When More Isn't Better: The Curvilinear Effects of ESG on Firm Performance

ABSTRACT This study examines the non‐linear effects of ESG performance on firm value in Chinese A‐share listed firms from 2009 to 2023, addressing a gap in emerging‐market ESG research that often assumes a linear, universally positive relationship. Using 29,439 firm‐year observations and performance measures including Tobin's Q, ROA, and ROE, the study applies two‐way fixed‐effect, Lind‐Mehlum U ‐tests, and robustness checks with alternative ESG ratings (Bloomberg and Huazheng) and by excluding extreme market shocks (the 2015 stock market crash and COVID‐19). The findings reveal a robust inverted U‐shaped relationship, demonstrating that moderate ESG engagement enhances firm performance, whereas excessive ESG investment results in diminishing or even negative returns. Heterogeneity analyses show that this effect is strongest in non‐state‐owned, financially unconstrained, and high‐polluting firms, while SOEs and constrained firms exhibit weaker or more linear effects. Pillar‐level analysis highlights environmental and governance dimensions as primary drivers, whereas social initiatives have limited impact. The study's novelty lies in providing empirical evidence for the curvilinear ESG‐performance link in an emerging market context, advancing theory by showing that ESG investments create intangible assets such as legitimacy, trust, and innovation only up to an optimal threshold, with institutional and financial contexts shaping the relationship. These insights inform policymakers and managers to calibrate ESG strategies strategically, and motivate future research across other markets, ESG ratings, and causal designs.