlying assumptions. This may involve measuring financial performance, analyzing key developments in the industry and the company's position within it, and monitoring potential changes in overall market conditions. It is helpful to revisit the investment thesis regularly to assess its validity and make adjustments as necessary.

What's the difference between an investment thesis for startups and publicly traded companies?

An investment thesis for a startup often focuses on the growth potential of a new or emerging market, considering the innovative products or services the startup offers in that market. Here, the focus may be more on the potential for long-term value creation, the management team's ability to execute on their vision, and market fit.

For publicly traded companies, the investment thesis may include analysis of current financial performance, valuation multiples, and overall market trends. Publicly traded companies have more historical data and financial performance information available, allowing investors to make more informed decisions based on these factors.

How does an investment thesis guide decision-making in private equity?

In private equity, the investment thesis helps guide the selection of companies to invest in, as well as the structuring of deals to acquire those companies. It provides a blueprint for how the private equity firm aims to create value, including plans for operational improvements, financial engineering, or growth strategies. This thesis serves as a basis for monitoring the progress of an investment and helps make decisions on the timing of potential exits.

How can real estate investment theses differ from other sectors?

Real estate investment theses may focus on factors such as location, property type, market dynamics, and demographic trends to identify attractive investment opportunities. The analysis may also take into account macroeconomic factors, such as interest rates and economic growth, which can influence real estate markets. Additionally, real estate investments may be structured as either direct property investments or through financial instruments like Real Estate Investment Trusts (REITs), affecting the underlying investment thesis.

What considerations should a first-time fund manager have when developing a fund's investment thesis?

For a first-time fund manager, crafting a compelling and robust fund's investment thesis is paramount for attracting investors. Given their lack of a track record, these managers need to lean heavily on the research, clarity, and vision articulated in their investment thesis. The thesis should detail how the fund aims to identify ideal investments, especially those in industries with high margins. It should also benchmark the strategies against industry standards to highlight the manager's acumen and awareness of market norms.

How is a stock pitch related to an investment thesis and what role does a target price play in it?

A stock pitch is essentially a condensed, persuasive form of an investment thesis, often presented to stakeholders to advocate for investing in a particular publicly-traded company. A key element of any stock pitch is the target price, which is an estimation of what the stock is worth based on projections and valuation models. This target price serves as a quantitative anchor for the investment thesis, giving stakeholders a specific metric against which to measure potential returns and risks.

• Guest Login

   File Download

• FullText.pdf

   Links for fulltext

     (may require subscription).

• DOI:   10.5353/th_b5270556

Supplementary

• Economics & Finance: Theses
• HKU Theses Online

postgraduate thesis : Product market competition and investment efficiency

• Show simple item record
• Show full item record
• Export item record

Export via OAI-PMH Interface in XML Formats

Export to other non-xml formats.

• Bibliography
• More Referencing guides Blog Automated transliteration Relevant bibliographies by topics
• Automated transliteration
• Relevant bibliographies by topics
• Referencing guides

We've detected unusual activity from your computer network

To continue, please click the box below to let us know you're not a robot.

Why did this happen?

Please make sure your browser supports JavaScript and cookies and that you are not blocking them from loading. For more information you can review our Terms of Service and Cookie Policy .

For inquiries related to this message please contact our support team and provide the reference ID below.

What Is a Self-Directed IRA? Pros and Cons of This Unique Investment Account

Going beyond stocks and bonds, self-directed IRAs bring both opportunity and risk.

What's a Self-Directed IRA?

Getty Images

Best practices for investing in a self-directed IRA include thorough research, diversification and understanding investment risks.

A self-directed individual retirement account is a very specific tax-advantaged vehicle that gives investors the ability to choose investments beyond traditional options such as stocks, bonds and exchange-traded funds, or ETFs .

A self-directed IRA can hold alternative assets such as real estate, private equity, precious metals and other commodities, and cryptocurrencies . They can't hold investments in collectibles, life insurance or real estate you live in.

Advisor's Corner

Advisor's Corner is a collection of columns written by certified financial planners, financial advisors and experts for everyday investors like you.

While self-directed IRAs offer the potential for greater returns, they also require thorough research and understanding of the investment options, as well as compliance with IRS regulations to maintain tax-advantaged status. Here's what you need to know about self-directed IRAs:

• Know the rules and risks of a self-directed IRA.
• Pros of a self-directed IRA.
• Cons of a self-directed IRA.
• Does a self-directed IRA have higher returns?
• Potential pitfalls of self-directed IRAs.
• Best practices when investing in a self-directed IRA.

