How do ESG firms invest?

Abstract

Using panel data from 46 countries, we examine the global relationship between ESG ratings and investment efficiency within the Fazzari-Hubbard-Petersen framework. In developed markets, firms with higher ESG ratings often deviate from traditional investment paths, which may result in resource misallocation. Conversely, in emerging markets, high ESG ratings are linked to reduced financial constraints and do not lead to misallocation. The misallocation effect is amplified in regions where stakeholders and financiers prioritize ESG factors. In such cases, investment shifts toward ESG-related opportunities, weakening its alignment with traditional investment criteria. These findings suggest that while firms in emerging markets use high ESG ratings to secure additional funding and address underinvestment, firms in developed markets, often closer to optimal investment levels, face efficiency losses under ESG pressures due to limited flexibility in countering stakeholder and managerial agency issues.