Does ESG Create Firm Value? A Critical Review of Conflicting Empirical Evidence and Explanatory Mechanisms

Abstract

Although environmental, social and governance (ESG) factors have gained increasing prominence in the formulation of corporate strategies, analysis of investments, and financial decision-making, there is still no consensus about the influence of good ESG performance on corporate value despite the large body of research on the topic. Many studies find positive effects on firm value through better stakeholder relations, less restrictive financing conditions, reputation, innovations, customer satisfaction, and mitigation of environmental and social risk factors. At the same time, some studies find no significant or even negative impacts. More recent studies tend to find nonlinear effects. The mixed results raise doubts about the cost of investing in ESG, different institutional environments, investors' perceptions, ESG measurements and the difference between disclosure and actual ESG performance. This paper provides a critical review of the theories explaining and the evidence for the relation between ESG and firm value. Based on stakeholder theory, agency theory, signaling theory, legitimacy theory, and resource-based theory, the review finds that both positive and negative valuation impacts are possible from a theoretical perspective. Further, empirical findings suggest that the link between ESG and firm value is contingent upon the issue of materiality, industry specifics, horizon of analysis, institutional context, ESG metric construction and methodological approaches. In addition, recent findings regarding the existence of a threshold and an S-shape relationship pose an issue as to the widely-held belief in the linear association. Issues of ESG ratings discrepancy, endogeneity, and aggregation of the environmental, social and governance dimensions continue to be the significant methodological issues. While there is an increase in evidence drawn from emerging markets, research remains focused on the rather narrow number of countries, such as China, while the Gulf Cooperation Council (GCC) region continues to attract less attention.