ESG performance, corporate governance mechanisms, and ESG risk rating: Evidence from Europe

Companies have started integrating their Environmental, Social, and Governance (ESG) objectives into their corporate strategy and managerial decision-making processes to enhance ESG performance. Pursuing sustainable business practices is meant to generate reputational and social capital, thereby reducing firm risk. Furthermore, the sustainability committee and ESG-linked executive compensation represent corporate mechanisms that may align and monitor stakeholders’ interests. These should, in turn, reduce stakeholders’ external evaluation of companies’ ESG risks. Therefore, this study investigates whether companies’ ESG performance and corporate governance mechanisms, including ESG-linked executive compensation and the sustainability committee, negatively affect companies’ ESG risk rating. We adopt a quantitative research method on a sample of 304 EU-listed companies to test our hypotheses. Our findings show that the ESG risk rating decreases for higher ESG performance. It is also lower for companies that have appointed the sustainability committee. Our research contributes to the ESG and governance literature by proving that ESG performance and the sustainability committee are significant drivers in meeting stakeholders’ demands and expectations. Stakeholders indeed reward those companies with lower ESG risk ratings.