An Attempt to Understand Stock Market Investors’ Behaviour: The Case of Environmental, Social, and Governance (ESG) Forces in the Pakistani Stock Market

Abstract

The present study investigates the decision-making process of investors on the Pakistan Stock Exchange with regard to portfolio construction, explicitly focusing on the incorporation of ESG concerns. A quantitative research approach has been implemented for this paper. The hypotheses have been developed and tested through the adapted questionnaires. The data were collected from individual Pakistani investors. The present study employed SmartPLS-SEM to quantitatively assess data received from a sample of 421 out of 500 respondents. Based on the available data, investors participating in the Pakistan Stock Exchange are notably impacted by ESG aspects. The findings of this study hold significance for emerging economy firms, regulators, and investors, in terms of both theoretical and practical ramifications. The study’s findings demonstrate a clear indication of investors’ significant emphasis on ESG matters. This research made a significant contribution to the field of behavioural finance with a focus on ESG-related issues. This work contributes to the literature on ESG elements by using the Theory of Planned Behaviour (TPB) to adapt the ESG components from the United Nations Global Compact (UNGC) and Thomson Reuters Corporate Responsibility Index (TRCRI). Furthermore, it provides valuable insights for stakeholders who are involved in the ever-evolving realm of sustainable finance within developing countries.

1. Introduction

ESG activities have experienced a significant rise in prominence in academia, business, and government. Meyer and Hess (2018) assert that the early proponents of socially responsible investing (SRI) were the primary individuals who initially included ESG factors in their investment strategies. Therefore, the ESG framework is frequently cited as the “pillars of sustainability” (Ewens and Townsend 2020). The terms “ethical”, “green”, “impact”, “mission”, “responsible”, “socially responsible”, “sustainable”, and “values” encompass concepts that are relevant to strategies aimed at attaining a balanced state of corporate responsibility, social fairness, and environmental standards. These strategies aim to provide advantages for society while attaining sustainable competitive profitability in the long run.

Przychodzen et al. (2016) have pointed out that there has been a substantial expansion in the worldwide socially responsible investment (SRI) business in recent years.

Umar et al. (2020) have observed a worldwide surge in attention given to ESG aspects. The ESG criteria provide a structured framework for assessing the managerial quality of potential investment opportunities. The three fundamental pillars of ESG encompass the domains of “environmental”, “social”, and “governance”. The environmental factors encompassed within a corporate context are its waste management strategies, the utilization of renewable energy resources, and the dedication to mitigating greenhouse gas emissions. Social factors include the observance of human rights, the elimination of child labour, the provision of fair salaries, and the establishment of safe working conditions. As discussed by Bollen (2007) and Riedl and Smeets (2017), SRI has several notable benefits. These advantages encompass enhanced financial returns, less risk in times of uncertainty, effective reputation management, and a sense of security. In contrast to modern finance’s boundless investment portfolio, regarded as the most suitable option for an investor looking to allocate capital, the demand for ethical, environmental, and SRI has declined in recent decades. Financial scandals and crises, like the global financial crisis, have promoted ethical, environmentally friendly, and socially responsible investing in various ways.

Global investors are increasingly interested in ESG investments (Sultana et al. 2018). ESG-driven investments take into consideration non-financial factors. Since events such as Enron and the global financial crisis shook investor confidence, organizations have made more significant efforts to promote social change (Galbreath 2012). Since unethical or socially irresponsible behaviour can result in legal repercussions or reputational harm for a business, investors are paying more attention to ESG issues. Investing in companies with a strong track record of positive environmental, social, and governance practices offers more than financial security.

According to Sultana et al. (2018), after this collapse, investors were under increased pressure, as they had to take on financial losses as well as the psychological effects of more than a thousand people’s fatalities, which also had an impact on thousands more people’s lives and hopes. At the same time, they were charged with emphasizing business interests over the well-being of society and the local community (Aybars et al. 2019).

According to Chiromba (2019), investors are rational in the long and short terms, as assumed by traditional financial theory; i.e., they are wealth maximizers who adopt basic financial principles and base their investment plans primarily on risk–return considerations. In other words, according to Rehman and Vo (2020), investors are motivated to maximize both short- and long-term wealth/returns. However, Nilsson’s (2008) SRI behaviour indicated that consumer investment in socially responsible investments (SRIs) is associated with both financial opinions and pro-social approaches. Additionally, according to research (Ani and Özarı 2020; Shefrin and Statman 2011), internal and external behavioural or ethical considerations, which tend to contradict traditional finance, have also been shown to influence investors’ financial decisions in behavioural finance.

