When a Rival’s ESG Scandal Improves Corporate Investment

Environmental and social scandals do not stop at the boundaries of the company responsible. By creating information gaps and heightened uncertainty, they can damage the reputation and performance of innocent competitors. In our recent Journal of Corporate Finance article, we examine whether an environmental or social incident at one company changes investment decisions at comparable firms not involved in the incident.

Measuring spillovers between genuine competitors

Our analysis covers observations of 3,872 US firms from 2007 to 2021. We identify negative environmental and social incidents using RepRisk, which monitors corporate controversies reported by media and other public sources.

Rather than assuming that all firms within a conventional industry classification are equally relevant, we identify each company’s five closest competitors using text-based similarities in their product-market descriptions. This lets us capture the firms investors, consumers, and managers are most likely to regard as meaningful peers.

We then examine whether investment becomes more closely aligned with Tobin’s Q—a market-based measure of a company’s growth opportunities—after one of these peers experiences an incident. Greater investment sensitivity to genuine growth opportunities indicates more efficient capital allocation.

The results are economically significant. Following a peer incident, investment sensitivity to growth opportunities increases by approximately 58%. Although firms reduce capital expenditure slightly on average, they become more selective: investment shifts more strongly toward opportunities supported by market valuations. The results remain robust under alternative definitions of peer incidents, different samples, propensity-score matching, and placebo tests.

Why do peer scandals change managerial behaviour?

We identify three complementary explanations.

First, a scandal increases external monitoring. Analysts and investors may treat misconduct at one company as evidence of risks shared across its sector. They consequently scrutinise comparable firms’ governance, controls and investment strategies more closely. Consistent with this explanation, the improvement in investment efficiency is concentrated among companies with greater analyst coverage and higher stock-trading volume.

Proximity also matters. The effect is substantially stronger when the offending company offers similar products or is a particularly close competitor. Incidents involving more distant firms produce no comparable effect. Stakeholders therefore appear to distinguish between general controversy and misconduct that reveals risks relevant to a company’s immediate competitive environment.

Second, peer incidents provide information managers can learn from. A scandal can reveal previously underappreciated regulatory, operational and reputational risks. Managers can also observe how investors react and incorporate those market signals into subsequent investment decisions. The effect is stronger in competitive and uncertain product markets and where stock prices contain more firm-specific information.

Third, peer scandals can discipline overinvestment. We find that unaffected firms experience lower profitability and higher administrative expenses following peer incidents, potentially reflecting reputational contagion and additional spending on compliance, communication or stakeholder engagement. These pressures reduce the financial and managerial space for poorly justified projects. Accordingly, investment efficiency improves most among firms that previously overinvested.

Implications for boards and regulators

For boards, ESG oversight should extend beyond monitoring misconduct within their own company. Incidents involving close competitors can reveal shared weaknesses in business models, supply chains, compliance systems or stakeholder relationships. Boards should treat such events as prompts to reassess capital expenditure, internal controls and the assumptions underlying major investments.

For regulators, the findings suggest that enforcement actions and the public disclosure of corporate misconduct may influence an entire competitive network, not merely the offending company. Transparency can strengthen market discipline by enabling analysts and investors to identify common risks and press other firms to respond.

These benefits should not be interpreted as suggesting that corporate scandals are socially desirable. We also find adverse effects on unaffected firms, including negative stock-market reactions and weaker operating performance. Instead, our evidence shows that transparency and market scrutiny can turn a damaging incident into a broader governance and learning event. The corporate consequences of misconduct—and of the legal and regulatory responses to it—extend well beyond the company directly responsible.

The authors’ complete article can be accessed here.

Thang Ho is an Assistant Professor in Finance at the University of Bradford School of Management.

Duc Trung Do is a Lecturer in Banking and Finance at Bangor Business School, Bangor University.

Giray Gozgor is an Associate Professor of Economics and Finance at the University of Bradford School of Management.

Jing Li is a Professor of Accounting at the University of Bradford School of Management.