Enhancing Investment Efficiency Through ESG: The Mediating Role of High Quality of Financial Reporting

Abstract

This study examines the influence of Environmental, Social, and Governance (ESG) performance on investment efficiency, with a focus on the mediating role of financial reporting quality (FRQ). We analyze a panel dataset comprising 85 non-financial firms listed on the PSX from Pakistan's emerging market, spanning the years 2010 to 2023. Our methodology incorporates OLS regression; the application of GMM mitigates endogeneity, whereas Sobel tests explicitly authenticate mediation, hence augmenting the reliability of results. This study presents three principal insights: First, the performance of ESG factors has a positive influence on investment efficiency, indicating that firms with robust sustainability practices allocate capital more effectively. Second, ESG disclosure markedly improves the quality of financial reporting, indicating a spillover effect from non-financial to financial transparency. Third the quality of financial reporting serves as a partial mediator in the relationship between ESG and investment efficiency, functioning as a crucial transmission mechanism that mitigates information asymmetry and agency costs. Robustness assessments employing alternative proxies for ESG, FRQ, and investment inefficiencies validate the consistency of our findings. This study contributes to the existing literature on sustainable finance by highlighting the importance of financial reporting quality as a key mechanism through which ESG actions yield tangible economic benefits. These findings have significant implications for company managers, regulators, and investors, underscoring the need to incorporate ESG and financial transparency into corporate governance frameworks to enhance capital allocation efficiency.