Limited scholarly research has thus far examined the influence of non-financial metrics, encompassing moral, spiritual, and ESG considerations, in the context of investment choices (Gasperini 2020; Przychodzen et al. 2016; Sairally 2015; Sreekumar Nair and Ladha 2014; Syed 2017; Umar et al. 2020; Winegarden 2019; Sandhu and El-Gohary 2022; Omopariola et al. 2021; Hussain et al. 2020; Nkwocha et al. 2019; Owusu-Manu et al. 2023).

However, our understanding still needs to be improved regarding the impact of behavioural factors such as attitudes, norms, and perceptions on the investing selection of individual investors (Pellinen et al. 2015). This knowledge gap is particularly salient given that ESG factors cannot be assessed in isolation. Consequently, the present study seeks to address this void within the ESG literature by investigating how individual investors’ attention to ESG considerations influences their behaviour in the Pakistani stock market.

Furthermore, the research by Ng (2018) examines individual investors in developing countries where ESG problems are important. One possible implication of the research is that effective communication with various stakeholders regarding investors’ ESG inclinations could assist in altering attitudes about certain ESG concerns related to sustainable growth. This research has practical implications for businesses that can identify investor demand for ESG, behave sustainably, and build long-run value. Regulators can recognize the significance of this and establish procedures and laws to increase ESG performance reporting. Furthermore, regulators might initiate measures to introduce the ESG index in the Pakistan Stock Exchange or other nations with related cultural contexts. Investors will make gains through sustainable investment returns, confirming their commitment to the environment, society, and stability of the economy. This will eventually be central to the nation and the sustainable growth of the world.

The paper’s main goal is to define the impact of ESG concerns on individual investor behaviour.

2. Review of Literature and Development of Hypotheses

Theoretical Underpinning

The present study expands upon the foundational work of Ajzen and Icek’s original Theory of Planned Behaviour (TPB) developed in 1985, as well as the subsequent update of the TPB proposed by Wang et al. (2019). The TPB posits that individuals’ willingness to pursue specific behaviours is shaped by their ideas about the value they attach to these behaviours, the level of control they perceive over their actions, and the significance of this control for their overall pleasure. This inquiry is grounded in the core principles of the TPB, specifically focusing on the constructs of “attitude” and “intention”.

According to the proposition put forth by Fishbein and Ajzen (2011), the behaviour of an individual is mainly influenced by their emotional state. The TPB addresses stock market investors’ “intention” to invest in ESG-practicing companies when making investment decisions by determining their “attitudes” to these issues. An “attitude” regarding behaviour is defined as an entire collection of desirable behavioural beliefs (Ajzen 1991) and an individual’s intention to participate in conduct is also known as an “intention” (Fishbein and Ajzen 2011). Since attitude, in addition to other psychological constructs, may predict and explain social behaviour effectively (Fishbein and Ajzen 2011) and because investors’ opinions regarding various investment criteria are important when they make an investment decision (East 1993), the “attitude” and “intention” components of TPB are studied. In their comprehensive study, Jafarkarimi et al. (2016) undertake a thorough examination of the various aspects that impact users’ moral discernment when engaging with social networking sites. This study highlights the intricate nature of the connection between an individual’s viewpoint and their subsequent actions in such situations. A study conducted by Yadav and Pathak (2016) demonstrates that consumer-purchasing decisions are highly influenced by their opinions of a product’s environmental friendliness.

Despite the widespread popularity of the Technology Acceptance Model (TPB), there exists a notable need for scholarly understanding regarding its potential application in examining the motivations and viewpoints of investors. The theoretical framework is further enhanced by including the ESG notion as a behavioural determinant for individual investors. The conceptual framework for this investigation is depicted in Figure 1.

A crucial investment decision phase is selecting stock from the many possibilities accessible on different stock markets. According to conventional economic theory, people are rational actors who may benefit from opportunities and make appropriate choices based on their knowledge, skill, and anticipations. However, behavioural theory demonstrates how investors comprehend the world and make investment choices based on emotional preferences, ingrained cognitive behaviours, and psychological biases of individuals (Cohen and Kudryavtsev 2012; Somathilake 2020). ESG is critical for business and investment decisions, particularly when assessing long-term firm performance and risk (Kumar et al. 2020).

3. Independent Variables

Natural systems and environmental sustainability lie at the heart of environmental concerns. The factors above encompass pollution, water resources, alterations in land utilization, management of natural resources, and the utilization of sustainable energy sources (UN PRI 2015). The consideration of environmental effects has consistently played a significant role in shaping investment decisions, as shown by Sultana et al. (2018).

Conversely, social concerns involve a wide range of issues that impact individuals’ fundamental rights, freedoms, and overall wellbeing. UN PRI (2015) places significant emphasis on human rights, freedom of expression, diversity, employee relations, efficient human capital management, engagement with local communities, and consumer protection.

