HOW GOVERNANCE CREATES FINANCIAL VALUE: THE MEDIATING ROLE OF INVESTMENT AND THE MODERATING EFFECT OF ECONOMIC DEVELOPMENT

Abstract

This study examines the mediating role of the investment channel in the relationship between governance performance and financial performance and the moderating effect of economic development level across 28 emerging economies using a multi-year panel dataset. Grounded in stakeholder theory, the analysis applies second-generation panel econometric techniques, including cross-sectional dependence tests, slope heterogeneity diagnostics, panel cointegration analysis, and system Generalized Method of Moments (GMM) estimation, to address methodological limitations in prior ESG–financial performance research. Using data from the MSCI Emerging Markets Index, the results show that environmental performance has a positive and statistically significant effect on financial performance, while governance performance also demonstrates a positive association. Importantly, the findings reveal that the investment channel fully mediates the governance–financial performance relationship, indicating that governance influences financial outcomes primarily through investment decisions rather than direct effects. Furthermore, economic development level significantly moderates this mediated relationship, with stronger investment effects observed in higher-income emerging economies. The study advances theoretical understanding by identifying the mechanism linking governance to financial performance and highlights policy implications related to strengthening governance frameworks, enforcing environmental regulations, promoting investment incentives, and tailoring development strategies to income levels.