The moderating role of sector risk in the relationship between ESG and financial performance: Evidence from top companies in Malaysia

Abstract

This paper delves into the role of contextual factors, specifically examining how sector risks interact with the relationship between ESG and financial returns in Malaysian companies. ESG practice integration into business strategies has gained momentum, but understanding the link between ESG and financial performance remains complex. Utilising ESG data from 2019 to 2021 and corresponding financial data lagged by one year, this study analysed the impact of overall and pillar-specific ESG scores on financial returns across sectors categorised as high, medium, and low risk. The findings highlight the critical role of sector risk as a moderating variable. The high-risk sector has strong governance initiatives that bolster financial performance, while social initiatives showed mixed effects. Governance efforts become strategic advantages in high-risk sectors by mitigating risks and attracting investors. Conversely, the medium-risk sector witnessed a positive association between social initiatives and returns, but other ESG factors exhibited varied impacts. Notably, the low-risk sector exhibited minimal links between ESG and financial performance, with certain factors displaying negative tendencies. This suggests that the financial impact of ESG practices is not uniform and instead varies dramatically depending on the risk profile of the sector. While the insights generated by this research are valuable, it is crucial to acknowledge certain limitations, such as a modest sample size and potential influences from the COVID-19 pandemic. By elucidating sector-specific variations, this study empowers companies to strategically align their ESG initiatives with their risk profiles and achieve optimal financial outcomes.