Impact and Mechanism of ESG and Innovation on Chinese Enterprises Financial Performance

Abstract

Growing stakeholder scrutiny and the dual carbon policy context in China have heightened the need to understand whether and how ESG governance enhances firm outcomes. This study investigates the role of ESG governance in shaping corporate innovation and financial performance, and tests whether realized ESG performance strengthens the governance–innovation link. Using an unbalanced panel of China A share listed firms from 2014 to 2024 with 10,962 firm year observations, we combine CSMAR financials with the China Securities comprehensive ESG score to measure governance quality, innovation inputs and outputs, and market based performance. Panel regressions with firm, industry, and year controls show that ESG governance is positively associated with valuation proxied by Tobin’s q, and the result holds with ROA and ROE as alternative outcomes. ESG governance significantly raises innovation, and innovation mediates the governance–performance relation, as demonstrated by stepwise tests and confirmed by Sobel and Bootstrap procedures under one period and two period lags. Realized ESG performance positively moderates the effect of ESG governance on innovation, consistent with signaling and resource mobilization channels. The findings are robust to alternative specifications, additional lags, and an instrumental variables strategy based on two stage least squares, and they are qualitatively reinforced by two focus group interviews with senior managers. The results clarify mixed evidence in prior work by separating governance capability from ex post ESG outcomes and by identifying a process oriented pathway through innovation. Theoretically, the study integrates stakeholder, innovation, and strategy based responsibility perspectives into a coherent mechanism. Practically, it guides boards, investors, and regulators toward process based ESG oversight, capital allocation to innovation, and decision useful disclosure.