Short-term costs and long-term gains of ESG initiatives in high-risk environments: Evidence from UK firms

This study investigates the dynamic relationship among environmental, social, and governance (ESG) practices, firm-level climate risk exposure, and stock returns using a robust system-generalised method of moments (GMM) estimator. The GMM approach effectively addresses endogeneity concerns, including reverse causality and omitted variable bias, which are prevalent in ESG performance studies. Empirical findings reveal that while ESG investments initially exert negative impacts on stock returns- reflecting substantial upfront costs and operational disruptions- these negative effects diminish over time, transitioning into significant long-term benefits through improved firm resilience and enhanced market valuation. Furthermore, our analysis reveals a strategic interplay between ESG initiatives and climate risk exposure, indicating that effective ESG integration can mitigate adverse climate impacts. The study also examines how market concentration and firm size impact ESG effectiveness, highlighting differential biases across various firm categories. Additionally, we emphasise the crucial role of regulatory frameworks, particularly the Paris Agreement, in amplifying the positive outcomes of ESG commitments. Overall, this research underscores the nuanced complexity of ESG investments, highlighting their potential to deliver substantial long-term advantages in risk management and financial performance despite initial implementation challenges.