Do ESG activities reduce agency costs?

This work explores the ongoing debate about whether a firm's increased Environmental, Social, and Governance (ESG) activities affect its agency costs—the expenses arising from conflicts between shareholders and managers, or shareholders and creditors. Proponents argue that strong corporate governance, often bundled with ESG, leads to sound financial choices, effectively allocating resources and thereby lowering agency conflicts. Conversely, critics highlight the ambiguity surrounding ESG definitions and measurements, noting the existence of hundreds of divergent metrics. They also point out that mutual funds focused on ESG themes haven't necessarily shown abnormal returns. This work, based on 2,277 Chinese firms from 2009-2024, directly tests this relationship, concluding that Social activities generally lower both Type I (Principal-Agent) and Type II (Principal-Principal) agency costs. This finding suggests another route through which ESG adds value to firms.