Beyond the tipping point: The nonlinear impact of material sustainability on investment efficiency

Drawing on the shareholder viewpoint adopted by the Sustainability Accounting Standards Board (SASB) to determine materiality, we propose and test a hypothesis for the optimal level of allocating financial resources to projects prioritizing environmental, social, and governance factors, namely sustainability investment. Based on the premise that shareholders consider specific thresholds for sustainability investments, we postulate that shareholders respond positively if the firm's sustainability investments are below the optimal level, whereas they react negatively if the investments are above the optimal level. Using a quadratic and piecewise linear regression, we demonstrate a significant inverted U-shaped linkage between materiality ratings of sustainability and capital investment efficiency for a sample of all U.S. companies listed on ASSET4 spanning from 2008 to 2021. Upon further examination of the sensitivity of the turning point to firm- and market-specific characteristics, we find that leveraged firms and those facing exogenous shocks have a higher optimal level. Our results remain robust across a range of sensitivity tests and offer significant policy implications for regulators and standard setters. These findings can inform the frameworks and guidelines developed by organizations such as the U.S. Securities and Exchange Commission (SEC), the SASB, and the International Sustainability Standards Board (ISSB).