Firms and other invested entities govern governance concerns. Concerns related to the management of an organization and other stakeholders in general include executive compensation, board structure, diversity, information disclosure, shareholder rights, risk management, and internal controls (UN PRI 2015). When making investment decisions, investors evaluate corporate governance practices as an essential measure of their state of economic prudence (Crifo et al. 2015). According to Giannetti and Simonov (2006), investors ought to refrain from supporting businesses with weak corporate governance. Investors have grown more worried about integrating governance concerns into investment decisions due to the corporate governance catastrophes involving Enron and others. The consideration of the current situation with corporate governance challenges the essential function of governance matters in global investor decisions (Sultana et al. 2018).

Table 1. ESG Indicators.

ESG Factors	Factors
Environment	Climate change
	Energy consumption Water Management
Social	Fair Trade
	Safety
	Philanthropy
Governance	Corruption
	Bribery

Source: Sultana et al. (2018).

illustrate different ESG indicators.

4. Effect of Independent Variables on Dependent Variables

4.1. ESG and Affinity Bias

An investor frequently needs to make more efficient investment decisions depending on how a sale or buying of a security will impact their morals. This bias in information processing is caused by emotion. In particular, investors frequently demonstrate “home-country bias” and favour acquiring shares in domestic companies. More patriotic regions or countries have lesser foreign equity interests. Affinity bias often leads investors to acquire stocks in selling businesses that enjoy shopping and “ESG” companies they believe will greatly impact the world, despite the reality that these companies may have poor future performance prospects (Pompian 2017).

4.2. ESG and Gambler’s Fallacy

The phenomenon commonly referred to as the “law of small numbers” is alternatively recognized as the “gambler’s fallacy”. Concerning the stock market, there exists a common assumption among individuals that a stock is likely to undergo a decrease after a period of expansion. The investor will closely observe the performance of companies with positive growth prospects and that meet all relevant ESG criteria. The investor will refrain from succumbing to the gambler’s fallacy (Bloomfield and Hales 2002) due to the similarity between these investments and lottery games, wherein there are no certainties, and the result is entirely contingent upon random chance.

4.3. ESG and Herding Behaviour

The study by Kumar et al. (2020) showed that the investment behaviour known as “herding” is widely observed. Herd behaviour is observed when individuals in the market disregard their own personal beliefs and objective assessments and instead choose to imitate the actions and decisions of their fellow participants. As a consequence of such trading activity, the price of an asset has the potential to exhibit significant fluctuations, deviating considerably from its intrinsic worth. Research has shown that investors tend to exhibit herd behaviour more frequently when faced with market instability. The study conducted by Lee (2004) showed that private investors tend to display a higher propensity for engaging in herd behaviour compared to institutional investors.

Based on the available data, market participants who possess higher levels of expertise or hold prominent positions within the business often reassess their investment evaluations promptly when confronted with ESG concerns. The statement above underscores the importance of incorporating ESG practices, as they can enhance an investor’s standing within their professional network by positioning them as a more dependable and credible player (Semmann et al. 2005).

4.4. ESG and Loss Aversion

As stated by behavioural finance authors, loss aversion bias is a very significant bias (Tversky et al. 1992). According to Tversky and Kahneman (1991), loss aversion bias makes investors make irrational decisions. Depending on one’s attitude towards risk, ESG shortcomings may play a greater or smaller role in investment decision making (Przychodzen et al. 2016). It is significant to remember that there is proof that risk aversion and loss aversion depend on the domain. Investors are encouraging businesses to think about the connection between their investments and significant changes in governance, the environment, and social issues (Goel 2018). When knowing about the ESG investing path, the loss-averse investor might have confined his choices to value or ESG investments since they provide low risk for a long time and value-adding possibilities for investment. A previous research study (Dash and Kajiji 2020) urged incorporating ESG into the investment decision-making process as a loss-mitigating element.

4.5. ESG and Mental Accounting

It is a well-known notion that Richard Thaler stated that the “two-pocket” idea and mental accounting bias are both cognitive biases in which people treat every aspect of their portfolio separately. Numerous categories are used to classify investments reliant on the financing or purpose of the account (Jain et al. 2019). Investors can use mental accounting to manage and organize their investment portfolios in many accounts (Mahapatra et al. 2016), significantly affecting asset prices (Barberis and Huang 2001). The investor who employs a value-based accounting system and seeks to enhance the socially responsible composition of their portfolio is referred to as a socially responsible investor (SRI) (Bilbao-Terol et al. 2016). Calvo et al. (2016) integrate the concept of social responsibility into the mean–variance portfolio selection model, thereby introducing an extra non-financial aim. When formulating investment selections, ESG investing incorporates non-financial aspects in addition to a company’s financial success (Sairally 2015). Therefore, investors need to consider supporting companies emphasizing environmental, social, and governance issues. The conclusion is erroneous since investors concerned about ESG principles are unlikely to invest their money into a stock that is losing money (Landi and Sciarelli 2019). According to (Lungeanu and Weber 2021), there may be an association between philanthropy and corporate social responsibility (CSR) through mental accounting.

