Do Improvements in ESG Risk Management Enhance Operational Profitability? A Benefit‐of‐the‐Doubt Composite‐Indicator Approach

ABSTRACT

Understanding how sustainability and financial performance can be evaluated jointly remains a central challenge in ESG research. Although environmental, social and governance (ESG) risk metrics and financial indicators are widely used, they are typically analysed separately, providing limited insight into firms' ability to simultaneously manage sustainability risks and maintain operating profitability.

This study develops and applies an integrated performance framework that combines ESG risk exposure and operating profitability within a single composite indicator. The empirical analysis examines year‐on‐year changes in ESG risk exposure and operating profitability, measured through EBIT margins, using a dynamic and exploratory difference‐based approach. The dataset includes a sector‐specific sample of 30 firms in the pulp and paper industry—an environmentally intensive sector with high ESG salience—and a broader cross‐industry additional sample of 58 firms to assess generalisability. ESG risk data are obtained from Sustainalytics, a global provider of independent assessments, which measures firms' unmanaged, financially material ESG risk on an absolute scale, and financial data are derived from audited financial statements.

The empirical strategy combines regression analysis with a directional benefit‐of‐the‐doubt composite indicator. Although the regression results indicate that reductions in ESG risk are economically aligned with improvements in EBIT margins, the short‐term relationship is not statistically significant within the observation window analysed.

The composite‐indicator analysis provides additional information by jointly evaluating ESG risk exposure and operating profitability. The results show that firms with similar ESG risk profiles may display substantially different positions once operating profitability is incorporated into the assessment, highlighting the multidimensional nature of sustainability‐performance dynamics.

Overall, the findings suggest that improvements in ESG risk primarily contribute to long‐term operational resilience and risk‐adjusted performance rather than to immediate accounting gains. By proposing an integrated ESG‐financial composite indicator and applying it within a dynamic, sector‐aware empirical framework, this study provides both methodological and empirical contributions to the literature on sustainability and corporate performance. The results also offer practical insights for managers, investors and policymakers seeking to evaluate sustainability‐related performance more comprehensively.