Know the Rules and Risks of a Self-Directed IRA

"A self-directed IRA is a sharp object, meaning the user should read the safety manual before proceeding," says Christopher Shepler, a chartered financial analyst who serves as vice president and investment officer at Fiduciary Trust Co. in Boston.

For example, he says, many people are familiar with TV commercials featuring an actor who touts the benefits of buying gold in a self-directed IRA. "There may or may not be a good thesis for buying gold, but the celebrity is not considering the questions of asset location and tax efficiency," Shepler says. "Gold doesn't pay interest or dividends, so depending on advice from a tax professional, not an actor, it could be better to hold an asset like gold outright rather than in a tax-deferred vehicle."

Pros of a Self-Directed IRA

Beyond investment flexibility, a self-directed IRA offers several benefits. For example, investors can take more control over their retirement savings, potentially leading to higher returns. In addition, self-directed IRAs provide the opportunity to invest in alternative assets that may not be available through traditional retirement accounts, such as real estate or private equity.

Like other IRAs, they also offer tax advantages.

"Investing through a self-directed IRA provides unique perks that can help bolster your retirement savings," says Ines Zemelman, founder and president of TFX, a New York company that offers tax preparation and other services for U.S. expats. "Built-in tax breaks on the earnings from your investments are one of the key advantages," she says.

She cites the example of an investor who purchases a rental property within a self-directed IRA. Any rental income generated from that property is typically tax-deferred or tax-free within the IRA, depending on whether it's a Roth or a traditional IRA. The property is owned by the IRA and is an investment only, and it cannot be used for personal purposes.

"This means you won't owe taxes on the rental income as long as it remains within the IRA," Zemelman says. "If you sell the rental property for a profit within the IRA, any capital gains from the sale would also be tax-deferred or tax-free, again depending on the type of IRA."

That can result in significant tax savings compared to investing in the same assets outside of a retirement account, where an investor would be subject to immediate taxation on rental income and capital gains.

Cons of a Self-Directed IRA

While self-directed IRAs offer flexibility, they also come with risks and drawbacks .

Investors may face complexity and regulatory compliance issues when managing alternative assets. That's something you don't typically face with a standard IRA holding stocks, bonds or funds.

Additionally, there's a higher potential for fraud or misuse of funds without proper due diligence, and the lack of professional guidance could lead to risky investment decisions.

"The risk is high with non-standard, potentially unregulated investments," says Sean Lovison, a certified financial planner and accountant at Purpose Built in Moorestown, New Jersey. "Payoffs can be enormous, but they should primarily be considered lottery tickets and not make up the bulk of your retirement plan."

For example, holding shares of a pre-initial public offering company may not result in the payday an investor is hoping for. "You need to be realistic about the likelihood of any private company going public and becoming the next Google," Lovison says.

Does a Self-Directed IRA Have Higher Returns?

Because self-directed IRAs offer the opportunity to invest in a wider range of assets, investors may get better returns from alternative investments such as real estate , private equity or precious metals.

Also, the ability to make investment decisions independently allows investors to take advantage of specific market opportunities, potentially leading to greater profitability over the long haul.

Lovison offers an analogy for investors considering a self-directed IRA, which he says can feel like planting an exotic garden.

"While it's riskier and requires more care, the blooms can be extraordinary," he says. "Yes, there's potential for higher returns, especially if you're investing in areas where you have expertise. However, like any garden, it's all about the right conditions: knowledge, timing and a bit of luck."

Potential Pitfalls of Self-Directed IRAs

Investors should be aware that fees may be higher in self-directed IRAs, due to the complexity and administrative burden associated with managing alternative investments .

"The fees are higher as most of these investments must be made manually; think real estate closings," says Jaime Raskulinecz, founder and CEO at Next Generation Trust Co. in Roseland, New Jersey.

Raskulinecz says investors should do their due diligence not only when it comes to self-directed IRAs, but in other areas of financial services.

"If it sounds too good to be true, it usually is. This applies to alternative investments as well," she says.

Raskulinecz adds that some traditional, big-name custodians say they offer self-directed IRAs, but those amount to being able to invest in products that the brokerage sells. "This is much different than true self-direction," she says.

Best Practices When Investing in a Self-Directed IRA

Avoiding prohibited transactions and maintaining accurate records are also crucial for compliance and avoiding penalties.

"Choose a specialized custodian that can guide you to ensure that the tax-advantaged status of the account remains intact," Raskulinecz says.

She suggests talking to that custodian often to avoid inadvertently creating a prohibited transaction. "There are rules that are easy to understand and follow," she says.

