The ESG Tipping Point: Nonlinear Effects and Thresholds in ESG Scores and Financial Performance of Selected African Firms

Abstract

This study investigates the nexus between environmental, social, and governance (ESG) performance and corporate financial outcomes, with a focus on sustainable disclosure and Sustainable Development Goal (SDG)-aligned business practices in Africa. Based on a panel of 173 firms over the 2010–2022 period, the analysis employs the system generalized method of moments (SGMM) to address endogeneity and capture dynamic effects. Results indicate that ESG dimensions exert asymmetric impacts on firm performance: environmental and social scores significantly enhance market capitalization, while no robust positive association emerges for accounting-based performance measured by return on assets (ROA). Pronounced nonlinearities are observed as environmental and governance practices improve ROA only beyond critical engagement thresholds, underscoring the need for substantive and transparent ESG commitments to generate profitability gains. The social dimension follows an inverted U-shaped trajectory, suggesting diminishing returns when firms overinvest in social initiatives. The U-shaped relationship between the governance score and market capitalization shows that governance quality is a critical issue for investors in the financial markets. The heterogeneity of the identified thresholds, with governance requiring the highest level of engagement, offers new insights into the optimal design of ESG strategies. These findings highlight the crucial role of credible ESG disclosure in aligning corporate practices with stakeholder expectations, mobilizing sustainable capital, and advancing the Sustainable Development Goals in emerging markets.

1. Introduction

The accelerating pace of climate change and its socio-economic repercussions have placed sustainability at the center of global policy and corporate agendas. The State of the Global Climate 2024 report by the World Meteorological Organization (WMO, 2025) [1] warns that 2024 is expected to be the hottest year on record, underscoring the profound risks that climate change poses to ecosystems, economic systems, and human well-being. Simultaneously, the Global Resources Outlook 2024 (UNEP, 2024) [2] emphasizes that escalating resource scarcity, mounting social tensions, and recurrent environmental crises demand a fundamental transformation of economic practices worldwide. These systemic challenges cannot be addressed by governments alone: corporate actors are now recognized as pivotal agents in the transition toward a sustainable development model. Within this context, environmental, social, and governance (ESG) criteria have emerged as a globally accepted framework to assess firms’ contribution to sustainability and to guide investment decisions. Recent regulatory milestones have reinforced the strategic importance of ESG disclosure. The International Sustainability Standards Board (ISSB) issued IFRS S1 and IFRS S2 in 2023, establishing a global baseline for sustainability reporting focused on investor-relevant information (IFRS Foundation, 2023) [3]. In parallel, the European Union’s Corporate Sustainability Reporting Directive (CSRD), effective January 2023, obliges over 50,000 companies to publish standardized and comprehensive ESG disclosures in line with the European Sustainability Reporting Standards [4]. These developments signal an irreversible shift toward enhanced corporate transparency and accountability, aligning firms more closely with the expectations of investors, regulators, and other stakeholders, and advancing the objectives of the Sustainable Development Goals (SDGs).

This surge in ESG adoption has catalyzed a rich and rapidly expanding literature examining its financial implications. Empirical findings, however, remain fragmented and inconclusive. Several studies report that ESG engagement improves corporate profitability and market valuation [5,6,7,8], whereas others argue that the high costs of ESG initiatives can erode financial performance [9,10,11]. A third stream of research finds no statistically significant association between ESG scores and firm outcomes [12]. This lack of consensus may be attributed to differences in methodology, sample coverage, and the potential presence of nonlinearities in the ESG–performance relationship [12,13,14].

The present study seeks to advance this debate by providing novel evidence on the ESG–performance nexus in Africa, an under-researched but highly relevant region in the sustainability discourse. The analysis offers four key contributions. First, it focuses on African listed firms, capturing the dynamics of economies characterized by institutional fragility, heterogeneous regulatory frameworks, and unique socio-economic challenges. The findings generate actionable insights for both corporate decision-makers and policymakers across the continent. Second, the study adopts a dual-metric approach to financial performance, simultaneously considering accounting-based measures (return on assets, ROA) and market-based indicators (market capitalization). This distinction allows for a nuanced understanding of how ESG engagement influences short-term operational efficiency and long-term market valuation. Third, the analysis disaggregates ESG scores into their environmental, social, and governance dimensions, enabling the identification of which pillars are value-enhancing, neutral, or potentially detrimental to firm performance. Finally, the study explicitly tests nonlinearities and critical thresholds in ESG engagement, responding to theoretical propositions that the net benefits of ESG initiatives may materialize only after surpassing a maturity point [13,15]. Methodologically, the study applies the system generalized method of moments (SGMM) estimator to address endogeneity and dynamic panel bias. The dataset comprises 173 firms from Egypt, Morocco, Nigeria, and South Africa over the 2010–2022 period, thereby offering a broader geographical coverage than most prior studies, which have focused exclusively on South Africa. The results reveal that ESG dimensions exert heterogeneous and nonlinear effects on financial performance. Environmental and governance practices improve accounting performance only beyond critical thresholds, whereas the social dimension displays an inverted U-shaped relationship, with excessive engagement ultimately reducing profitability. The identified thresholds differ across ESG pillars, with governance requiring the highest level of commitment to generating positive returns. Furthermore, market performance results indicate that investors systematically reward engagement in environmental and social dimensions. At the same time, governance shows a nonlinear relationship with market value, suggesting that financial markets penalize firms with poor governance quality, while they valuate firms exhibiting high governance standards.

By combining a novel regional focus, a disaggregated ESG approach, dual performance metrics, and threshold analysis, this study enriches the understanding of how ESG engagement shapes value creation in emerging markets. The findings provide practical guidance for corporate leaders seeking to design cost-effective ESG strategies, and for regulators and investors aiming to encourage transparency, mobilize sustainable capital, and accelerate progress toward the SDGs.

The remainder of this paper is structured as follows. Section 2 reviews the theoretical and empirical literature on ESG performance and corporate financial outcomes, with a particular focus on studies addressing emerging markets and potential nonlinear effects. Section 3 presents the econometric model, describes the system GMM methodology, and outlines the statistical properties of the sample. Section 4 reports and discusses the empirical results and provides empirical evidence and insights. Finally, Section 5 concludes by summarizing the main insights, formulating recommendations for corporate decision-makers and policymakers, and identifying avenues for future research aimed at strengthening ESG disclosure and advancing the Sustainable Development Goals in the African context.

2. The ESG–Performance Debate: Evidence, Mechanisms, and Research Gaps

2.1. ESG Engagement, Disclosure, and Corporate Financial Performance

The United Nations’ 17 Sustainable Development Goals (SDGs) provide a global framework to promote economic growth, social inclusion, and environmental protection. The concept of environmental, social, and governance (ESG) practices is closely linked to these goals. The environmental dimension supports goals such as SDG 13 (Climate Action) and SDG 12 (Responsible Consumption and Production) by encouraging firms to reduce pollution and use resources efficiently. The social dimension relates to SDG 3 (Good Health and Well-being) and SDG 8 (Decent Work and Economic Growth) through fair labor practices and community support. The governance dimension contributes to SDG 16 (Peace, Justice, and Strong Institutions) by promoting transparency and ethical management. Therefore, ESG initiatives help companies in Africa contribute directly to the achievement of the UN 2030 Agenda for Sustainable Development.

