The value of a firm’s engagement in ESG practices: Are we looking at the right side?

Firms allocate many resources to environmental, social, and governance (ESG) issues and to growth options as if they were independent sources of value. Challenging this view, this paper explores the interplay of a firm's engagement in ESG practices and growth options in determining its total value. We draw upon real options reasoning to explain how ESG practices can carry two opposite (trust-enhancing and risk-reducing) forces, driving an inverted U-form relationship between ESG performance and growth options value. Moreover, we argue that ESG performance and growth options are likely to build substitutive insurance mechanisms which might exert a negative moderating effect of growth options on the relationship between ESG performance and a firm's total value. Empirical analyses of ESG scores and growth options values on a panel of U.S. firms from 2009 to 2018 provide substantial support for our hypotheses. Our results show that the inverted U-form relationship between ESG performance and growth options value becomes stronger for the environmental and social pillars. Our evidence on the moderating effect of growth option values also provides valuable insights for interpreting prior conflicting empirical evidence on the association between ESG performance and a firm's total value.