4.6. ESG and Overconfidence

When individuals exhibit overconfidence, they mistakenly believe they can successfully perform a task, even in the face of substantial hurdles. Overconfidence can be regarded as a cognitive bias, as posited by Thaler (1992). Jain et al. (2019) conducted a study on this topic. The choice is bestowed with a higher level of trust than what would often be anticipated. Overconfident investors overreact to market information (Parveen et al. 2020). Tversky et al. (1992) have proposed a theory explaining how individuals act when given unclear decisions. According to Dick et al. (2021), executives at these companies who are overconfident tend to perform better in terms of CSR.

Consequently, overconfident executives could reduce a family’s tendency for control by emphasizing establishing their reputation by functioning socially responsibly. Moreover, Dick et al. (2021) highlight that corporate leaders in such organizations perform better when it relates to ESG while they are overconfident. Thus, a family’s propensity for control can be mitigated by overconfident managers who overlook the family’s control risk and focus on developing a reputation by acting socially carefully. Overconfident managers take greater chances and develop more (Hirshleifer et al. 2012).

Hypotheses of the Study:

H1. 

ESG has a positive effect on the affinity bias of individual Pakistani stock market investors.

H2. 

ESG has a positive effect on the gambler’s fallacy of individual Pakistani stock market investors.

H3. 

Herding of investors in the Pakistani stock market is positively affected by ESG.

H4. 

ESG impacts Pakistani stock market investors’ loss aversion.

H5. 

ESG impacts Pakistani stock market investors’ mental accounting.

H6. 

ESG impacts Pakistani stock market investors’ overconfidence.

A researcher has taken into account a 5% significance level.

5. Research Methodology

In order to achieve its objectives, this study uses quantitative methodologies. In order to evaluate the efficacy of a novel instrument, it is essential to employ quantitative data-collection methods to analyze occurrences (Ivankova et al. 2006). The primary research approach entails conducting a questionnaire survey targeting individual investors in the PSX, aligning with the research objectives. The data were acquired through a simple random sampling technique. Consequently, this work adopts a positivist paradigm, as it seeks to uncover empirical regularities that can be subjected to testing using empirical datasets (El-Gohary 2009, 2012).

Individual stock market investors in Pakistan constitute the population. While the researcher could not obtain data from every investor, an appropriate population sample was selected. As of 2019, the Pakistan Central Depository Company reported 56,053 individual investors in Pakistan. The population that is being examined in this study is well-defined. When determining the sample size, the authors depend on the formula suggested and implemented by well-established scholars (e.g., El-Gohary 2012; Saunders et al. 2009) to determine the population for the present investigation. The primary sample size was 383; however, to address the possible outliers, insufficient information, and non-response rates, an additional 10% was added to the proposed sample size, resulting in a sample of 421 (383 + 38).

Based on previous scholarly investigations, the present study employed a modified questionnaire comprising three primary constructs (Appendix A). The constructs under consideration encompass ESG components (Sultana et al. 2018), behavioural features (Antony and Joseph 2017; Mouna and Anis 2015; Metawa et al. 2019), and metrics of trading performance. Participants’ responses were rated on a 5-point Likert scale from “strongly disagree” to “strongly agree”. This research employs ESG dimensions to investigate the ESG considerations of stock market investors. We determined the minimum sample size using SmartPLS (Version 3.3.3) and structural equation modelling.

The SmartPLS-SEM approach was chosen over regression or other models for this investigation. Rather than examining each variable independently, it allows for the simultaneous study of several variables incorporated into the model. SEM is used because, unlike conventional regression models, it addresses the error component, which is ignored in other cases (Byrne 2016).

6. Analysis and Results of the Study

In this paper, the data were examined using Smart PLS 3 (SEM), and the outcomes of the analysis are presented using a two-step methodology.

The current study employed the Partial Least Squares Structural Equation Modelling (PLS-SEM) approach, as Ringle et al. (2015) suggested, to assess the reliability and validity of the gathered data. The evaluation involved the utilization of factor loading, average variance extracted (AVE), Cronbach’s alpha, composite reliability, and average extracted variance. The present analysis utilized the method developed by Fornell and Larcker (1981) to evaluate the discriminant validity. The results for the convergent validity and internal consistency reliability of the measurement model are presented in

Table 2. Measurement Model Assessment.

