How the Pursuit of Sustainability Poses Tradeoffs Between Legitimacy and Reputational Spillovers

Abstract

Due to persistent dynamism regarding societal standards and expectations of sustainability, firms are increasingly expected to pursue sustainability by way of increased commitments to environmental, social, and governance (ESG) practices. Likewise, amidst such uncertainty and dynamism investors are likely to reward industry-specific conformity of ESG practices as a means of reducing risk. We argue, however, that such conformity regarding ESG practices increases the unanticipated risk of negative reputational spillovers in the event that the firms’ peers and their ESG practices are publicly criticized. We test our hypotheses using a balanced panel dataset of 2,313 companies across 62 industries and 70 countries from 2013 to 2018. Our results suggest that although conformity indeed benefits a firm’s financial performance on average, it also accentuates negative spillover effects—effects, which in the event that industry peers are highly criticized, can outweigh any legitimacy-related gains associated with conformity. Firms in industries with highly diverse sustainability practices alternatively benefit from positive spillovers when their industries’ peers are severely criticized. Our findings contribute to longstanding research on categorization and optimal distinctiveness, while advancing the growing and important literature on spillover effects in the context of sustainability.