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Does ESG Performance Improve the Quantity and Quality of Innovation? The Mediating Role of Internal Control Effectiveness and Analyst Coverage

Sustainability 2023, 15(1), 104; https://doi.org/10.3390/su15010104

by Shuying Li¹, Yujie Liu^2,* and Yang Xu³

Reviewer 1: Anonymous

Reviewer 2:

Thanh-Lam Nguyen

Reviewer 3: Anonymous

Reviewer 4: Anonymous

Sustainability 2023, 15(1), 104; https://doi.org/10.3390/su15010104

Submission received: 17 November 2022 / Revised: 12 December 2022 / Accepted: 14 December 2022 / Published: 21 December 2022

(This article belongs to the Section Economic and Business Aspects of Sustainability)

Round 1

Reviewer 1 Report

I had the chance to look at the manuscript, and I confess to being positive about it. The objective of the research is clear, the econometric analysis is well designed and executed and the results are coherent with the overall narrative of the paper. There are still some issues to be solved before the paper can be considered ready for publication, as listed below.

Authors should define the acronym ESG in the abstract.
In the methodology section, authors should specify why they use the natural logarithm plus 1 instead of the total number of invention authorized patents to measure the corporate Innovation.
The literature review is incomplete and must be modified to include these references dealing with the link between sustainability and corporate innovation:

Baldassarre, B., Calabretta, G., Bocken, N. M. P., & Jaskiewicz, T. (2017). Bridging sustainable business model innovation and user-driven innovation: A process for sustainable value proposition design. Journal of cleaner production, 147, 175-186.
Calabrese, A., Forte, G., & Ghiron, N. L. (2018). Fostering sustainability-oriented service innovation (SOSI) through business model renewal: The SOSI tool. Journal of Cleaner Production, 201, 783-791.
França, C. L., Broman, G., Robert, K. H., Basile, G., & Trygg, L. (2017). An approach to business model innovation and design for strategic sustainable development. Journal of Cleaner Production, 140, 155-166.
Rantala, T., Ukko, J., Saunila, M., & Havukainen, J. (2018). The effect of sustainability in the adoption of technological, service, and business model innovations. Journal of cleaner production, 172, 46-55.

Additionally, you should include these references dealing with the sustainability reporting:

Calabrese, A., Costa, R., Levialdi Ghiron, N., & Menichini, T. (2019). Materiality analysis in sustainability reporting: a tool for directing corporate sustainability towards emerging economic, environmental and social opportunities.
Jones, P., Comfort, D., & Hillier, D. (2016). Materiality in corporate sustainability reporting within UK retailing. Journal of Public Affairs, 16(1), 81-90.

Landrum, N. E., & Ohsowski, B. (2018). Identifying worldviews on corporate sustainability: A content analysis of corporate sustainability reports. Business Strategy and the Environment, 27(1), 128-151.

Author Response

Response to Reviewer 1 Comments

Dear Reviewer 1,

We are glad that you think our paper has clear research objectives and that the econometric analysis is well designed and executed. We are very pleased that you believe our paper shows potential for publication. We greatly appreciate your insightful comments and suggestions. You are as devoted to improving this paper as we are. We have worked hard to improve the paper as much as possible. We hope you are pleased with our revised paper.

In the following, we document how we have addressed the points that you raise.

Point 1: Authors should define the acronym ESG in the abstract.

Response 1: We are sorry for our negligence in omitting the definition of ESG acronym in the abstract. Thank you very much for pointing this out. We have defined the acronym ESG in the abstract and the modified abstract is as follows.

Revised section on page 1, line 10.

Abstract: This study tests the performance of environmental, social, and governance (ESG) on corporate innovation and the mediating effect of internal control effectiveness and analyst coverage on this relationship, by using data on China’s A-share listed companies from 2009 to 2020. The results show that ESG performance significantly improves innovation quantity, measured by the number of authorized invention patents, and innovation quality, measured by the number of patent citations. The internal and external mechanism tests show that the quantity and quality improvement effect of ESG performance on corporate innovation is dependent on effective internal controls and adequate analyst coverage. The results of the heterogeneity analysis show that improvement in the quality of enterprise-driven innovation is primarily due to knowledge spillover into the domestic market. The additional analysis suggests that the promoting effect is more obvious when the Chief executive officer (CEO) serves as a board chairman, the corporation belongs to non-state-owned and large-scale enterprises, the industry in which the market competition is higher, and the corporation is located in a general city. This study provides a foundation for developing a better ESG valuation theory to assist management and investors in making better decisions to improve business performance and investment returns.

Point 2: In the methodology section, authors should specify why they use the natural logarithm plus 1 instead of the total number of invention authorized patents to measure the corporate Innovation.

Response 2: Thank you for raising this issue. We use the logarithmic form mainly because the patent data are count data, and many companies do not have granted invention patents in that year. Therefore, there are many zero values in the sample, which can lead to a right-skewed distribution of the corporate innovation variables and may not satisfy the normal distribution. Taking the logarithm can alleviate this problem as much as possible. Also, it can make more use of the sample and avoid a large number of samples being removed in the regression. We acknowledge that a description of the variable definition is better. Thank you very much for pointing this out. we have further clarified the definition of corporate innovation. The specific details of the revision are as follows.

Revised section on page 8, line 357-360.

Where denotes the dependent variable, including the quantity of innovation (lnPatent) and and the quality of innovation (lnCitation). Since patents are count data, the study alleviates the estimation bias that may be caused by the right-skewed distribution of patent data by taking patents in a logarithmic form to make them more closely to a normal distribution.

Point 3: The literature review is incomplete and must be modified to include these references dealing with the link between sustainability and corporate innovation.

