From synchronicity to fragility: How corporate ESG performance reshapes systemic risk

Building on a framework in which firms are interconnected through fire-sale spillover mechanisms, we argue that strong ESG performance acts as a protective buffer for firms with weak financial performance against stock price declines. This reduces the dispersion of asset returns, thereby reducing cross-firm heterogeneity and inadvertently strengthening systemic linkages. To empirically examine how ESG performance reshapes systemic risk, we develop a novel network-based granular instrumental variable (GIV) that weights rating shocks by agency centrality to address endogeneity concerns. Consistent with theoretical predictions, our empirical results reveal that while superior ESG performance significantly mitigates individual tail risk, it simultaneously intensifies systemic linkages among firms. These effects are amplified when the information environment enhances the perceived credibility of ESG signals. Our findings illuminate the dual nature of ESG in systemic risk dynamics: while providing firm-level protection, ESG performance may inadvertently amplify system-wide fragility through enhanced interconnectedness.