The Hidden Cost of Shame: <scp>ESG</scp> Controversies and Cost Efficiency in Banks – An <scp>SFA</scp> Approach

ABSTRACT This study explores how ESG controversies affect banks' operating costs. Using data from the world's largest banks and applying stochastic frontier analysis, we show that ESG controversies significantly reduce cost efficiency by increasing non‐interest expenses. The magnitude of this effect, however, depends heavily on the institutional context. Banks in the European Union or countries with strong rule of law and regulatory quality experience smaller cost increases following ESG controversies, while those operating under highly effective government structures face stronger cost pressures. We also find that higher baseline ESG performance improves cost efficiency and serves as reputational insurance, mitigating the adverse impact of controversies. Additionally, greater digital visibility, measured through Google Search Volume, is associated with marginally higher operating costs but facilitates ESG reputation recovery. Overall, the study shows that ESG failures carry measurable financial consequences for banks and that both institutional quality and digital engagement shape their capacity to manage ESG‐related reputational shocks.