She also advises against trying to game the system. "There are plenty of things that are allowed that will give potentially greater gains without deliberately doing something not allowable," she says.

Finally, Raskulinecz says, "Make sure you understand the investments you'd like to make and that you are well versed enough that you can perform due diligence."

Should You Get a Gold IRA?

Rachel Hartman Sept. 7, 2023

U.S. News wants to hear from you!

Send us your topic ideas for the next Advisor's Corner.

Tags: investing , IRAs , retirement , money , real estate , renting , income , capital gains , gold , stock market , Advisor's Corner

The Most Important Ages for Retirement Planning

Comparative assessments and other editorial opinions are those of U.S. News and have not been previously reviewed, approved or endorsed by any other entities, such as banks, credit card issuers or travel companies. The content on this page is accurate as of the posting date; however, some of our partner offers may have expired.

You May Also Like

Oil stocks tied to crude prices.

Wayne Duggan April 19, 2024

7 Best Dividend ETFs to Buy Now

Jeff Reeves April 19, 2024

Best Tech ETFs to Buy

Coryanne Hicks April 19, 2024

15 Best Dividend Stocks to Buy for 2024

Ian Bezek April 19, 2024

Commodity Stocks to Buy for Dividends

Matt Whittaker April 18, 2024

ETF vs. Index Funds: What to Know

Tony Dong April 18, 2024

Best Actively Managed ETFs

Glenn Fydenkevez April 18, 2024

8 Top Nancy Pelosi Stocks to Buy

Wayne Duggan April 18, 2024

7 Best Manufacturing Stocks to Buy Now

Jeff Reeves April 17, 2024

5 Cloud ETFs to Buy Now

Coryanne Hicks April 17, 2024

8 Best Stocks to Buy Now With $1,000

Wayne Duggan April 16, 2024

Mutual Funds vs. Stocks

Marc Guberti April 16, 2024

7 Best Semiconductor ETFs to Buy in 2024

Tony Dong April 16, 2024

7 Best Funds to Hold in a Roth IRA

Money Market Funds to Buy for Safety

Tony Dong April 15, 2024

Smart Tax Strategies

Kate Stalter April 15, 2024

Best Long-Term Stocks to Buy and Hold

Glenn Fydenkevez April 15, 2024

6 Best Nasdaq 100 ETFs

Wayne Duggan April 15, 2024

10 Best Value Stocks to Buy Now

Ian Bezek April 12, 2024

Water Stocks and ETFs

Matt Whittaker April 12, 2024

Create an account

Create a free IEA account to download our reports or subcribe to a paid service.

Clean energy is boosting economic growth

Cite commentary

IEA (2024), Clean energy is boosting economic growth , IEA, Paris https://www.iea.org/commentaries/clean-energy-is-boosting-economic-growth, Licence: CC BY 4.0

Share this commentary

• Share on Twitter Twitter
• Share on Facebook Facebook
• Share on LinkedIn LinkedIn
• Share on Email Email
• Share on Print Print

Clean energy is moving towards centre stage in the global energy system – and as its importance rises, a new clean energy economy is emerging .

Clean electricity accounted for around 80% of new capacity additions to the world’s electricity system in 2023, and electric vehicles for around one out of five cars sold globally. At the same time, global investment in clean energy manufacturing is booming, driven by industrial policies and market demand. Employment in clean energy jobs exceeded that of fossil fuels in 2021 and continues to grow.

Quantifying the expanding role of clean energy in the economy is therefore essential to fully understand the stakes and momentum behind energy transitions.

Clean energy accounted for 10% of global GDP growth in 2023

Our new country-by-country and sector-by-sector analysis finds that in 2023, clean energy added around USD 320 billion to the world economy. This represented 10% of global GDP growth – equivalent to more than the value added by the global aerospace industry in 2023, or to adding an economy the size of the Czech Republic to global output.

This assessment is based on a first-of-its-kind analysis of three categories of activity in the clean energy sector:

• Manufacturing of clean energy technologies : investment in clean energy manufacturing, covering the value chains for solar PV, wind power and battery manufacturing
• Deployment of clean power capacity : investment in deployment of clean electricity generation capacity – such as solar PV, wind power, nuclear power and battery storage – and in electricity networks
• Clean equipment sales : sales of electric cars (EVs) and heat pumps.

