Purpose ― Understanding how Environmental, Social, and Governance (ESG) practices interact with firm value within the framework of Sharīʿah compliance is essential, as Islamic capital markets integrate financial objectives with ethical and sustainable principles. The present study focuses on the bidirectional relationship between ESG performance and firm value. It investigates the moderating role of Sharīʿah compliance and examines the effect of external governance mechanisms on ESG practices in Sharīʿah-compliant firms in the context of Indonesia.
Design/Methodology/Approach ― The final sample consists of 155 public firms listed in the Indonesia Sharia Stock Index (ISSI). Structural Equation Modelling using Partial Least Squares (SEM-PLS) is employed to test the hypothesised relationships.
Findings ― The study finds a significant negative effect of ESG performance on firm value, suggesting that ESG investments may incur short-term costs that reduce immediate market valuation. In contrast, firm value significantly and positively influences ESG performance, indicating that firms with stronger financial standing are more likely to invest in sustainability initiatives. While Sharīʿah compliance does not moderate the relationship between ESG and firm value, it was found that it positively affects ESG engagement, reflecting the close alignment of Islamic values with sustainability. The study also reveals that external governance factors do not have a significant impact on ESG performance.
Originality/Value ― This study extends prior ESG research by modelling the ESG-firm value relationship as a bidirectional process and introducing Sharīʿah compliance as a moderator variable, thereby offering new insights into ethical investing and sustainable finance in Islamic capital markets.
Research Limitations/Implications ― The study adopts a cross-sectional design, which limits the ability to capture longitudinal dynamics and sectoral variations.
Practical Implications ― The study offers practical insights for managers, regulators, and investors by demonstrating how ESG engagement with Sharīʿah constraints may involve short-term value trade-offs while shaping sustainability outcomes in Islamic capital markets.