ESG criteria constitute a multidimensional framework for evaluating corporate sustainability and non-financial performance [16,17,18,19]. Rooted in the principles of sustainable development, ESG emphasizes the integration of economic, social, and environmental objectives to safeguard the well-being of present and future generations [20]. Unlike traditional financial assessments, ESG criteria encourage firms to expand their accountability to a broader set of stakeholders, including employees, local communities, and the environment [21]. First introduced in the landmark Who Cares Wins report of the United Nations Global Compact (2004) [22] and subsequently institutionalized through the Principles for Responsible Investment (UNPRI, 2006) [23], ESG has evolved into a cornerstone of sustainable finance and a key determinant of responsible investment strategies worldwide.

ESG performance is conventionally assessed through three interdependent pillars [19,24]. The environmental dimension focuses on a firm’s stewardship of natural resources, including efforts to reduce greenhouse gas emissions, adapt to climate change, and implement eco-efficient technologies [25]. The social pillar encompasses employee well-being, diversity and inclusion, respect for human rights, and the quality of relationships with stakeholders such as customers, suppliers, and local communities [24]. Finally, the governance dimension evaluates the effectiveness of corporate governance structures, including board composition and independence, executive accountability, transparency, and compliance with legal and ethical standards [26]. Together, these pillars provide a holistic measure of a company’s sustainability performance and its capacity to balance economic, social, and environmental objectives [8].

The financial implications of ESG engagement have been the subject of extensive scholarly inquiry, producing a diverse and sometimes contradictory body of evidence. Proponents argue that ESG practices enhance corporate reputation, strengthen stakeholder trust, lower the cost of capital, and mitigate operational and regulatory risks, thereby improving financial performance [27,28]. Empirical findings frequently show that firms with robust ESG practices attract patient capital and benefit from higher market valuation [29]. Nevertheless, critics underscore the significant costs associated with ESG implementation, suggesting that these investments may erode short-term profitability. Di Giuli and Kostovetsky (2014) [30] report that higher ESG scores are often associated with underperformance in stock returns and lower return on assets (ROA) in the short run, consistent with the hypothesis that ESG-related expenditures initially outweigh financial benefits. Alduais (2023) [31] further highlights endogeneity concerns, arguing that financially stronger firms may have greater capacity to adopt ESG strategies rather than ESG being the driver of superior financial outcomes.

A parallel stream of research finds no statistically significant relationships between ESG scores and firm performance, suggesting that value creation may be conditional on institutional context, industry characteristics, and ownership structure. For example, Hsu et al. (2023) [32] show that environmental initiatives in state-owned enterprises do not directly translate into value creation, while Humphrey et al. (2012) [33] find no meaningful differences in risk-adjusted returns between high- and low-ESG portfolios.

Despite these mixed results, a growing consensus indicates that market-based indicators of performance are more responsive to ESG engagement than accounting-based measures. Investors appear to interpret ESG commitment as a signal of long-term resilience and sustainable value creation. Vochenko et al. (2024) [7] provide evidence of a robust positive correlation between ESG scores and market capitalization, reinforcing the notion that financial markets increasingly reward firms demonstrating credible ESG strategies. This perspective is supported by the meta-analysis of Liang et al. (2025) [27], which synthesized over 2000 empirical studies and concluded that approximately 90% found a non-negative association between ESG and financial performance, with the majority reporting a positive relationship.

However, several research gaps remain. Most prior studies pool ESG dimensions into a composite index, implicitly assuming homogeneous effects across the environmental, social, and governance pillars. This approach may obscure potentially divergent impacts of individual dimensions on financial performance. Furthermore, linear modeling frameworks dominate the literature, overlooking the possibility of threshold effects or diminishing returns from ESG engagement. Finally, African markets, characterized by heterogeneous regulatory environments, lower ESG disclosure maturity, and unique socio-economic challenges, remain underrepresented in empirical research, with the majority of studies focused on developed economies or exclusively on South Africa. Addressing these gaps is critical to providing context-specific evidence that can inform both corporate strategy and policymaking in emerging markets.

Theoretical Foundations of the ESG–Performance Relationship: Agency, Signaling, and Impression Management Perspectives

The relationship between ESG practices and corporate financial performance can be better understood through several complementary theoretical lenses. Among the most relevant are agency theory, signaling theory, and impression management theory, each offering unique insights into the mechanisms through which ESG engagement influences firm value, stakeholder perception, and long-term sustainability [34].

According to agency theory, conflicts of interest may arise when managers prioritize personal goals over those of shareholders, leading to information asymmetry and inefficient resource allocation. Robust governance mechanisms, transparency, and accountability, core components of the “G” dimension in ESG, help mitigate these agency problems. ESG reporting, in this sense, functions as an internal control mechanism that ensures managerial discipline and enhances oversight. Firms that adopt strong ESG policies demonstrate their commitment to long-term value creation rather than short-term profit maximization, thereby aligning managerial and shareholder interests. This alignment ultimately fosters investor confidence and improves access to financial resources, which are particularly crucial in emerging African markets characterized by governance and disclosure challenges [35].

From the perspective of signaling theory, ESG performance serves as a credible signal to external stakeholders about a firm’s quality, integrity, and strategic orientation. High ESG scores signal lower operational and reputational risk, attracting investors who seek stable, responsible, and forward-looking companies. In markets with information asymmetry or weak regulatory systems, conditions often observed in African economies, such positive signals are especially important for differentiating firms and building legitimacy in the eyes of global investors. ESG engagement thus becomes not only a moral or environmental choice but also a strategic communication tool that enhances market valuation and stakeholder loyalty [36,37].

Impression management theory complements these perspectives by emphasizing how firms use ESG disclosure to shape perceptions and manage legitimacy. Beyond genuine sustainability efforts, some firms strategically disclose ESG information to maintain a favorable image and secure social approval from stakeholders. However, when disclosure lacks substantive action, commonly referred to as “greenwashing”, the perceived credibility of ESG efforts diminishes, potentially eroding trust and market value. Therefore, the authenticity and consistency of ESG communication play a decisive role in determining whether disclosure contributes to or detracts from financial performance [38,39].

Together, these theoretical perspectives offer a multidimensional understanding of the ESG performance nexus. Agency theory underscores internal control and governance mechanisms; signaling theory explains external market perceptions and investor behavior; and impression management theory highlights reputational dynamics and legitimacy-seeking strategies. Integrating these frameworks clarifies why ESG practices may yield heterogeneous effects across contexts and firms. Importantly, in the African setting, where institutional quality, regulatory enforcement, and ESG disclosure standards remain uneven, these mechanisms interact in complex ways. Strengthening governance systems and enhancing transparency can amplify the positive signaling value of ESG engagement, while reducing the scope for symbolic or opportunistic practices [34].

