Does investor sentiment enhance the impact of ESG ratings on firms' financial performance? Evidence from China

Prior studies have explored the link between ESG ratings and firms' financial performance, but few have focused on its interplay with investor sentiment. This study examines how investor sentiment moderates the relationship between ESG ratings and financial performance. We use a fixed‐effect regression model applied to panel data from Chinese listed firms from 2011 to 2020. We find strong evidence that investor sentiment can reinforce the impact of ESG ratings on financial performance. We further investigate how investor sentiment moderates the relationships between the dimensions of ESG—environmental (E), social (S), and governance (G)—performance, and financial performance, respectively. Evidence shows that investor sentiment can enhance the negative impact of E on financial performance, while it enhances the positive impacts of S and G on financial performance. Our results are robust across various econometric techniques, including generalised‐least‐squares regression, first‐difference regression, and system‐generalised method of moments estimation. We provide insights for firm managers on leveraging investor sentiment to enhance ESG strategies to improve financial performance and offer implications for policymakers in crafting effective regulations that account for investor sentiment dynamics.