Do ESG practices enhance stock returns through firm fundamentals? Evidence from Indonesia

Type of the article: Research ArticleAbstractThis study examines whether Environmental, Social, and Governance (ESG) performance enhances stock returns directly or indirectly through firm fundamentals in an emerging market context. The analysis focuses on non-financial firms listed on the Indonesian Stock Exchange (IDX) over the period 2014–2023, following the expansion of sustainability reporting regulations in Indonesia. The final sample comprises 4,037 firm-year observations, of which 477 contain available ESG scores obtained from a third-party rating database. Panel data regression models with firm-level controls and mediation analysis are employed to test both direct and indirect relationships. The empirical results indicate that ESG performance has a positive and statistically significant effect on total factor productivity (TFP) and return on assets (ROA), suggesting that sustainability practices are associated with improvements in operational efficiency and profitability. In turn, both TFP and ROA exhibit positive and significant effects on stock returns. However, ESG does not demonstrate a statistically significant direct effect on stock returns after controlling for firm fundamentals. Mediation analysis confirms that ESG influences stock returns indirectly through productivity and profitability channels, with productivity emerging as the stronger transmission mechanism. These findings suggest that, in the Indonesian capital market, ESG operates primarily as a fundamental value-enhancing mechanism rather than as an independent pricing signal. Sustainability performance contributes to shareholder value when it strengthens firms’ internal efficiency and financial resilience, highlighting the importance of fundamental performance channels in emerging markets.