2.2. Nonlinear Effects and Threshold Dynamics in the ESG–Performance Nexus

Recent scholarship increasingly highlights that the ESG–performance relationship may be nonlinear rather than strictly linear, as early studies assumed. ESG initiatives typically require substantial upfront investments in compliance, technology, and organizational change, which can initially depress profitability before yielding strategic and reputational benefits, an effect described by the investment maturity hypothesis [13]. Empirical evidence supports the existence of threshold effects, whereby ESG strategies contribute positively to financial performance only once engagement surpasses a minimum critical level [40]. Other studies report inverted U-shaped relationships, particularly for the social dimension, indicating that moderate engagement enhances performance, but excessive investment can divert resources from core operations and reduce returns [41]. Similarly, governance mechanisms may exhibit diminishing marginal benefits, as overly rigid control structures risk constraining strategic flexibility [42]. These findings suggest that both insufficient and excessive ESG engagement can be value-neutral or even detrimental, emphasizing the need to empirically identify the “tipping points” that separate value-eroding from value-creating ESG practices. Yet, most existing research applies linear models and uses aggregate ESG scores, thereby masking heterogeneity across the E, S, and G pillars and overlooking potential nonlinear dynamics, gaps that are particularly pronounced in studies of African firms. Addressing these limitations, the present study investigates dimension-specific nonlinearities and critical thresholds, offering a more granular understanding of how ESG engagement shapes accounting-based and market-based financial performance in emerging markets.

2.3. Linking ESG Engagement to Financial Performance: Hypotheses Formulation and Research Model

Despite notable differences in empirical findings, several consistent insights emerge from the literature, which, when applied to the African context, motivate four key hypotheses. These hypotheses reflect theoretically grounded expectations and identify areas that warrant empirical investigation, considering recent advances in ESG disclosure standards and the growing global emphasis on corporate sustainability.

H1. 

ESG engagement positively influences the financial performance of African firms.

A substantial body of research indicates that ESG commitment can enhance firm value by improving stakeholder relationships, reducing risk exposure, and signaling long-term strategic orientation [43,44]. While the implementation of ESG practices often entails significant upfront costs, these investments have been shown to improve organizational efficiency and generate sustainable competitive advantages, ultimately contributing to superior financial outcomes. Evidence from African markets reinforces this view: Nyahuna and Doorasamy (2023) [45] report that the adoption of environmental management practices significantly improves the financial performance of firms listed on the Johannesburg Stock Exchange. These findings collectively suggest that ESG engagement can act as a strategic lever for value creation and risk mitigation in African businesses.

H2. 

The environmental pillar exerts a significant and positive effect on financial performance.

The environmental dimension of ESG is particularly salient in investor decision-making, especially in resource-intensive and carbon-intensive sectors. Empirical evidence indicates that reductions in greenhouse gas emissions are associated with improved accounting measures such as ROA and ROE [46], while initiatives such as Green Supply Chain Management (GSCM) have been shown to enhance operational efficiency and profitability in South Africa [47]. Beyond improving efficiency, environmental engagement helps firms enhance their reputation, meet regulatory expectations, and reduce exposure to pollution-related liabilities, thereby strengthening competitiveness and attracting capital. Kaakeh and Gokmenoglu (2022) [48] further demonstrate that firms with established environmental strategies exhibited greater resilience during the COVID-19 crisis, underscoring the protective role of environmental initiatives in periods of systemic stress.

H3. 

The social (S) and governance (G) pillars have relatively limited direct effects on financial performance.

While the social and governance dimensions play a crucial role in shaping a firm’s reputation and stakeholder trust, their direct financial impact is often weaker and more context-dependent [49]. Robust social practices may boost employee engagement, reduce turnover, and improve productivity, but when misaligned with corporate strategy, the costs of such initiatives can outweigh their benefits. Similarly, effective governance enhances transparency, reduces agency costs, and mitigates regulatory risks. However, some studies note that excessive governance expenditures or overly complex compliance structures may impose significant costs without generating proportional financial gains [50].

H4. 

ESG scores, both aggregate and disaggregated, exhibit nonlinear relationships with financial performance.

Emerging research highlights that the benefits of ESG engagement may only materialize after surpassing a critical threshold, consistent with the investment maturity hypothesis [27,51]. Below this threshold, ESG adoption may be too symbolic to produce measurable financial benefits and, in some cases, may even impose net costs. This nonlinear pattern is particularly relevant in the African context, where firms operate in heterogeneous institutional environments and often face limited regulatory and financial incentives to invest in ESG practices. Le and Nguyen-Phung (2024) [46] observe that African firms need to achieve a substantial level of ESG engagement before realizing their performance-enhancing effects, a finding that underscores the importance of identifying tipping points across the environmental, social, and governance pillars.

3. Research Design, Econometric Methodology, and Sample Description

3.1. Econometric Model Specification and Estimation Strategy

To evaluate the hypotheses, the model is specified and estimated according to the following equation:

$${PF}_{it}=\delta {PF}_{it-1}+{\beta }_1{ASSETS}_{it}+{\beta }_2{EQ ASSETS}_{it}+{\beta }_3{DEBT}_{it}+\gamma X_{it}+{\alpha }_i+{\alpha }_t+{\epsilon }_{it}$$

(1)

where

• ${PF}_{it}$ is an indicator of financial performance, measured either by the return on assets ratio of the firm at time t, ${ROA}_{it},$ or by the market capitalization of firm i at time t, ${Mcap}_{it}$.
• ${PF}_{it-1}$ is the lagged indicator of financial performance $({Mcap}_{it-1}$ or ${ROA}_{it-1})$.
• ${\beta }_1,{\beta }_2,{\beta }_3$,$\delta ,$ and $\gamma$ represent the coefficients to be estimated.
• ASSETS_it, EQ ASSETS_it, and DEBT_it are the control variables representing, respectively, firm size (measured by total assets), the equity-to-assets ratio, and the debt ratio of the firm.
• $X_{it}$ is the independent variable representing one of the following scores: ESG_it, E_it, Sit, or G_it.
• ${\alpha }_t,{\alpha }_i, \mathrm{a}\mathrm{n}\mathrm{d} {\epsilon }_{it},$ respectively, represent time-fixed effects, firm-fixed effects, and the error term.

The individual fixed-effects control for the unobserved characteristics of each firm, while the time fixed-effects control for the business cycle and the impact of exogenous shocks on the dependent variable. The introduction of the time fixed effects is crucial because the sample period includes several shocks, such as the COVID-19 crisis, which are likely to produce significant and sizeable effects on financial performance.

The dynamic nature of the model reflects the persistence of corporate performance. A positive accounting result may place the firm in a favorable position to perform well in the following year. Similarly, difficulties encountered during one fiscal year can negatively impact results in the subsequent year. Furthermore, stock prices generally follow lasting trends that induce a strong correlation between prices in two consecutive periods.

Large firms benefit from economies of scale and have easier access to financing, which should enhance their profitability [52,53,54]. Thus, firm size is expected to have a positive effect on performance. However, some studies suggest that beyond a specific critical size, a firm becomes increasingly challenging to manage, leading to diseconomies of scale and deteriorated performance [52,55]. Moreover, a high equity ratio limits the firm’s exposure to solvency risk and therefore serves as a sign of financial stability. It is expected to boost financial performance by allowing the firm to finance itself at a lower cost [56,57,58,59]. A high debt ratio can stimulate future performance by reflecting the intensity of the firm’s investment efforts. Nevertheless, excessive debt makes access to financing more difficult and expensive, which negatively impacts performance. A high debt ratio may also reflect the financial difficulties faced by the firm and thus be indicative of deteriorated performance [60]. Table 1 provides a summary of the model variables, and all data are extracted from the Refinitiv ESG Scores database.

