Differentiation strategies and firms' environmental, social and governance: The different moderating effects of historical and social performance shortfalls

Abstract Whether and when differentiation strategies affect firms' environmental, social and governance (ESG) involvement remains unclear. Based on resource‐based view and behavioral theory of the firm, we propose that as the degree of differentiation strategies increases, firms' motivation to engage in ESG increases. Additionally, we propose that performance shortfalls moderate the relationship between differentiation strategies and a firm's ESG involvement. Specifically, we argue that historical performance shortfalls enhance this relationship, whereas social performance shortfalls weaken it. Using a large longitudinal dataset constructed from empirical data on Chinese listed companies from 2011 to 2020, we find strong support for these theoretical arguments. This study extends the differentiation strategies, and ESG literature by providing the first large sample of evidence that differentiation strategy is a key factor in facilitating firms' ESG involvement. The findings of this study also help firms to enhance their ESG practices by revisiting their existing strategies and relative performance.