Effect of Environmental, Social and Governance Disclosure on Financial Performance of Commercial Banks in Kenya

Abstract

This study investigated the effect of environmental, social, and governance disclosures on the financial performance of commercial banks in Kenya, motivated by the increasing focus on sustainability practices within the financial sector. As stakeholders demand greater transparency in ESG practices, understanding the impact of these disclosures on financial outcomes has become essential for policymakers, investors, and banks. Anchored on the Triple Bottom Line Theory, Stakeholder Theory, and Institutional Theory, this study examined how ESG reporting influences 11 financial performance, as measured by ROA. A descriptive research design was employed, utilizing secondary data from annual reports of 39 commercial banks over five years (2019–2023), yielding 195 observations. Data analysis was conducted, with descriptive statistics, correlation analysis, and multiple regression analysis performed to assess relationships between ESG disclosures and ROA. The model summary showed an R square of 0.304, indicating that 30.4% of the variance in financial performance (ROA) could be explained by the ESG variables and control variables of firm liquidity and size. Regression results revealed significant positive effects of ESG components on ROA, with governance disclosures having the highest coefficient (B = 0.204, p = 0.000), followed by social disclosures (B = 0.157, p = 0.000) and environmental disclosures (B = 0.162, p = 0.001). Firm size also exhibited a positive relationship with ROA (B = 0.293, p = 0.000), while liquidity did not significantly affect financial performance (B = 0.027, p = 0.260). The study concludes that ESG disclosures, particularly governance and social reporting, positively influence the financial performance of Kenyan commercial banks. This suggests that transparent reporting on governance practices, social initiatives, and environmental efforts not only meets regulatory expectations but also enhances stakeholder trust, potentially leading to better financial outcomes. Larger banks, benefiting from economies of scale, may be particularly well-positioned to leverage these disclosures for improved profitability, while liquidity, although essential for operational stability, appears not to directly impact ROA. Based on these findings, the study recommends that policymakers establish clear guidelines and incentives to encourage comprehensive ESG reporting, with a focus on governance and social disclosures. Banks should be proactive in their ESG efforts, integrating social responsibility and environmental transparency into core business strategies to enhance public trust and long-term profitability. For smaller banks, tailored support through grants or industry partnerships could enable them to engage effectively in ESG reporting, thereby fostering a more inclusive and responsible banking sector in Kenya. Suggestions for further research include expanding the scope to other financial institutions, conducting longitudinal studies to observe the long-term impact of ESG disclosures on financial performance, and incorporating qualitative methods to gain deeper insights into banks’ motivations and challenges in ESG implementation.