Table 1. Definition of variables.

Variable Name	Formula
Return on Assets (ROA, in %)	(Net Income/total assets) × 100
Market capitalization (MCAP, in Million USD)	End-of-year market value of outstanding shares in million USD.
ESG score (ESG)	Weighted average of the three pillar scores: Environmental (E), Social (S), and Governance (G) ranging from 0 to 100
Environmental pillar (E)	Score assessing emissions level, innovation, and resource use efficiency (ranging from 0 to 100).
Social pillar (S)	Score assessing the company’s ability to build trust and loyalty among employees, customers, and society (ranging from 0 to 100).
Governance pillar (G)	Score assessing systems and processes aimed at protecting shareholders’ rights and implementing responsible strategies (ranging from 0 to 100).
Firm Size (ASSETS, in Billion USD)	Total assets
Equity Ratio (EQ ASSETS, in %)	(Equity/Total assets) × 100
Leverage ratio (DEBT)	Total debt/Total equity

Source: Authors’ own presentation based on data extracted from the Refinitiv ESG Scores database.

To analyze the impact of ESG criteria on financial performance (ROA and market capitalization), we adopted the system generalized method of moments (SGMM). This approach, developed by Arellano and Bover (1995) [61] and refined by Blundell and Bond (1998) [62], is particularly well suited to dynamic panel data. It also has the advantage of addressing biases caused by endogeneity. Endogeneity arises when explanatory variables are correlated with the error term. This issue typically occurs due to omitted variables, measurement errors, or reverse causality.

Although the two-stage least squares (2SLS) regression is commonly used to address endogeneity, it has limitations in terms of efficiency, particularly in dynamic models [63]. In contrast, the SGMM method overcomes these limitations by using internal instruments based on lagged values of the explanatory variables. Due to the inclusion of the lagged dependent variable among the regressors, second-order or higher lags are used as instruments for variables suspected of being endogenous. The estimates obtained using the SGMM method are subjected to standard diagnostic tests to verify their robustness. The Hansen test of over-identifying restrictions checks the exogeneity of the instruments, while the Arellano–Bond test verifies the absence of second-order autocorrelation in the error terms. These diagnostic tests ensure that the instruments used are not correlated with the model’s errors, thereby confirming the reliability of the estimates [46,64,65].

We implemented the SGMM estimator using the Stata software by applying the xtabond2 command developed by Roodman (2009) [66]. The “two-step” option provides the SGMM “Windmeijer-corrected” standard errors. In small samples, the standard errors based on the GMM weight matrix are down-ward-biased. The Windmeijer correction improves inference by accounting for extra variability and correcting this negative bias. On the other hand, the “collapse” option reduces the number of instruments and allows for avoiding the traditional over-instrumentation problem, which leads to overfitting endogenous variables.

We note that negative returns on assets are truncated by setting them to zero in the underlying database. Censored data may lead to biased results and require specific esti-mation methods. However, our sample includes a single ROA observation taking the value zero. In this case, censoring should not affect the robustness of our results. Various studies have shown that standard estimation methods are relevant for large sample including a very small proportion of censored data (Kuttatharmmakul et al., 2001; Antweiler and Tay-lor, 2008) [67,68].

Ultimately, the SGMM method offers a robust and effective solution for estimating the relationship between ESG scores and financial performance, as it accounts for the persistence of the dependent variable and corrects for endogeneity bias, thus allowing for a precise and reliable interpretation of causal relationships.

3.2. Data Sources, Sample Construction, and Descriptive Statistics

The sample consists of 173 listed African companies observed over a 13-year period (2010–2022). These firms are distributed across four countries as follows: 27 from Egypt, 35 from Morocco, 5 from Nigeria, and 106 from South Africa. The predominance of South African firms reflects the higher availability and completeness of ESG disclosures in this market, due to its more advanced sustainability reporting framework compared to other African countries.

All data were extracted from the Refinitiv Eikon database and include both aggregate and disaggregated ESG scores (environmental, social, and governance), along with financial performance indicators and relevant control variables.

Africa still lags behind in terms of ESG reporting. This is mainly due to the fact that ESG reporting is complex, time-consuming, and expensive to implement. Most African companies possess neither the expertise nor the resources necessary to collect and report on ESG data. Moreover, a few countries implemented laws to enforce ESG reporting. Given data scarcity, the previous literature focused on country case studies, mainly in South Africa, which is a leading country in this field. According to the meta-analysis conducted by Kogi et al. (2025) [69], among the African ESG literature, only 5.6% of the studies dealt with a transnational framework, while 24.7% focused on the South African stock market.

Our study tries to fill this gap by considering a sample including firms from four different countries, covering three of the five African regions. The retained stock markets represent around 75% of the total market capitalization of the African continent. Table 2 presents the descriptive statistics of the model variables.

Table 2. Descriptive statistics.

	Mean	Median	Maximum	Minimum	Std. Dev.	Observations
ROA (%)	8.019	6.360	123.260	0.000	8.272	1934
MCAP (Million USD)	42.294	10.160	1494.939	0.0338	103.694	2050
ESG (score 0 to 100)	46.401	47.550	89.270	1.360	19.356	1424
E (score 0 to 100)	39.837	38.185	96.390	0.000	25.778	1424
S (score 0 to 100)	47.858	48.780	96.440	0.560	23.060	1424
G (score 0 to 100)	51.187	51.760	97.540	2.390	21.774	1424
ASSETS (Billion USD)	196.570	18.382	12,903.470	0.106	874.445	2136
EQ ASSETS (%)	39.336	40.607	99.960	0.924	22.234	2123
DEBT (ratio)	0.939	0.506	88.316	0.000	2.594	2124

Source: authors’ own presentation based on data extracted from the Refinitiv ESG Scores database. Note: Negative ROA values are truncated by setting them to zero.

Due to missing data, the different specifications of Model (1) will be estimated based on an unbalanced panel dataset. Therefore, we should expect the number of observations to vary from one specification to another, depending on data availability of the variables included in the model. The average Return on Assets (8.02%) indicates that the sample firms achieved high returns during the study period. However, the standard deviation (8.27%) along with the maximum and minimum values, reflects notable performance disparities across firms. The high standard deviations associated with the total assets (ASSETS) and market capitalization (Mcap) also indicate sizable differences across firms in terms of size.

The descriptive statistics also reveal important disparities between the debt to equity ratios, suggesting that the sample firms have opted for different indebtedness strategies, and are therefore exhibiting major differences in terms of financial resilience and risk profiles. This result stems mainly from the sample composition, which includes industries characterized by important differences in terms of leverage ratios. For instance, real estate, banking or utilities industries are known to exhibit high leverage ratios (frequently exceeding one thousand percent) due to important fixed costs (Odhiambo et al., 2022; Kalemli-Ozcan et al., 2012) [70,71]. These results also highlight important discrepancies in terms of ease of access to credit between African firms (Babajide, 2017) [72]. In parallel to the highly indebted firms, the moderate mean value (0.94) indicates that most of the sample firms are exhibiting ordinary leverage ratios.

