ESG Ratings and Corporate Investment Efficiency: Evidence from South Africa

In environments with weak external monitoring, investment inefficiency persists due to agency conflicts and information asymmetry. This study examines the effect of environmental, social, and governance (ESG) ratings on corporate investment efficiency in non-financial listed firms in South Africa using a panel dataset of 2921 firm-year observations from 2010 to 2023. Employing fixed effects, instrumental variable regressions, and mediation models, the analysis reveals that higher ESG ratings are significantly associated with lower levels of investment inefficiency. This effect is particularly stronger in firms with weaker governance quality, where ESG substitutes are inadequate for internal monitoring. Furthermore, the findings show that ESG ratings reduce underinvestment by lowering information asymmetry and curbing overinvestment by constraining agency-driven resource misuse. The heterogeneity analysis demonstrates that ESG-driven efficiency gains are amplified in non-state-owned firms, younger firms, and nonpolluting industries, where competitive market pressures, proactive strategic signaling, and a stronger reliance on stakeholder trust enhance the role of ESG ratings in improving capital allocation. These findings underscore that ESG ratings function not only as a strategic signal of stakeholder alignment but also as a mechanism for addressing structural inefficiencies in capital allocation. This study provides a foundation for refining sustainability-oriented investment policies in emerging markets, where ESG frameworks are nascent but financially important.