ESG Performance and Stock Returns in China: Uncovering the Financial Distress Channel

HRMARS - As ESG has become increasingly prominent and gradually incorporated into capital market pricing, whether ESG performance is reflected in stock returns has emerged as a central research question. Using a sample of 4,452 Chinese A-share listed firms from the Shanghai and Shenzhen stock exchanges over the period 2014–2024, this study employs a two-way fixed effects model to examine the effects of overall ESG performance and its environmental, social, and governance pillars on stock returns, while further exploring the mediating role of financial distress. The findings show that overall ESG performance is significantly positively associated with stock returns, suggesting that the capital market assigns a premium to firms with superior ESG practices. Further analysis reveals that the environmental and social pillars do not exhibit significant positive market effects, whereas the governance pillar exerts a significant positive effect on stock returns. Mediation analysis indicates that financial distress serves as a significant mediator in the relationship between ESG performance and stock returns, with the mediating effect mainly driven by the governance pillar. The results remain robust to a series of robustness checks and endogeneity tests. This study enriches the literature on the capital market consequences of ESG performance by focusing on stock returns and provides new empirical evidence on the heterogeneous effects of ESG pillars and their underlying mechanisms in emerging markets.