Structure or Composition? Explaining the ESG Premium in Firm Profitability With Oaxaca and Pseudo‐Panel Evidence

Abstract

ABSTRACT This study examines whether ESG‐related profitability differences arise from observable firm characteristics or from structural differences in how firms convert those characteristics into performance outcomes. Using an unbalanced panel data design, the final sample comprises 727 firm‐year observations from 178 publicly listed non‐financial firms across 11 MENA countries and 10 economic sectors, covering the fiscal years from 2016 to 2023. The analysis combines fixed‐effects estimation, system GMM, Blinder–Oaxaca decomposition, and a cohort‐based pseudo‐panel framework. The results show that the positive cross‐sectional relationship between ESG and profitability disappears after controlling for firm‐fixed effects, indicating that ESG premiums are primarily driven by persistent firm characteristics rather than within‐firm ESG improvements. Dynamic panel and lagged specifications provide limited evidence of a causal effect of ESG on profitability. Blinder–Oaxaca decomposition results indicate that observable firm characteristics explain only a small share of the profitability gap between high‐ and low‐ESG firms, while most of the gap reflects differences in the estimated returns to those characteristics rather than differences in firm composition. Overall, the findings suggest that ESG‐related profitability differences are predominantly structural rather than compositional.