Environmental, Social, and Governance Risk on Firm Performance: The Mediating Role of Firm Risk

Abstract

Business sustainability can be improved by achieving Environmental, Social, and Governance (ESG) aspects. The research aimed to examine the effect of ESG risk on firm risk and performance, the effect of firm risk on performance, and the mediating role of firm risk between ESG risk and performance. The research sample included 150 firms listed on the Indonesia ESG Leaders Index in Indonesian Stock Exchange in 2020-2022. The research measured ESG risk by the value of ESG risk, firm risk by stock return volatility, and performance by Return on Asset (ROA) and Tobin’s Q. Data analysis applied path analysis. Based on data analysis, lower ESG risk reduces firm risk and increases performance. Moreover, lower firm risk increases performance, and lower ESG risk increases performance through firm risk reduction. The result indicates that lower ESG risk captures the ability of ESG implementation to reduce the risk of economic value and give benefit to reducing costs of conflict, uncertainty, and bad reputation risk. Furthermore, lower ESG risk improves performance by helping firms to promote higher revenue and cost efficiency. In additional analysis, the effect of lower ESG risk on firm risk reduction and performance improvement occurs more for firms in the environmentally sensitive industry. The results show that industry sensitivity strengthens the positive effect of ESG risk on firm risk and the negative effect of ESG risk on performance. The research contributes to giving new evidence of ESG risk on firm risk and performance in Indonesia since ESG risk assessment is a new evaluation on the Indonesian Stock Exchange.