ESG : Signal or Driver? Panel Evidence and Implications for Sustainable Business Strategy

ABSTRACT This study examines the ESG–firm performance relationship using panel analysis, a question with direct implications for sustainable investment strategy and corporate decision‐making. Using Refinitiv and S&P Global ESG scores matched to Compustat financials for approximately 1120 global firms over an 11‐year panel (2015–2025), we compare pooled OLS estimates with firm‐fixed‐effects specifications that control for time‐invariant unobserved heterogeneity. Results reveal that significant associations observed in the pooled OLS largely disappear with firm‐fixed effects across both ESG rating providers. Coefficients shrink by 65%–133% and lose statistical significance across the four performance outcome measures: gross profit margin, asset turnover, EV/Sales ratio, and Tobin's Q. The attenuation pattern holds under a series of robustness checks, including lagged ESG, difference GMM (Arellano‐Bond), and substituting Refinitiv with S&P Global ESG scores, which substantially reduces concern that the findings are provider‐specific. These findings do not provide evidence of a causal within‐firm relationship between ESG and firm performance when unobserved firm characteristics, such as management quality, organizational culture, and strategic positioning, are taken into consideration. Among many theoretical frameworks that could elucidate the relationship, our results align with signaling theory, that is, the evidence is more consistent with ESG functioning as a signal of underlying firm quality than a driver of financial outcomes. For sustainable finance practitioners, ESG scores may remain informative for quality screening, but our results provide little evidence that within‐firm improvements in ESG scores systematically generate corresponding improvements in the financial outcomes examined. For corporate strategy, capability‐building investments that authentically improve stakeholder relationships create more durable value than optimizing ESG metrics. For policymakers, our results caution against justifying ESG mandates solely on the assumption that improvements in ESG scores necessarily generate firm‐level financial gains; the case for such mandates rests more securely on societal benefits and externality correction.