Does Managerial Ability Improve Environmental Performance and Overall ESG Ratings? The Impact of the European Sustainability Reporting Mandate

ABSTRACT This study examines the role of managerial ability in driving environmental performance and overall environmental, social, and governance (ESG) ratings in the context of the European Union sustainability reporting regulations. Using a sample of 7242 firm‐year observations over the period 2015–2023, our results indicate a structural change in the relationship between managerial ability and ESG scores, documenting an inverted U‐shaped relationship after the reporting mandate came into force. Our findings suggest that, in a more demanding organizational environment, more capable managers increase sustainability performance, but only up to a saturation point, around which they optimize the costs and benefits of ESG initiatives. Furthermore, we find that the relationship between managerial ability and sustainability performance is moderated by managerial discretion. The relationship weakens after the reporting mandate becomes effective, limiting managerial discretion, but strengthens in the presence of larger boards, which provide legitimacy to managerial decisions and more discretion regarding ESG.