	FL	Cronbach’s Alpha	rho_A	CR	AVE	VIF
Affinity Bias	-	0.891	0.916	0.909	0.590
AB-1	0.827					2.129
AB-2	0.798					1.920
AB-3	0.75					1.547
AB-4	0.739					2.055
AB-5	0.737					2.173
AB-6	0.742					2.045
AB-7	0.776					2.070
Anti-Bribery		0.898	0.941	0.928	0.762
BR-1	0.884					2.456
BR-2	0.906					2.640
BR-3	0.862					2.424
BR-4	0.838					2.462
Climate Change		0.850	0.855	0.89	0.579
CC-1	0.617					3.178
CC-2	0.647					3.278
CE-1	0.831					3.603
CE-2	0.8					2.811
CE-3	0.791					2.900
CE-4	0.847					3.612
Corruption		0.907	1.063	0.927	0.762
CO-1	0.937					2.697
CO-2	0.825					3.068
CO-3	0.893					2.742
CO-4	0.831					2.688
Energy Consumptions		0.93	0.978	0.954	0.875
EN-1	0.94					4.447
EN-2	0.945					3.349
EN-3	0.921					3.803
Fair Trade		0.937	0.962	0.951	0.796
FT-1	0.909					3.473
FT-2	0.89					3.112
FT-3	0.894					3.934
FT-4	0.871					3.141
FT-5	0.897					3.783
Gamblers Fallacy		0.893	0.982	0.875	0.596
GF-1	0.724					2.683
GF-2	0.642					2.561
GF-3	0.526					1.704
GF-4	0.969					3.211
GF-5	0.909					3.739
Herding		0.901	0.906	0.920	0.590
HE-1	0.76					2.137
HE-2	0.806					2.192
HE-3	0.779					2.038
HE-4	0.775					2.105
HE-5	0.749					1.900
HE-6	0.766					1.928
HE-7	0.727					1.762
HE-8	0.781					2.074
Loss Aversion		0.898	0.883	0.907	0.586
LA-1	0.86					2.299
LA-2	0.826					2.057
LA-3	0.791					2.252
LA-4	0.841					2.035
LA-5	0.584					1.775
LA-7	0.765					2.281
LA-8	0.65					2.066
Mental Accounting		0.908	0.946	0.920	0.624
MA-1	0.659					2.527
MA-2	0.737					2.762
MA-3	0.752					2.618
MA-4	0.862					2.598
MA-5	0.851					2.314
MA-6	0.871					2.893
MA-7	0.771					1.782
Over Confidence		0.908	0.916	0.925	0.609
OC-1	0.789					2.404
OC-2	0.851					2.967
OC-3	0.819					2.318
OC-4	0.827					2.492
OC-5	0.751					1.914
OC-6	0.664					1.615
OC-7	0.79					2.051
OC-8	0.734					1.843
Philanthropy		0.927	1.030	0.943	0.767
PH-1	0.819					2.583
PH-2	0.869					3.155
PH-3	0.875					3.112
PH-4	0.894					2.945
PH-5	0.919					3.279
Safety		0.926	0.945	0.942	0.729
SA-1	0.87					2.989
SA-2	0.816					2.435
SA-3	0.832					2.619
SA-4	0.871					2.741
SA-5	0.856					2.760
SA-6	0.875					2.768
Water Management		0.919	1.547	0.933	0.778
WM-1	0.872					3.789
WM-2	0.957					3.622
WM-3	0.821					3.834
WM-4	0.875					3.954

. The methodology necessitated the establishment of accurate measurement standards for both items and metrics. Converged validity is achieved when the outer loadings of a model surpass a threshold of 0.650.

Furthermore, the discriminant validity of the model was confirmed with a mean–variance exceeding 0.50, as reported by Shiau et al. (2020). Based on the findings of Shiau et al. (2020), it can be inferred that an increase in the composite dependability score beyond 0.70 indicates an improvement in internal consistency. The model’s convergence validity, internal consistency, and general dependability can be assessed by comparing its metrics to those of the studies above.

Table 3. Fornell–Larcker Criteria.

	1	2	3	4	5	6	7	8	9	10	11	12	13	14
Affinity Bias	0.768
Anti-Bribery	0.133	0.873
Climate Change	0.188	0.109	0.761
Corruption	−0.032	0.038	0.031	0.873
Energy Consumptions	0.128	0.112	0.390	0.058	0.935
Fair Trade	0.225	0.166	0.422	−0.001	0.289	0.892
Gamblers-Fallacy	−0.066	−0.080	−0.020	0.250	−0.089	−0.043	0.772
Herding	0.340	0.085	0.202	−0.070	0.126	0.188	−0.071	0.768
Loss-Aversion	0.093	0.066	0.203	−0.028	0.217	0.220	−0.034	0.014	0.766
Mental-Accounting	0.242	0.124	0.287	0.007	0.168	0.141	0.001	0.186	0.165	0.790
Over-Confidence	0.227	0.163	0.356	−0.116	0.214	0.283	−0.160	0.244	0.163	0.199	0.780
Philanthropy	0.007	0.081	0.121	0.099	0.059	0.146	0.046	0.076	−0.076	0.044	0.118	0.876
Safety	0.093	0.144	0.406	0.096	0.390	0.420	−0.105	0.108	0.084	0.180	0.163	0.050	0.854
Water Management	0.044	0.166	0.221	0.144	0.160	0.194	0.086	0.004	−0.044	0.129	−0.018	0.127	0.259	0.882

illustrate the Fornell–Larcker Criteria.

