Can One Desire Too Much of a Good Thing? Nonlinear Effects of ESG Disclosure on Firm Performance

In recent decades, there has been a surge of research on Environment, Social, and Governance (ESG) investing and its financial and nonfinancial benefits, particularly at the corporate level. This study investigates how the influence of ESG disclosure by U.S. firms on corporate financial performance (CFP) varies across different levels of ESG scores. Put another way, it examines whether ESG investment is rewarding to firms at initial levels, but beyond a cutoff point, the increased costs associated with further disclosure begin to diminish or even reverse its impact. Using a sample of 500 publicly listed U.S. firms from 2005 to 2022, the analysis employs a panel smooth transition regression (PSTR) model to identify potential threshold effects in the ESG–performance relationship. The empirical results reveal a nonlinear relationship, with a single ESG threshold at a score of 70.10. Below this value, ESG performance exerts a positive influence on CFP; but the impact turns negative once the threshold is exceeded, demonstrating that ESG yields reverse returns at higher levels of disclosure. Pillar‐level estimates further show that the positive effects of the environmental and social dimensions reverse after thresholds of 62.85 and 63.01, respectively. In contrast, the governance dimension exhibits diminishing—but still positive—returns beyond a threshold of 74.00. Sensitivity analyses, including alternate CFP metrics and estimation techniques addressing endogeneity, confirm the key conclusions of the study. These findings provide valuable insights for corporate managers and investors, suggesting that optimizing—rather than maximizing—ESG disclosure may be key to enhancing firm profitability.