Unpacking the ESG–financial performance nexus: The moderating effect of volatility on Indian companies

Abstract This paper investigated the impact of environmental, social, and governance (ESG) factors on the financial performance of 37 Indian companies from 2013 to 2022, focusing on stock returns, Tobin's Q , and return on capital employed (ROCE). Using a dynamic panel data model and the Arellano and Bond approach, the study explored the moderating effect of stock return volatility on the ESG–financial performance relationship. The findings revealed that ESG scores negatively affect Tobin's Q and stock returns, suggesting investor caution or perceived short‐term costs associated with ESG practices. Conversely, ESG scores positively impact ROCE, indicating that sustainable practices enhance operational efficiency and long‐term profitability. Volatility diminished the negative effect of ESG on Tobin's Q and stock returns and the positive impact on ROCE. These findings suggest that policymakers may incentivize ESG adoption through regulations and enhance corporate communication to highlight its long‐run benefits. This study also recommends that corporate managers align ESG strategies with market conditions, focusing on risk mitigation during volatile periods and long‐term value in stable conditions. This study also advises investors to adapt their evaluation approach, prioritizing ESG's stability benefits in volatile markets and its profitability contributions in stable markets to make better investment choices.