ESG Risks and Market Valuations: Evidence from the Energy Sector

The link between ESG and financial performance is still under debate. In this study, we explore which aspects of ESG specifically drive market valuations through both systematic and idiosyncratic risk channels. We analyze the impact of the three core ESG pillars, 10 subcategories, and associated controversies on market valuations in the energy sector. This analysis reveals that the environmental factor has a stronger impact (regression coefficient = 0.05) than the governance factor (regression coefficient = 0.003), emphasizing the need to prioritize environmental performance in ESG strategies. The positive coefficients for environmental resource use (0.005) and innovation (0.008) indicate that investments in efficiency and clean technologies are beneficial, while the negative coefficient for emissions (−0.004) underscores the risks associated with poor emissions management. These findings suggest that environmental risks currently outweigh governance risks for the energy sector, reinforcing the importance of aligning governance practices with environmental goals. To maximize ESG effectiveness, energy firms should focus on measurable improvements in resource efficiency, innovation, and emissions reduction and transparently communicate this progress to stakeholders. The evidence suggests that energy firms approach the ESG landscape differently, with sustainability leaders benefiting from higher valuations, particularly when ESG efforts are aligned with core competencies. However, many energy companies under-invest in value-creating environmental initiatives, focusing instead on emission management, which erodes value. While they excel in emission control, they lag in innovation, missing opportunities to enhance valuations. This underscores the potential for ESG risk analysis to improve portfolio performance, as sustainability can both create value and mitigate risks by factoring into valuation equations as both risks and opportunities. This study uniquely contributes to the ESG–financial performance literature by disentangling the specific ESG dimensions that drive market valuations in the energy sector, revealing that value is created not through emission control but through strategic alignment with eco-innovation, governance, and social responsibility.