The average ESG score stands at 46.4, indicating a significant level of engagement by African companies in this domain. The analysis of disaggregated scores shows that African firms place greater emphasis on the governance dimension, with an average score of 51.19, followed closely by the social dimension, which records an average score of 47.86. The environmental dimension lags, with an average score of 39.84, indicating that environmental concerns remain a secondary priority for African companies. This result can also be explained by the fact that many large African firms operate in extractive industries, which are inherently polluting. These companies often invest in the social domain to ensure local community support for their presence and for the environmental damage they may cause. It is also noteworthy that the average scores are associated with very high standard deviations, indicating a great diversity in ESG practices among African firms. This diversity makes the sample a suitable setting for studying the impact of ESG practices on the performance of African companies.

Table 3 shows a positive and significant correlation between market capitalization (MCAP) and the overall ESG score, suggesting that companies with more developed ESG practices tend to have higher market value. Except for the governance dimension, the disaggregated scores, environmental (E) and social (S), are also positively and significantly correlated with market capitalization. However, return on assets (ROA) shows no significant correlation with ESG scores, indicating that strong ESG performance does not necessarily translate into immediate improvements in accounting-based profitability. These findings also indicate that financial market investors positively value companies’ commitment to ESG practices, even though such engagement may not have a direct and immediate impact on firm performance.

Table 3. The correlation coefficients between the model variables.

	ROA	MCAP	ESG	E	S	G	ASSETS	EQ ASSETS	DEBT
ROA	1.000
MCAP	0.079 ***	1.000
ESG	0.026	0.185 ***	1.000
E	−0.026	0.165 ***	0.834 ***	1.000
S	0.048 *	0.247 ***	0.906 ***	0.746 ***	1.000
G	0.002	0.027	0.675 ***	0.335 ***	0.401 ***	1.000
ASSETS	−0.138 ***	0.475 ***	0.091 ***	0.101 ***	0.122 ***	−0.014	1.000
EQ_ASSETS	0.433 ***	−0.049 **	−0.130 ***	−0.150 ***	−0.137 ***	−0.053 **	−0.246 ***	1.000
DEBT	−0.101 ***	−0.026	0.031	0.038	0.004	0.025	0.035	−0.279 ***	1.000

***, ** and * indicate significance at the 1%, 5%, and 10% levels, respectively. Windmeijer-corrected standard errors.

The correlation coefficients are summarized in Table 3. We notice that only the social score (S) is significantly correlated to the ROA. Moreover, the correlation coefficients between the four ESG scores and the return on assets ratio are very weak. Such results suggest that strong ESG engagements do not necessarily translate into immediate improvements in profitability. On the other hand, results in Table 3 show a positive and significant correlation between market capitalization (MCAP) and the overall ESG score, suggesting that companies with more developed ESG practices tend to have higher market values. The environmental (E) and social (S) scores are also positively and significantly correlated with market capitalization. These findings indicate that financial market investors positively value companies’ commitment to ESG practices, even though such engagement may not produce a direct and immediate impact on firm performance. Such results also suggest that the impact of the ESG scores on financial and market performances should be investigated separately.

The overall ESG score is also highly correlated with both the environmental and social scores, which indicates that firms place greater emphasis on these two dimensions compared to governance. This observation is further confirmed by the very strong correlation between the E and S scores, whereas both are less strongly correlated with the G score. This suggests that in their ESG strategies, companies tend to prioritize specific dimensions over others. It follows from these observations that the ESG components should be introduced into the model alternately, first, to avoid potential multicollinearity issues, and second, to allow for a more precise analysis of the individual impact of each dimension on profitability. Finally, we note the absence of strong correlations among the control variables, indicating that multicollinearity is unlikely to pose a problem in empirical analysis.

4. Empirical Evidence and Insights

4.1. The Impact of ESG Scores on Performance Indicators

We first consider the return on assets (ROA) ratio as the dependent variable. The estimation results of Model (1) using the SGMM method are summarized in Table 4. Firstly, the Hansen test results confirm the validity of the instruments, while the Arellano and Bond test results rule out the presence of second-order autocorrelation.

Table 4. Effects of ESG, E, S, and G scores on ROA.

	ESG	E	S	G
L.ROA	0.517 ***	0.412 ***	0.528 ***	0.507 ***
	(0.163)	(0.113)	(0.166)	(0.00178)
ASSETS	−0.286	−0.297 **	−0.225	−0.179 ***
	(0.175)	(0.126)	(0.175)	(0.0000232)
EQ ASSETS	0.0448	0.0456	0.0673 *	0.0785 ***
	(0.0407)	(0.0325)	(0.0405)	(0.000411)
DEBT	0.239	0.0516	0.309	0.00539 ***
	(0.310)	(0.0791)	(0.696)	(0.00136)
ESG	−0.0811
	(0.0646)
E		−0.0241
		(0.0151)
S			−0.0315
			(0.0363)
G				−0.00518 ***
				(0.000254)
Constant	7.262 ***	4.176 ***	4.268 *	3.131 ***
	(2.604)	(1.338)	(2.319)	(0.0540)
Nb of Observations	1149	1149	1149	1149
Nb of Firms	171	171	171	171
AR (1)	0.147	0.189	0.166	0.177
AR (2)	0.422	0.426	0.462	0.369
Prob. Hansen test	0.695	0.313	0.831	0.559

Windmeijer-corrected standard errors in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1.

Regarding the control variables, the coefficients associated with firm size (ASSETS) are all negative but are only significant in two out of four equations. These results suggest that large firms, due to the complexity of their structures, may experience negative effects on profitability. This finding is consistent with prior studies, such as Canback (2004) [73], which argue that beyond a certain scale, firm expansion can lead to diseconomies of scale and increased managerial inefficiencies, thereby reducing profitability. The opposite is true for the equity-to-assets ratio, whose positive coefficients (two of which are statistically significant) indicate that financial stability has a positive impact on firm performance. A similar result was highlighted by Muigai et al. (2015) [74], who found that well-capitalized Kenyan firms are better equipped to absorb shocks and invest in long-term value creation, reinforcing the role of capital structure in sustaining financial performance.

As for the debt ratio (DEBT), although it shows non-significant coefficients in the first three equations, it has a positive and significant effect on performance in the specification including the governance score (G). This suggests that companies with good governance practices effectively utilize debt. This aligns with Bhattacherjee and Mishra (2025) [75], who suggest that strong governance frameworks can mitigate the risks associated with leverage, enabling firms to employ debt more strategically to enhance profitability. In this context, governance quality appears to act as a moderating mechanism, improving the efficiency of capital allocation and amplifying the positive impact of financial leverage on firm outcomes.

The results show that the global ESG score and the environmental and social scores (E, S) do not have any significant impact on ROA, while the governance score (G) produces a negative and significant effect on return on assets. These findings suggest that ESG practices do not translate into accounting gains for African firms and may, in some cases, even deteriorate their performance. Several explanations can be put forward to account for the lack of significant relationships between ESG, E, and S scores and financial performance. The environmental and social strategies implemented by African firms may prove ineffective due to poor governance or inappropriate strategic choices. This interpretation is consistent with the negative impact of the governance score on financial performance. Moreover, ESG engagement is relatively recent among many African firms. In such cases, the benefits of ESG initiatives are likely to materialize only in the long term. Finally, it is plausible that the relationship between ESG scores and performance is nonlinear, and that the expected positive effects will only emerge beyond a certain critical threshold. These results are in line with [76], which reported that ESG investments may initially constrain profitability before generating longer-term benefits. However, they diverge from those highlighted by [77], who observed predominantly positive ESG–performance associations in more mature markets. This contrast underscores the contextual specificity of African firms, where weak governance systems, limited disclosure quality, and institutional inefficiencies can hinder the effective transmission of ESG initiatives into financial gains. The results, therefore, support the idea that ESG value creation in emerging markets depends critically on governance quality and institutional maturity, consistent with signaling and agency theory perspectives. Given the recent ESG commitments of African firms, we can reasonably expect such strategies to have a long-run effect on their profitability. This may explain the absence of short-run significant effects.