Alternatively, the heterotrait–monotrait ratio can be employed to evaluate a construct’s discriminant validity in differentiating between two distinct groups. Discriminant validity pertains to the degree to which items belonging to one concept demonstrate associations with items from other constructions that are unrelated and should not demonstrate such relationships. To ascertain the extent of variance ascribed to a collection of constructs, it is imperative to develop a statistically significant differentiation between two conceptually distinctive constructs (Henseler et al. 2012).

In order to ensure discriminant validity, it is recommended to maintain the HTMT (heterotrait–monotrait ratio) value at or below 0.85, as suggested by Kline (2011).

Table 4. Heterotrait–Monotrait Ratio.

	1	2	3	4	5	6	7	8	9	10	11	12	13	14
Affinity Bias
Anti-Bribery	0.153
Climate Change	0.188	0.135
Corruption	0.051	0.062	0.06
Energy Consumptions	0.105	0.113	0.434	0.087
Fair Trade	0.212	0.188	0.463	0.053	0.3
Gamblers Fallacy	0.050	0.047	0.051	0.196	0.145	0.054
Herding	0.379	0.096	0.224	0.076	0.139	0.19	0.077
Loss Aversion	0.082	0.064	0.177	0.046	0.183	0.173	0.093	0.078
Mental Accounting	0.256	0.123	0.268	0.05	0.144	0.125	0.051	0.17	0.138
Over Confidence	0.230	0.185	0.399	0.108	0.225	0.303	0.129	0.26	0.145	0.182
Philanthropy	0.034	0.092	0.127	0.136	0.058	0.156	0.06	0.077	0.089	0.062	0.117
Safety	0.102	0.165	0.457	0.121	0.426	0.446	0.127	0.113	0.138	0.161	0.181	0.065
Water Management	0.065	0.184	0.246	0.192	0.166	0.208	0.085	0.036	0.057	0.127	0.066	0.127	0.289	-

provides evidence that the study meets the requirements for establishing discriminant validity. Meanwhile,

Table 5. Model Fit Criteria.

	SM	EM
SRMR	0.053	0.07
d_ULS	8.985	15.454
d_G	3.115	3.222
Chi-Square	6209.9	6389.553
NFI	0.739	0.732

illustrate the Model Fit Criteria.

Structural Model Assessment

Table 6. Structural Model.

	Std. Beta	S.E	t-Values	p-Values	CILL	CIUL	Decision
ESG → Affinity Bias	0.235	0.076	3.007	0.003	0.130	0.348	Supported
ESG → Gamblers Fallacy	−0.072	0.124	0.938	0.349	−0.242	0.147	Not Supported
ESG → Herding	0.241	0.080	2.911	0.004	0.120	0.367	Supported
ESG → Loss Aversion	0.277	0.140	2.059	0.040	−0.273	0.420	Supported
ESG → Mental Accounting	0.303	0.055	5.201	0.000	0.191	0.406	Supported
ESG → Over Confidence	0.386	0.047	8.125	0.000	0.285	0.473	Supported

provides a visual representation of the evaluation of the structural model (Direct Effect). An investigation was conducted to assess the structural model within the SEM-PLS framework and validate the study’s hypotheses. Specifically, the study’s first, third, fourth, fifth, and sixth hypotheses posit a significant positive association between ESG and variables such as overconfidence, mental accounting, loss aversion, and affinity bias. The outcomes of the structural model analysis reveal that the dependent variables exert a statistically significant influence on the independent variables, thereby confirming the hypotheses.

The analysis produced the following results: (β = 0.235, t = 3.007); (β = 0.241, t = 2.911); (β = 0.277, t = 2.059); (β = 0.303, t = 5.201); and (β = 0.386, t = 8.125). Consequently, these findings support hypotheses H1, H3, H4, H5, and H6. However, for the study’s second hypothesis, the connection between ESG and the gambler’s fallacy (GF) is statistically insignificant. The study’s outcomes reveal that ESG and the GF exhibit a negative but statistically insignificant relationship (β = −0.072, t = 0.938), failing to provide statistical support for H2.