It is based on detailed project-by-project data gathered and processed by the International Energy Agency (IEA) from primary and secondary sources. We conducted this analysis at the country level, and present here the in-depth results for four of the largest economies: the United States, the European Union, China and India, which together account for two-thirds of global GDP. 1

GDP in the United States grew by a robust 2.5% in 2023. Clean energy was an important contributor: The Inflation Reduction Act and the Bipartisan Infrastructure Law drove a surge in investment in clean energy manufacturing, and sales of EVs also grew strongly. Consequently, clean energy growth accounted for around 6% of GDP growth in the world’s largest economy in 2023. This is comparable in scale to the contribution to GDP growth in 2023 from the United States’ booming, artificial-intelligence-driven digital economy. 2

Clean energy accounted for around one-fifth of China’s 5.2% GDP growth in 2023. Each of the three categories assessed grew strongly, with the largest increase coming from investment in clean power capacity, followed by clean equipment sales, particularly EVs. Expansion in clean energy manufacturing accounted for around 5% of China’s GDP growth in 2023, although the country’s surplus production capacity in technologies such as batteries (utilisation rates were around 30% in 2023) may limit the scope of this growth driver going forward. Similar assessments have come to comparable conclusions, albeit with slightly different boundaries.  

In the European Union, clean energy accounted for nearly one-third of GDP growth in 2023, the highest share of any region assessed, although its share is inflated by weak overall GDP growth of around 0.5%. Nonetheless, the EU’s strong climate targets and policies, such as the Fit for 55 package and the proposed Net Zero Industry Act, are supporting investments in clean energy manufacturing, which more than doubled between 2022 and 2023, driven in particular by battery manufacturing.

India was the fastest growing large economy in 2023, with GDP increasing by around 7.7%. Clean energy contributed slightly less than 5% of GDP growth in 2023, predominantly from investment in new solar power capacity. Meanwhile, policies such as the Production Linked Incentive are attracting investment in new clean energy manufacturing capacity. In 2023, this remained relatively small as a portion of India’s overall economy, but interest from businesses and investors is increasing.

Contribution of investment and sales in selected clean energy technologies to GDP growth, 2023

Assessing the extent to which different sectors of the clean energy economy contribute to GDP growth from year to year helps show the direction of travel. Yet looking at their share of GDP in a single year is also useful in understanding their economic importance. In 2023, clean energy investment and sales accounted for between 1% and 4% of total GDP in the four major regions assessed – substantial shares in the context of these large and diversified economies. The chemicals industry accounts for about 3% of value added in India and China. Clean energy technologies therefore already provide a sizable contribution to GDP in these economies today.

The clean energy sector also drove a substantial share of total investment growth across the economy in these regions in 2023. In the case of China, it contributed 50% of the growth in total investment in 2023, and 20% in the United States. At the global level, we estimate that around USD 200 billion was invested in clean energy technology manufacturing in 2023, an increase of 75% over the previous year. This compares with global capital investment in semiconductor manufacturing of around USD 170 billion to 250 billion per year in recent years.

Share of investment and sales in selected clean energy technologies in GDP, 2023

Share of investment in selected clean energy technologies in total investment, 2023.

This analysis highlights the scale and weight of the clean energy economy. It shows that it is not only growing quickly, but also has already become a powerful economic force. As energy transitions advance, clean energy’s importance for economies around the world is only set to grow further.

Modernising energy and industrial systems to drive energy transitions requires very large investments and the transformation of huge markets. It also comes with many significant benefits beyond mitigating climate change and reducing air pollution alone; in 2023, 36 million workers were employed across clean energy supply chains.

And while China still leads in investment in the manufacturing of clean energy technologies, other regions are also seeing a jump in projects and investments. The large share of one country has raised questions about the resilience and diversity of global clean energy technology supply chains, but it also currently provides opportunities to accelerate global decarbonisation based on an abundant supply of low-cost clean energy equipment. The analysis developed here highlights the importance of comprehensively assessing the size of the clean energy economy when designing energy, climate and industrial policies.

The estimates for investment in the manufacturing of clean energy technologies come from a first-of-its-kind analysis that builds on methodologies developed in the IEA’s The State of Clean Technology Manufacturing report and Energy Technology Perspectives reports. The detailed findings will be presented in the upcoming Energy Technology Perspectives Special Report Advancing Clean Technology Manufacturing , requested by G7 Leaders at the 2023 Hiroshima Summit in Japan. Investment in the deployment of clean power capacity comes from the forthcoming edition of our World Energy Investment series. Macroeconomic data comes from Oxford Economics, based on national sources, in order to ensure cross-country consistency. 

In 2023 , the “data processing, internet publishing, and other information services” sector contributed around 9% to real growth in gross value added (GVA).

Reference 1

Reference 2, subscription successful.

Thank you for subscribing. You can unsubscribe at any time by clicking the link at the bottom of any IEA newsletter.