The impact of ESG performance on firm performance: the moderating role of audit quality – evidence from China

Purpose This study examines how environmental, social and governance (ESG) performance relates to firm profitability in China and whether audit quality conditions this link. We assess both the direct effect of ESG and its heterogeneity across state-owned enterprises (SOEs) and non-SOEs. By foregrounding external assurance and ownership context, the study clarifies when ESG translates into economic value. The goal is to provide evidence-based guidance for scholars, managers, and policymakers on how credible sustainability practices, supported by high-quality audits, can enhance firm outcomes in an emerging-market setting. Design/methodology/approach We analyze 35,175 firm-year observations for Chinese A-share firms (2015–2024). ESG scores (Huazheng) are rescaled to 0–100 and standardized by year. Baseline models use firm and year fixed effects with clustered standard errors; interaction models test moderation by audit quality (abnormal audit fees, ln audit fees, Big-4 and audit opinion). Robustness includes alternative ESG z-scores, lag structures, SOE versus non-SOE splits and endogeneity checks via two-step system and difference GMM, plus instrumental variables (local audit market concentration and partner workload). Variables entering interactions are mean-centered; controls include size, cash flows, leverage, board size and Tobin's Q. Findings ESG performance is positively associated with profitability (ROA/ROE); effects are statistically robust yet economically moderate. A one-standard-deviation rise in ESG increases ROA by ∼0.18–0.19 percentage points and ROE by ∼0.65–0.68 points. Dynamic panel estimates indicate short-term gains weaken once profit persistence is considered, implying benefits accrue through longer-term channels. Audit quality shows mixed moderation: abnormal (and raw) audit fees reduce profitability but do not consistently strengthen ESG effects; Big-4 shows limited incremental influence. ESG impacts are stronger for SOEs, while non-SOEs are more sensitive to audit frictions. Research limitations/implications Results pertain to listed Chinese firms and Huazheng ESG metrics; generalization to private or non-Chinese firms requires caution. ESG ratings and audit proxies may embed coverage and methodology biases, and audit fees can reflect complexity as well as quality. Although we address endogeneity using lagged models, IVs, and system/difference GMM, residual identification concerns remain. Future work could triangulate multiple ESG providers, exploit regulatory shocks or inspection outcomes, and extend to other markets to test external validity. Practical implications Managers should treat ESG as a long-term investment that enhances profitability when paired with credible governance and transparent reporting. Prioritize material ESG initiatives, sustain disclosure quality, and manage audit frictions – especially in non-SOEs – by planning engagements that balance fee levels with assurance depth. Boards can use abnormal-fee diagnostics to monitor audit complexity and risk. Policymakers should strengthen disclosure standards and promote reliable assurance to curb greenwashing and improve comparability, thereby lowering firms' financing costs and encouraging efficient capital allocation. Social implications Trustworthy assurance elevates the credibility of ESG disclosures, curbing greenwashing and aligning corporate actions with societal goals. By clarifying when audits add informational value, the study supports investor protection, fairer capital markets and more effective progress toward environmental and social targets. Strong, transparent ESG practices – verified by credible audits – benefit not only firms and investors but also employees, communities, and the broader public. Originality/value We provide one of the most up-to-date, large-sample analyses for China (2015–2024), integrating multiple audit-quality proxies and an explicit SOE versus non-SOE perspective within an institutional-theory framework. The study reconciles mixed prior findings by quantifying economic magnitudes, testing standardized ESG metrics and deploying dynamic panel estimators. We show that audit quality's moderating role is context-dependent, while ESG's performance benefits are primarily long-term – offering clear, actionable insights for scholars, regulators, and practitioners.