These findings contribute to the ongoing debate on the ESG–performance nexus in emerging markets, where institutional frameworks and disclosure practices remain heterogeneous. They also indicate that ESG investments, in their current form, may reflect a compliance-driven approach rather than a value-enhancing strategic orientation [78].

As for the negative impact of the governance score, various studies have pointed out the poor governance quality within African firms. In this respect, Areneke et al. (2022) [79] argued that even countries that have adopted corporate governance codes continue to exhibit weak corporate accountability and governance practices. Governance problems in African firms stem mainly from factors like corruption, weak board leadership, and poor internal controls [80]. On the other hand, the governance score (G) is calculated based on criteria such as transparency, board diversity, and the existence of specialized committees. Although these criteria are intended to enhance the quality of governance and, consequently, firm performance, numerous studies have shown that they can have the opposite effect. Beyond the costs associated with adopting such criteria, board diversity can intensify internal conflicts within the governance body and hinder effective decision-making. Specialized committees make governance structures more complex, thereby slowing down the decision-making process. These combined factors may explain the negative impact of the governance score on the performance of African firms.

As we have previously explained, our sample is composed mainly of South African firms, which may lead to a selection bias and prevent the generalization of the results to the other firms in the sample. To address this issue, we estimated Model (1), while restricting the sample to the firms belonging to the three other countries. The number of countries and observations will be reduced compared to the previous estimation set, but remains sufficiently high to provide robust results. Results relative to this subsample are reported in Table 5. We notice that the coefficient associated with the global ESG score, as well as the environmental and social scores, is negative and non-significant, while the governance score produces a negative and significant impact on financial performance. These results are identical to those reported in Table 4, which attests to the robustness of the full sample results and excludes the risk of a potential selection bias.

Table 5. Effects of ESG, E, S, and G scores on ROA, in a restricted sample.

	ESG	E	S	G
L.ROA	0.805 ***	0.290 *	0.518 ***	0.442 **
	(0.267)	(0.152)	(0.175)	(0.191)
ASSETS	0.0326	−0.117	−0.00358	−0.0349
	(0.114)	(0.0952)	(0.0665)	(0.0927)
EQ ASSETS	0.0342 *	0.0348	0.0607 **	0.0542 **
	(0.0198)	(0.0218)	(0.0243)	(0.0268)
DEBT	−0.236	−0.689 ***	0.0919	−1.17 ***
	(0.749)	(0.189)	(0.539)	(0.356)
ESG	−0.0327
	(0.0256)
E		−0.0145
		(0.0116)
S			−0.0181
			(0.0202)
G				−0.0571 ***
				(0.0192)
Constant	0.981	3.442 **	0.666	4.263 **
	(2.467)	(1.416)	(1.997)	(2.042)
Nb of Observations	211	211	211	211
Nb of Firms	67	67	67	67
AR (1)	0.081	0.061	0.036	0.072
AR (2)	0.881	0.806	0.977	0.853
Hansen	0.610	0.426	0.485	0.417

Windmeijer-corrected standard errors in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1.

The results regarding the effect of ESG, E, S, and G scores on market capitalization are summarized in Table 6. The results first reveal a very strong persistence in stock market performance. It is also observed that firm size and the equity-to-assets ratio have a positive and significant influence on market capitalization, reflecting that investors place greater trust in larger firms and those with stronger financial stability.

Table 6. Impact of ESG, E, S, and G scores on market capitalization.

	ESG	E	S	G
L.MCAP	0.859 ***	0.859 ***	0.854 ***	0.861 ***
	(0.0305)	(0.0316)	(0.0297)	(0.0321)
ASSETS	16.5 ***	16.5 ***	16.5 ***	16.1 ***
	(2.13)	(2.16)	(2.21)	(2.10)
EQ ASSETS	0.270 *	0.282 *	0.257 *	0.232 *
	(0.150)	(0.153)	(0.152)	(0.137)
DEBT	0.00947 *	0.00859	0.00996	0.00696
	(0.00554)	(0.00558)	(0.00565)	(0.00505)
ESG	0.199 ***
	(0.0595)
E		0.107 **
		(0.0426)
S			0.202 ***
			(0.0521)
G				0.0326
				(0.0333)
Constant	−29.03 ***	−3.139	−29.69 ***	−19.11 ***
	(8.340)	(6.703)	(8.285)	(6.979)
Nb of Observations	1374	1374	1374	1374
Nb of Firms	173	173	173	173
AR(1)	0.195	0.194	0.195	0.195
AR(2)	0.893	0.888	0.911	0.888
Hansen test	0.765	0.712	0.853	0.631

Windmeijer-corrected standard errors in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1.

Concerning ESG scores, it appears that the overall ESG score and the environmental (E) and social (S) pillars have positive and significant effects on market capitalization (MCap). This result suggests that markets positively value corporate engagement in ESG strategies, particularly in the environmental and social dimensions. In contrast, the impact of the governance pillar (G) is positive but not statistically significant, raising ongoing questions about the quality of governance within African firms and the nature of its relationship with performance. This finding aligns with studies indicating that capital markets tend to reward visible sustainability practices, especially those related to environmental stewardship and social responsibility, which are more directly observable to stakeholders. However, the non-significance of governance may indicate that investors remain cautious about governance mechanisms in African firms, where transparency, enforcement, and institutional credibility are still evolving [81]. As highlighted by recent studies [79,80], many African firms continue to struggle with weak institutional enforcement, concentrated ownership, corruption, and limited board independence. These issues suggest that formal governance structures may exist primarily for compliance purposes rather than as effective management mechanisms. Strengthening board diversity, leadership capacity, and institutional accountability remains critical for translating governance disclosure into real performance gains.

4.2. Are the Relationships Between ESG Scores and Financial Performance Nonlinear?

The non-significance of the relationship between ESG, E, and S scores and financial performance, as well as the adverse effect of the governance score, may be due to the existence of nonlinear relationships between these different scores and ROA. Indeed, several studies suggest that a low commitment to an ESG strategy may have adverse effects on performance, as the costs incurred may exceed the expected positive effects. Only firms that have made significant progress in their ESG commitments can expect positive net effects on their performance.

To explore this hypothesis, we introduce quadratic terms related to the different ESG scores into Model (1). The significance of the coefficients associated with the scores and their quadratic terms, as well as the signs of these coefficients, will determine the existence and nature of the nonlinear relationship. A positive sign for the score and a negative one for its quadratic term (or vice versa) would indicate a U-shaped relationship between the score in question and the firm’s financial performance. Such a result would confirm that the benefits of ESG strategies materialize only beyond a certain critical threshold. Firms just beginning to implement such a strategy may initially experience a decline in profitability if their score remains below this critical threshold.

