The Interaction Effect of ESG and Innovation on Firm Value

Abstract

Firm’s innovation and ESG activities are important factors to obtain competitive edge and to achieve sustainable growth. This paper investigates the interaction effect of ESG and innovation on firm value, using ESG scores, patents and innovation index, and Tobin’s Q. Empirical analyses show that both ESG and innovation have a positive effect on firm value and they are positively interact, which implies that ESG activities contribute to the increase in firm value by itself and as a catalyst of innovation. We also found that the interaction effect is insignificant in the firm with excessive free cash flow. This implies that the ESG activities in the firm with the high agency cost are considered an inefficient excessive investment and do not help strengthen innovation capabilities nor increase firm value. Our findings also suggest that ESG is a means of promoting firm value if invested efficiently, rather than a financial burden in the tradeoff relationship with innovation investment. These results are similar across three elements of ESG and robust to the two-stage least squares analysis to deal with endogeneity concerns in the estimation.