Risk Spillovers: When Politics Meets Sustainability

Abstract

This study examines the relationship between firms’ political risk and their susceptibility to the environmental, social, and governance (ESG) issues. Using quarterly data of U.S. public firms from 2019 to 2022, we find that firms exposed to higher uncertainty in political matters have higher exposure to financial risk caused by material ESG issues. While previous studies report that, as political volatility rises, firms invest more in sustainability-related activities to maintain legitimacy, we show empirical evidence that corporate ESG risk scores still increase in the face of heightened political risk, suggesting that their ESG initiatives in reaction to political instability are ineffective in mitigating firms’ exposure to ESG challenges. Political uncertainty creates negative sentiment toward political matters, which can signal an unfavorable environment for long-term sustainability developments, or higher ESG risks for firms. Our results also show that some strategic attributes, such as international presence and CEOs’ generalist skills, can protect firms’ ESG risk profiles from political turbulence.