Table 7 presents the estimation results of the models that include quadratic terms.

Table 7. Nonlinear relationships between ESG, E, S, and G scores and ROA.

	ESG	E	S	G
L.ROA	0.338 ***	0.237 **	0.548 ***	0.309 *
	(0.00258)	(0.105)	(0.116)	(0.168)
ASSETS	−0.00831 ***	−0.00622	−0.339 *	0.198
	(0.000579)	(0.193)	(0.177)	(0.275)
EQ ASSETS	0.125 ***	0.121 ***	0.0597 **	0.157 ***
	(0.000694)	(0.0307)	(0.0277)	(0.0561)
DEBT	0.0110 ***	0.129 ***	0.365 *	0.112 ***
	(0.000171)	(0.0276)	(0.215)	(0.0331)
ESG	−0.137 ***
	(0.00739)
ESG2	0.00184 ***
	(7.62 × 10−5)
E		−0.301 *
		(0.174)
E2		0.00331 *
		(0.00188)
S			0.207 *
			(0.121)
S2			−0.00231 **
			(0.00113)
G				−0.624 ***
				(0.228)
G2				0.00596 ***
				(0.00215)
Constant	3.736 ***	6.052 **	−0.521	12.78 **
	(0.153)	(2.812)	(2.327)	(5.079)
Nb of Observations	1149	1149	1149	1149
Nb of Firm	171	171	171	171
AR(1)	0.181	0.189	0.112	0.248
AR(2)	0.403	0.721	0.482	0.559
Hansen test	0.093	0.843	0.856	0.827

Windmeijer-corrected standard errors in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1.

The significance of the scores and their quadratic terms confirms that these variables have nonlinear relationships with ROA. The coefficient associated with the overall ESG score is negative and significant at the 1% level. At the same time, the quadratic term is positive and significant, indicating a U-shaped relationship between this score and financial performance. Similar conclusions can be drawn for the environmental (E) and governance (G) scores. These results suggest that ESG, E, and G scores only enhance financial performance when their values exceed respective critical thresholds. Therefore, only strong engagement in these dimensions enables firms to reap the benefits of such investments.

For the social (S) dimension, the coefficient signs suggest an inverted U-shaped relationship. This result implies that beyond a certain threshold, an increase in the S score would reduce performance. In other words, very high engagement in the social dimension may be detrimental to profitability. Based on the estimated coefficients, the critical thresholds for each score are calculated as follows: ESG* = 37.03; E* = 45.54; S* = 44.68; and G* = 52.33. To ensure the robustness of these results, Model (1) is estimated both before and after the critical threshold for each score. The results are presented in Table 8.

Table 8. The impact of high and low ESG scores on financial performance.

	ESG < 37.028	ESG > 37.028	E < 45.54	E > 45.54	S < 44.68	S > 44.68	G < 52.33	G > 52.33
L.ROA	0.461 ***	0.425 ***	0.184 ***	0.246 ***	0.00748	0.735 ***	0.440 ***	0.226 ***
	(0.0122)	(0.00450)	(0.0366)	(0.0468)	(0.175)	(0.150)	(0.0830)	(0.0297)
ASSETS	−0.17 ***	−0.13 ***	0.00222	−0.00434	−0.74	−0.33 *	0.19	−0.35
	(0.00445)	(0.00247)	(0.12)	(0.21)	(0.48)	(0.19)	(0.26)	(0.24)
EQ ASSETS	0.0464 ***	0.122 ***	0.145 ***	0.151 ***	0.131 **	0.0416 *	0.0370	0.0741 **
	(0.00471)	(0.000759)	(0.0298)	(0.0427)	(0.0622)	(0.0248)	(0.0286)	(0.0360)
DEBT	−0.143 **	0.013 ***	−0.111	−0.073 ***	−0.661	−0.019	−2.83 *	0.044 ***
	(0.0641)	(0.000236)	(0.324)	(0.00997)	(1.21)	(0.061)	(1.45)	(0.016)
ESG	−0.0359 ***	0.0145 ***
	(0.0113)	(0.00082)
E			−0.0669 *	0.220 ***
			(0.0368)	(0.0380)
S					0.284 **	−0.106 **
					(0.126)	(0.0467)
G							−0.0475 **	0.0288 **
							(0.0188)	(0.0124)
Constant	4.919 ***	−2.253 ***	3.622 **	−14.60 ***	−3.806	10.18 ***	7.070 ***	1.560
	(0.432)	(0.0907)	(1.627)	(2.817)	(5.069)	(3.571)	(2.080)	(1.511)
Nb of Obs.	360	789	679	470	496	653	581	568
Nb of Firms	94	126	138	81	125	109	128	125
AR (1)	0.052	0.228	0.246	0.021	0.667	0.001	0.003	0.052
AR (2)	0.345	0.297	0.744	0.724	0.051	0.827	0.496	0.23
Hansen test	0.999	0.292	0.544	0.441	0.963	0.694	0.817	0.391

Windmeijer-corrected standard errors in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1.

The findings related to the ESG score (columns 1 and 2) show that below the 37.03 threshold, limited ESG engagement reduces financial performance. At this stage, the initial costs of implementing ESG strategies outweigh the returns. Beyond this threshold, ESG efforts begin to generate financial returns, likely due to more effective governance, enhanced reputation, and increased attractiveness.

Similar observations can be made for the E and G scores. Environmental initiatives hurt the profitability of firms with low environmental scores but enhance performance once the score exceeds the 45.54 threshold. These positive effects may be explained by reduced energy costs and greater appeal to environmentally conscious customers. For governance, positive effects only appear above a score of 52.33. High-quality governance is expected to enhance profitability by improving control, risk management, and informed decision-making. These results support the nonlinear ESG–performance hypothesis, suggesting that firms must surpass a minimum level of sustainability maturity before financial benefits can materialize. As emphasized by Atugeba and Acquah-Sam, 2025 [82], partial or symbolic ESG adoption may be insufficient, while sustained, strategic investments in ESG practices can generate long-term value.

It is also noted that the critical threshold for governance is significantly higher than that for the environmental dimension. This suggests that the requirements in the governance area are higher than those in the environmental domain. African firms must therefore adopt strict governance standards to benefit from positive profitability outcomes.

Contrary conclusions are drawn for the social (S) score. Results from Table 7 suggest an inverted U-shaped relationship between this score and ROA. This implies that social actions initially generate gains by strengthening stakeholder engagement, but their effectiveness gradually decreases and disappears entirely beyond a certain critical threshold. Some social actions may enhance employee engagement and productivity. However, since marginal productivity typically decreases, productivity gains tend to diminish as social actions multiply, and the costs of these actions eventually exceed the benefits they may generate.