7. Discussion

This study investigates how ESG factors affect the investing selection of Pakistani stock market investors. This study, in a rapidly expanding economy, provides the first empirical evidence of individual ESG investor participation. This research expands the ESG and sustainability literature on Pakistani stock market investors.

The study provides evidence that investors hold a collective viewpoint on ESG matters and underscores the importance of integrating these aspects into financial decision making. The findings above suggest that investors are keenly interested in providing financial support to firms and projects that significantly contribute to sustainable development at the regional, national, and international levels. All survey participants were unanimous in acknowledging the inherent risk associated with investing in companies that exhibit subpar environmental standards. Furthermore, the study substantiated the notion that investors had a genuine interest in integrating ESG factors into their investment decision-making processes.

Furthermore, the study supports the notion that investors exhibit bounded rationality in their economic decisions, where they view the benefits of investing in terms of its social, economic, and psychological contributions (Guzavicius et al. 2014). This contrasts with traditional financial theories that assume investors are primarily concerned with financial gains. ESG, however, represents an intersection of traditional and behavioural finance theories, as environmental and social concerns can significantly impact long-term investment returns. Consequently, economic preferences and social and environmental considerations may play a role in shaping investment decisions. In contrast, rationality primarily influences governance factors and is supported by purely financial theories.

Based on the research findings, investors demonstrate a higher propensity to allocate their investments towards enterprises prioritizing ESG factors, assuming that such investments will yield favourable environmental outcomes. Pakistani stock market investors exhibit a much-diminished emphasis on ESG aspects compared to their previous experiences in the market. The available data indicate that Pakistani investors may need a more complete understanding of the societal implications of their stock market decisions.

Furthermore, the study reveals that individual investors in the stock market of Pakistan exhibit herd behaviour despite possessing knowledge of ESG-oriented equities. A recent study conducted by Rubbaniy et al. (2021) observed that investors commonly exhibit herd behaviour while making decisions connected to ESG factors. These findings provide support for the existing understanding of this phenomenon.

Furthermore, the study provides evidence that loss aversion substantially impacts the improvement in ESG parameters. Investors are more inclined to allocate their investments towards companies that demonstrate awareness of ESG factors when considering these organizations have a reduced likelihood of incurring financial losses. Investors prefer environmentally responsible enterprises due to their perception of them as more financially stable and secure investment options. The findings of this study align with previous research that suggests ecological considerations serve as a mitigating influence in making investment decisions (Dash and Kajiji 2020).

Furthermore, the evidence suggests that investors who exhibit overconfidence tend to assign greater importance to their viewpoints compared to the perspectives of their acquaintances, relatives, and coworkers. In the context of making decisions regarding finances, it has been discovered that people who display overconfidence and a reluctance to adjust their methods in reaction to fluctuations in the market are more likely to consider the implications that their decisions will have on the community. The statement above corroborates the outcomes of prior investigations conducted by Sultana et al. (2018).

Finally, this study reveals that investors opt for a diversified portfolio and consider socially responsible stocks, perpetually evaluating a range of investment opportunities to construct a diversified portfolio and explore socially responsible investment options, which is consistent with prior research (Lungeanu and Weber 2021).

7.1. Theoretical Implications

The study’s findings give arguments against commonly held ideas, as they demonstrate that various variables other than financial considerations influence Pakistani investors. In addition, concerns about culture, economics, and psychology are considered. This observation is consistent with the concepts of behavioural finance, demonstrating the complex nature of the decision-making process involved in investing and providing scholars on the subject with a vital insight into the behaviour of investors.

By highlighting that financial and non-financial factors, such as ESG, influence Pakistani investors, the study contributes to the ongoing dialogue that bridges traditional financial theories with behavioural finance. It posits that investors are not always rational agents, as traditionally portrayed, but rather complex decision makers influenced by a myriad of factors. Pakistan’s unique cultural, economic, and socio-political milieu provides a novel context for applying ESG and behavioural finance theories. This study adds depth to the literature by showcasing how ESG considerations play out in a rapidly expanding economy, which might differ from established Western markets.

By dissecting ESG into its environmental, social, and governance components and analyzing their differential impacts, this research adds nuance to the understanding of ESG as a multi-faceted construct. It moves the discourse beyond monolithic ESG discussions to a more nuanced understanding of each dimension. The study’s findings on herd behaviour and loss aversion, in the context of ESG factors, offer further insights into the variability of investor behaviour. It posits that even when armed with knowledge, investors may still fall prey to certain behavioural biases, complicating the predictable models of investor behaviour.

This study analyzes the impact that ESG factors have on the process of making financial decisions. The aspects of an organization that are typically associated with governance have a greater degree of congruence with rationality and finance theories. At the same time, environmental and social considerations significantly impact the method by which decisions are arrived at. This variation highlights the complex influence of ESG issues on investor behaviour. As a result, it provides valuable insights for the research that academics will conduct in the future.

