Do ESG controversies moderate the relationship between CSR and corporate financial performance in oil and gas firms?

Corporate Social Responsibility (CSR) is increasingly crucial for firms' competitive strategies, influencing market valuation and Corporate Financial Performance (CFP). The oil and gas (O&G) industry faces ongoing debates regarding its environmental impact. Stakeholders and the market increasingly favor socially responsible firms, penalizing those lacking in CSR. Environmental, Social, and Governance (ESG) controversies (ESGC) capture the market's negative assessment of firms' actions. This study examines whether ESGC moderate the relationship between ESG factors and CFP in the O&G industry. The research questions are: 1) To what extent do ESG factors affect CFP? and 2) Do ESGC influence the relationship between ESG factors and CFP? The increasing awareness of climate change and its impact on the O&G industry, a major contributor to global warming, necessitates understanding how ESG factors and controversies influence market valuation. While literature exists on the individual effects of ESG and ESGC, a significant research gap remains regarding their combined influence on O&G firm value. This paper seeks to address this gap by exploring the moderating role of ESGC on the ESG-CFP relationship within the O&G sector.

The literature on CSR's effectiveness and the impact of ESG factors and controversies on CFP is extensive but inconclusive. Studies on the relationship between environmental factors (emissions, resource use, environmental innovation) and CFP show mixed results, with some finding a positive relationship and others a negative one. The impact of social factors (workforce, human rights, community engagement, product responsibility) on CFP is also debated, with some studies indicating positive relationships and others showing no impact. Similarly, the impact of governance factors (board independence, anti-corruption measures, disclosure, stakeholder engagement) on CFP is not fully resolved. The role of ESGC (negative news, scandals, controversies) is also an area of mixed findings, with some studies suggesting a negative impact on CFP. This study considers stakeholder and legitimacy theories to explain the relationship between ESG factors, ESGC, and CFP. Stakeholder theory posits that strong ESG performance increases firm value, while legitimacy theory emphasizes the negative impact of ESGC on reputation and market value. The current literature often focuses on specific aspects of ESG or ESGC, lacking a comprehensive view of their combined impact on O&G firms. Therefore, this research aims to provide a more holistic understanding.

This study employs a Partial Least Squares Structural Equation Modeling (PLS-SEM) approach using a sample of 264 global O&G firms. Data on ESG factors (environmental, social, and governance) were collected from the Thomson Reuters Eikon database for the year 2019. ESGC data for 2018 were also sourced from Eikon, with a one-year lag to allow time for the effects of controversies to impact performance. The CFP construct is measured using market capitalization, Tobin's Q, and stock price. A two-stage approach was used to analyze the moderating effect of ESGC. The environmental, social, and governance pillars were treated as formative constructs, composed of multiple indicators from the Refinitiv data. ESGC was a single-item construct. Model 1 examines the direct relationships between ESG factors, ESGC, and CFP. Model 2 introduces the interaction terms (ESG factor * ESGC) to assess the moderating effect of ESGC. SmartPLS 3.3.3 software was used for the analysis. The goodness-of-fit of the models was assessed using SRMR and bootstrap-based indices to ensure reliability and validity. The study also conducts conditional analysis to examine the relationship at different ESGC levels.

The results of Model 1 show significant positive relationships between the environmental and social factors and CFP, supporting hypotheses H1 and H2. However, the governance factor had no significant influence on CFP. ESGC demonstrated a significant negative effect on CFP, supporting hypothesis H4. The R-squared value for Model 1 was 0.388, indicating a moderate level of variance explained. Model 2, incorporating interaction terms, revealed significant moderating effects of ESGC on the relationship between environmental and social factors and CFP, supporting hypotheses H4a and H4b. Specifically, higher ESGC levels weaken the positive relationship between environmental and social factors and CFP. The R-squared value improved to 0.398 for Model 2. The conditional analysis demonstrated that the positive impact of environmental and social practices on CFP is stronger when ESGC levels are low and weaker when ESGC levels are high. For example, a one-standard deviation increase in ESGC reduced the relationship between environmental and social factors and CFP by 16.26% and 52%, respectively. The moderating effect of ESGC was not significant for the governance factor.

The findings highlight the significant influence of both ESG performance and ESGC on the CFP of O&G firms. The positive relationship between environmental and social factors and CFP demonstrates the growing importance of sustainability in market valuations. However, the non-significant effect of governance suggests that in the O&G sector, environmental and social concerns currently outweigh governance considerations in terms of market impact. The significant moderating effect of ESGC underscores the sensitivity of the relationship between ESG and CFP to negative public perception. This suggests that companies should prioritize both strong ESG performance and effective management of ESGC to maximize their CFP. The industry's high level of scrutiny regarding environmental and social issues is reflected in the stronger moderating effect on these factors compared to governance.

This study contributes to the ESG literature by demonstrating the significant moderating effect of ESG controversies on the relationship between environmental and social factors and CFP in the O&G industry. O&G firms should prioritize strong ESG performance alongside effective ESGC management to enhance their financial outcomes. Further research should investigate the long-term impacts of ESGC, explore cross-national differences in the impact of controversies, and consider additional dimensions of governance.

The study's limitations include the use of a cross-sectional dataset, which restricts the ability to make causal inferences. The use of a single-year lag for ESGC might not fully capture the dynamic interplay between controversies and financial performance. Future research could explore the impact over longer time periods and investigate potential country-specific differences in regulatory environments and societal expectations.