A similar approach is applied to explain the non-significance of the relationship between the governance score and market capitalization. The estimation results of the model including a quadratic term (Table 9, column 1) indicate a U-shaped relationship between a firm’s governance score and its market value. The critical score calculated from the estimated coefficients is 50.63. To confirm the nonlinearity of this relationship, we re-estimate the model for firms with scores below and above this threshold. The results, reported in columns 2 and 3 of Table 9, indicate that the governance score enhances firm value only for companies with scores above the threshold. This suggests that optimized governance structures strengthen investor confidence and, therefore, market valuation. For companies with scores below the threshold, governance significantly reduces market capitalization. A score below 50.63 likely raises concern among investors regarding the quality of governance. It is also possible that initial governance improvements involve high upfront costs or expose internal dysfunctions, which can negatively affect the firm’s market valuation. This finding reinforces the view that governance reforms must go beyond formal compliance to deliver strategic value and transparency. Investors in African markets may differentiate between symbolic governance practices and substantive governance quality, rewarding only the latter with higher market valuation [83].

Table 9. Nonlinear relationship between governance scores and market capitalization.

	G2	G < 50.63	G > 50.63
L.MCAP	0.796 ***	0.948 ***	0.779 ***
	(0.0167)	(0.0230)	(0.0782)
ASSETS	17.10 ***	9.50 **	33.30 ***
	(4.35)	(3.79)	(4.26)
EQ ASSETS	0.176	1.592 ***	0.323
	(0.125)	(0.395)	(0.243)
DEBT	0.582 *	25.10 ***	0.0517
	(0.329)	(5.41)	(0.120)
G	−0.983 **	−0.867 ***	0.128 **
	(0.404)	(0.166)	(0.0584)
G2	0.00971 **
	(0.00413)
Constant	4.883	−80.62 ***	−11.82
	(6.997)	(17.31)	(11.39)
Nb of Observations	1374	667	707
Nb of Firms	173	131	128
AR (1)	0.083	0.153	0.073
AR (2)	0.845	0.964	0.228
Hansen test	0.153	0.935	0.343

Windmeijer-corrected standard errors in parentheses, *** p < 0.01, ** p < 0.05, * p < 0.1.

5. Key Conclusions and Practical Implications

The main objective of this study was to assess the impact of ESG scores on the financial performance of African firms, measured by both accounting-based (ROA) and market-based (market capitalization) indicators, over the period 2010–2022. The analysis also examined whether the three ESG pillars exert similar effects on performance and whether these relationships exhibit nonlinear dynamics.

The empirical results reveal contrasting effects depending on the performance measure. For ROA, ESG scores generally display insignificant or even negative effects, indicating that the initial costs of ESG integration, such as compliance expenditures, staff training, and technology upgrades, can temporarily weigh on profitability. In contrast, ESG, environmental, and social scores exert a positive and significant influence on market capitalization, suggesting that investors view ESG engagement, risk mitigation, and regulatory readiness as key drivers of firm value.

The results also highlight the governance paradox in African firms. In the linear specification, governance scores negatively affect ROA and show no significant link with market value. However, once nonlinearities are accounted for, we identify a U-shaped relationship between governance and both ROA and market capitalization, with positive effects emerging only beyond a critical threshold, revealing persistent governance challenges. Weak corporate governance, characterized by ownership concentration, limited board independence, and low transparency, continues to constrain the efficiency of ESG implementation in African companies. Strengthening governance frameworks, enhancing disclosure quality, and improving board accountability are, therefore, critical for transforming ESG engagement into tangible financial gains.

A second set of estimations identifies nonlinear (U-shaped and inverted U-shaped) relationships between ESG dimensions and firm performance. Specifically, ESG, environmental, and governance scores exhibit U-shaped effects on ROA, implying that only after surpassing certain critical thresholds do ESG investments yield financial benefits. Below these thresholds, the costs outweigh the advantages. Conversely, the social dimension follows an inverted U-shaped pattern, where moderate investments improve productivity and stakeholder relations, but excessive social spending leads to diminishing returns. For market capitalization, non-linearity concerns only the governance score. The detected U-shaped relationship reflects the importance given by investors to the quality of governance.

These findings collectively indicate that ESG engagement must evolve beyond symbolic disclosure toward substantive integration to generate sustained financial benefits. Firms that demonstrate maturity in ESG adoption, characterized by long-term, strategic engagement, are more likely to experience positive ROA outcomes once the learning curve and setup costs are absorbed. Moreover, the quality and credibility of ESG disclosures, particularly when aligned with international standards such as GRI or ISSB, enhance investor trust, reduce information asymmetry, and improve access to sustainable capital.

As practical guidance, we suggest that African firms should embed ESG principles into their corporate strategies through the establishment of strong governance mechanisms, transparent reporting systems, and performance-based sustainability incentives at the board level. Firms should strengthen internal audit and compliance functions to ensure accountability, while integrating ESG metrics into executive evaluation frameworks to align managerial behavior with long-term value creation. The promotion of training programs and digital ESG data systems will also help improve reporting reliability and facilitate stakeholder engagement. These enterprise-level actions directly derive from the empirical evidence presented in this study, confirming that only firms exhibiting high governance quality can draw benefits from their ESG strategies.

From a practical standpoint, managers can use these insights to strategically navigate ESG thresholds and optimize their performance outcomes. Specifically, African firms should embed ESG principles into their core corporate strategy through strong board-level commitment and performance-linked incentives, ensuring that sustainability objectives are integrated into decision-making processes. They should also invest in robust data systems and continuous staff training to enhance the credibility and consistency of ESG reporting. In addition, proactive engagement with investors, regulators, and industry associations is essential to align ESG goals with market expectations and evolving regulatory standards. Finally, firms should transparently communicate their ESG achievements and progress, leveraging sustainability performance as a strategic advantage to strengthen reputation, attract responsible investors, and enhance long-term competitiveness in both local and global markets. At the same time, investors and policymakers should recognize that the ESG–performance nexus is highly context-dependent, influenced by firm size, industry structure, governance quality, and the maturity of ESG practices.

This study’s main limitation lies in its sample composition, as South African firms constitute the majority of the dataset due to their comparatively advanced ESG disclosure systems. While this enhances the reliability and consistency of the data, it also limits the generalizability of the findings to countries with less developed reporting practices. To mitigate this concern, we conducted a robustness check using a restricted subsample that excluded South African firms; the results remained consistent, thereby confirming the stability and validity of our main findings.

The temporal scope (2010–2022) also encompasses major external shocks, including the COVID-19 pandemic and periods of global financial volatility. Although these effects are partially captured through time fixed effects, future research could adopt crisis-sensitive models or segmented time analyses to better capture how ESG–performance dynamics evolve under macroeconomic stress.

Further investigation could deepen these insights by segmenting firms according to ESG maturity to assess whether long-term adopters achieve stronger financial returns than recent entrants, and by developing an ESG disclosure–quality index to evaluate whether credible, standardized reporting enhances profitability. Additionally, future studies should aim to refine ESG thresholds across industries, firm sizes, and regions to identify context-specific tipping points where ESG investments begin to yield positive effects. Examining firm size as a moderating variable would also clarify whether small, medium, or large firms benefit most from ESG engagement, providing a more nuanced understanding of how organizational characteristics influence the ESG–performance relationship.

Finally, future research could adopt a mixed-methods approach, combining quantitative analysis with qualitative insights—such as interviews with corporate executives and ESG officers—to explore the internal motivations, institutional constraints, and cultural factors driving ESG implementation across African markets. Such an integrated framework would provide a richer understanding of how African firms can leverage ESG strategies not only to enhance profitability but also to contribute meaningfully to sustainable and inclusive economic development.