Non-linear ESG Impact on Stock Returns: The Role of Sharīʿah Compliance

Purpose — This study aims to investigate the non-linear relationship between environmental, social and governance (ESG) practices and stock returns on the Malaysian stock exchange, and to examine how Sharīʿah compliance moderates the threshold effects of ESG and its subcomponents. Design/Methodology/Approach — This study examines data from 45 publicly traded firms on Bursa Malaysia for the period 2014–2023 using a dynamic panel threshold regression model. Findings — The results indicate an inverted U-shaped relationship between ESG ratings and stock returns, suggesting that modest levels of ESG participation enhance financial success, while excessive efforts beyond a certain threshold lead to either declining or negative returns. Under optimal impact, disaggregated ESG components, notably environmental (E), social (S), and governance (G) variables, show different thresholds, with environmental activities having the largest positive effect below their tipping point. Especially for companies with high-ESG commitment, the relationship between Sharīʿah compliance and ESG magnifies these impacts, hence highlighting the complementary character of ethical investing approaches. Originality/Value — This study contributes to the expanding body of research examining the relationship between ESG and stock returns by exploring how ESG can be integrated with Islamic finance. Specifically, it looks at how Sharīʿah might affect the link between ESG and stock returns, which is an area that remains underexplored. It is expected that this study will provide market participants with relevant information about the prospects and effects of combining ESG and Sharīʿah compliance in Islamic finance. Research Limitations/Implications — The application of self-reported ESG information is vulnerable to biases, as firms may engage in ‘greenwashing’. Practical Implications — Practically, the study emphasises the possibility of double screening—combining ESG criteria with Islamic ethical guidelines—as a strong foundation for sustainable investment and provides actionable information for investors trying to maximise portfolio returns via ESG integration.