7.2. Practical Implications

The findings suggest that Pakistani investors exhibit a solid inclination to match their investment portfolios with sustainable development objectives. In order to facilitate increased capital allocation towards firms prioritizing environmental sustainability, investors and financial institutions should contemplate integrating ESG issues into their investment strategies and offerings.

Given the growing importance of ESG factors among Pakistani investors, publicly traded companies on the Pakistani stock market could be encouraged, or even mandated, to provide clearer and more comprehensive ESG reporting. This transparency would allow investors to make more informed decisions and align their portfolios with ESG preferences. Additionally, financial institutions can introduce investment products with a distinct ESG focus, catering to the growing segment of the market that values these factors. Examples include ESG-focused mutual funds or ETFs. In a similar context, regulatory bodies or trade associations could launch campaigns to improve the understanding of ESG issues among individual and institutional investors. These campaigns can dispel myths, provide clear data on the financial performance of ESG-focused investments, and educate individuals on the broader societal benefits.

It is imperative to provide investors with education and awareness regarding social issues, as a significant proportion may need more knowledge in this domain. The potential for the Pakistani stock market to experience positive outcomes lies in adopting sustainable investment practices. This transition could be facilitated by enhancing ESG knowledge among investors.

8. Conclusions and Recommendations

This paper makes a significant scholarly and practical contribution by examining the dynamic field of ESG investing in the context of the PSX. The study’s results reveal the demographic makeup and investing inclinations of individual investors in Pakistan, highlighting the significant worldwide relevance of ESG considerations. This report offers crucial insights into the current state of the sustainable investing sector. This phenomenon may compel corporations to reassess their operational strategies, hence enhancing the probability of stock market authorities incorporating investor preferences into the formulation of legislative measures. The research findings indicate that establishing and implementing ESG policies and protocols can potentially enhance the overall ESG landscape in Pakistan. This, in turn, can foster ecological and social balance and positively contribute to long-term development.

This study provides empirical evidence indicating a positive association between self-confidence among investors and their inclination to adhere to ESG principles. However, the underlying reasons for this relationship remain unexplained. Further investigation is necessary to explore the impacts of social, economic, affective, value-based, and societal issues.

The approach employed in this study is characterized by its distinctiveness, which stems from using ESG metrics sourced from recognized organizations worldwide. This particular feature received limited attention in earlier ESG studies. The utilization of measurement methodologies and the analysis of the ESG attributes of significant multinational corporations enhances the empirical basis of ESG research.

The study suggests that the increasing interest of investors in ESG principles could lead to the creation of guidelines and benchmarks to enhance ESG performance and transparency. The implementation of these programs may lead to the creation of an ESG index in Pakistan, which has the potential to yield advantages for both foreign investors and foreign direct investment (FDI). This phenomenon demonstrates significant efficacy in nations characterized by similar cultural standards, making a substantial contribution to the enduring stability of stock markets.

The study’s findings offer empirical support for the notion that cultural factors play a significant role in shaping the practice of ESG investment, particularly in emerging economies like Pakistan, where a shared cultural framework exists among its populace. In future studies, it is imperative to integrate a diverse range of religious and cultural perspectives. It is imperative to attain a comprehensive understanding of the benefits and drawbacks associated with ESG initiatives. Additional research is required to examine the unobserved variability present in ESG variables. Conducting comparative research with other emerging nations can provide valuable insights into this subject matter, and pursuing such investigations is strongly advised. This study represents a notable advancement in sustainable and responsible investment as it aids various stakeholders, including investors, corporations, regulators, and scholars, in gaining a deeper comprehension of the dynamic characteristics of ESG issues.

The outcomes of the study demonstrate that ESG factors significantly enhance the dependent variables, with the exception of the second variable. Therefore, if investors think that investing in an ESG-oriented stock will have positive effects on the globe, they are going to favour investing in ESG-oriented companies when making investment decisions (Rooh and Hussain 2022; Rooh et al. 2021; Sultana et al. 2018).

Limitations and Future Research Directions

Notwithstanding several constraints, this study elucidates the impact of ESG variables on the decision-making process of investors in the Pakistani stock market. The study’s conclusions may be limited due to several issues, including a small sample size, reliance on self-reported data, utilization of a cross-sectional methodology, a restricted number of contextual elements considered, and the potential inability to generalize the findings to other markets. Future research endeavour may consider utilizing experimental designs, conducting cross-national data comparisons, and employing longitudinal approaches to overcome these issues. Understanding the importance of ESG variables in investment decision making requires further study of distinct behavioural biases, regulatory consequences, information dissemination channels, and intervention tactics.