Does ESG predict future profitability? : evidence from Europe’s IT sector

Abstract

ESG performance relationship with corporate financial performance (CFP) has been extensively researched, yet the topic is important and relevant because the increased emphasis on ESG is shaping corporate strategies and hence ESG’s incremental contribution to profitability is of interest to stakeholder. Prior findings remain inconclusive and concluded that ESG influence is highly context-dependent, yet the European information technology (IT) sector has not been explored. This study investigates whether adding ESG improves the prediction of next-year Return on Equity (ROE) and Return on Assets (ROA) for European IT firms.

Using annual data from 2014–2023, Random Forest models with 5-fold cross-validation and hyperparameter tuning, are estimated under two specifications: a controls-only model and a full model including ESG. Predictive performance is evaluated using out-of-sample R², RMSE, and MAE, supplemented by Diebold–Mariano and Clark–West tests. The results show that ESG adds only marginal and statistically insignificant incremental predictive power for both ROE and ROA across all test years (2021-23), and it is not consistent across the test years. Traditional financial variables remain top predictors. Partial dependence plots reveal a nonlinear ESG–profitability relationship. A supplementary pillar-level analysis indicates that the aggregate ESG score masks the conflicting pillar effect. At least one pillar has significant distinct predictive power for ROE but not for ROA. Robustness check by alternative missing-data handling, confirm that results are not driven by sample composition.

Overall, the findings suggest that ESG offers limited short-term predictive relevance for profitability in the European IT sector supporting the Shareholder/ Trade-off view, and it is context dependent.