The ESG Dilemma: Navigating Sustainability & Firm Valuation : An Instrumental Variable AnalysisExamining ESG & Firm Valuation in Nordic Small-Cap Firms (2018–2022)

This thesis examines the relationship between Environmental, Social, and Governance (ESG) scores and firm valuation, with a focus on 52 Nordic small-cap firms between 2018 and 2022. Tobin’s Q is used as a measure of financial performance, engaging an instrumental variable approach to address potential endogeneity concerns. The European Union’s Non-Financial Reporting Directive (NFRD) utilised as a source of exogenous variation to isolate the impact of ESG performance on firm valuation. The results reveal a significant negative short-term relationship between ESG scores and firm valuation, suggesting that sustainability initiatives may incur costs, challenging immediate profitability for smaller firms. The study highlights the complexities of integrating ESG into corporate strategies, and underscores the need for further research to understand its long-term financial impacts. By addressing a gap in ex- isting literature, this thesis contributes valuable insights into the dynamics between ESG and firm valuation in the Nordic small-cap sector.