From risk to resilience: how ESG uncertainty drives R&D investment

Abstract

This study investigates the impact of environmental, social and governance (ESG) uncertainty on corporate innovation. Specifically, it explores whether heightened ESG-related uncertainty incentivizes firms to increase their research and development (R&D) investment as a strategic response to potential risks and regulatory ambiguity. To estimate the relationship between ESG uncertainty and R&D investment, the empirical strategy relies on multidimensional ordinary least squares (OLS) estimation using firm-level panel data. The study also conducts channel and moderating analyses to uncover underlying mechanisms and heterogeneity in firm responses. Our findings reveal a positive relationship between ESG uncertainty (ESGUI) and R&D investment, indicating that firms respond to ESG-related risks by proactively pursuing innovation. The channel analysis suggests that firms with higher production costs are more responsive, likely due to stronger incentives to improve operational efficiency. Furthermore, the moderating analysis shows that state-owned enterprises (SOEs) are less responsive to ESG uncertainty, benefiting from policy stability and greater government support. Similarly, firms with higher ESG performance exhibit a significantly stronger relationship between ESGUI and innovation. To address potential endogeneity, our results remain robust when using changes in fine particulate matter (PM2.5) concentration as an instrumental variable. Finally, the baseline findings hold under alternative measures of ESG uncertainty and different proxies for R&D investment. For corporate decision-makers, the findings highlight the importance of aligning innovation strategies with the evolving dynamics of ESG. In the face of ESG uncertainty, firms may need to enhance R&D investment to maintain competitiveness and resilience. For policymakers, the results reveal the potential unintended consequences of ambiguous ESG signals and underscore the need for clearer and more consistent ESG policy frameworks to guide corporate behavior effectively. While ESG's influence on firm behavior has been widely discussed, this study is among the first to examine how ESG uncertainty affects corporate innovation. It provides novel evidence on the effects of production costs and state ownership in shaping firm responses, offering a nuanced understanding of how firms navigate ESG-related challenges through innovation.