Board Governance as a Strategic Mechanism: Carbon Risk and Firm Performance

ABSTRACT Carbon emissions are a major contributor to global warming and pose significant threats to the environment. In response to the urgency of climate change, firms are under increasing pressure to adopt policies that enhance environmental performance while reducing carbon risk. Our study examines the relationship between carbon risk and firm performance using a dataset of 9560 firm‐year observations from Europe and the United States covering the period 2016–2023. We also explore the moderating role of board governance mechanisms in the carbon risk‐firm performance nexus. Using a fixed‐effects model, we find that carbon risk is significantly and negatively associated with firm performance. Importantly, our results demonstrate that strong board governance mitigates this negative effect, transforming it into a significant positive relationship. Our findings remain robust across alternative measures of firm performance and carbon risk and are further validated using the two‐step system GMM estimator to address potential endogeneity. Our study offers important implications for investors, regulators, creditors, and policymakers concerning the impact of carbon risk on firm performance and the effectiveness of governance mechanisms in managing these challenges.