Response 3: Thank you for raising this issue. We acknowledge that our previous manuscript did not do enough on the literature review. We have revised the paper accordingly. Firstly, we have reworked the existing research on ESG performance and corporate innovation in the introduction. Secondly, we added a chapter on the ESG sustainability concept and corporate innovation behavior to the literature review in order to remedy the deficiencies of the literature in the introduction. The specific details of the revision are as follows.

Revised section on page 2, line 49-75; page 3, line 123-158.

Previous discussions on ESG performance and corporate innovation concentrated on short-term financial performance and firm value. While these studies confirm a positive relationship between ESG, financial performance [6,7,8,9], and firm value [10,11,12], they also examine the role of their impact mechanisms from the perspective of stakeholders [13,14]. In recent years, some scholars have started to apply these discussions to corporate innovation activities [3,15,16], discovering that ESG performance can positively impact corporate innovation activities, but only through internal effects, such as alleviating financing constraints and agency costs. [17,18], The focus of internal and external governance mechanisms is different; the two are interdependent and complementary. A one-sided emphasis is unlikely to achieve the desired governance effect [19]. Relying solely on internal governance ignores the critical role of external oversight in interpreting information and promoting regulation; however, relying on external oversight alone does not bring the subjective role of internal governance into play [20].Therefore, according to the Theory of Second Best, this article discusses the mediating role of internal control effectiveness and analyst coverage in the relationship between ESG performance and corporate innovation.

Furthermore, current research on corporate innovation is more likely to categorize corporate innovation behavior based on innovation content and intensity than analyze it from a comprehensive perspective of innovation quantity and quality. In reality, enterprises engage in research and development (R&D) innovation to maintain a competitive advantage through technological innovation and engage in strategic innovation behaviors to maximize the direct profitability of innovation [4,21]. It is necessary to eliminate strategic innovation interference as much as possible from the research to investigate whether ESG performance can effectively influence firms’ real innovation output and thus achieve sustainable development. This study analyses the impact of ESG performance on firms’ real innovation by excluding strategic innovation and discussing innovation quality in an attempt to fill this knowledge gap.

2.1. Literature Review

2.1.1. ESG’s Concept of Sustainability

The importance of sustainability in global businesses continues to increase [29]. The challenges and opportunities related to the social transition to sustainable development are increasingly embedded in the transformation and development of enterprises [30]. They are embodied in the management system and information disclosure of enterprises [31]. Since its introduction by the United Nations in 2004 [32], the public has gradually expanded the criteria for judging corporate sustainability from corporate social responsibility (CSR) to ESG [33]. Pressure from official regulations, investors, and stakeholders to disclose ESG performance has influenced companies’ attitudes toward sustainability. From a financial perspective, ESG has been widely discussed as a socially responsible investment (SRI) [34]. However, the discussion of its impact on internal operations from sustainable development (SD) perspective has only emerged in recent years [35], with a limited focus on understanding customer needs and integrating them with corporate innovation to generate value [36]. Traditional innovations can no longer meet the requirements of social development. Technological innovation and business model innovation based on sustainable development provides a new perspective for enterprise innovation [37-40]. In innovation theory, business model innovation is an important tool for companies to realize the value of technological innovation [41]. Further, technological innovation is the key to ESG performance in driving sustainable development [15,18].

2.1.2. Corporate Innovation Behavior

Corporate innovation activities are a strategy to retain a certain level of competitiveness through technological innovation and may also be an action to meet the needs of the government and relevant regulatory bodies [4,21]. Corporate innovation, as a strategic behavior, is characterized by high risk and positive externalities. Specifically, the high riskiness of innovation is manifested in the uncertainty in terms of technology and returns [42], which directly limits the intensity as well as the motivation of firms to innovate. The positive externality of innovation manifests as the existence of a certain degree of spillover effects [43]. Knowledge spillover is an important feature of innovation. It refers to the ability of enterprises to learn, absorb, and imitate advanced knowledge and technology to improve enterprise production efficiency [44,45]. Knowledge spillovers depend on the size of the absorbing capacity of the absorbing party and the absorbing capacity of the spillover party and the level of knowledge stock [46,47]. Furthermore, in addition to R&D investment, the knowledge gap between enterprises influences their knowledge-absorption capacity. The depth and breadth of externally acquired knowledge impact innovation at the source of the value creation chain [48].

Jones, P.; Comfort, D.; Hillier, D. Materiality in corporate sustainability reporting within UK retailing. J. Public Aff. 2016,16, 81-90.

Calabrese, A.; Forte, G.; Ghiron, N.L. Fostering sustainability-oriented service innovation (SOSI) through business model renewal: The SOSI tool. J. Clean Prod. 2018, 201,783-791.

Landrum, N. E.; Ohsowski, B. Identifying worldviews on corporate sustainability: A content analysis of corporate sustainability reports. Bus. Strateg. Environ.2018,27, 128-151.

Baldassarre, B.; Calabretta, G.; Bocken, N.M.P.; Jaskiewicz, T. Bridging sustainable business model innovation and user-driven innovation: A process for sustainable value proposition design. J. Clean Prod. 2017, 147,175-186.

Rantala, T.; Ukko, J.; Saunila, M.; Havukainen, J. The effect of sustainability in the adoption of technological, service, and business model innovations. J. Clean Prod. 2018 172, 46-55.

França, C. L.; Broman, G.; Robert, K. H.;Basile, G.; Trygg, L. An approach to business model innovation and design for strategic sustainable development. J. Clean Prod. 2017,140, 155-166.

Daugaard, D.; Ding, A. Global Drivers for ESG Performance: The Body of Knowledge. Sustainability 2022, 14, 2322.

Zhang, Q.; Loh, L.; Wu, W. How do Environmental, Social and Governance Initiatives Affect Innovative Performance for Corporate Sustainability? Sustainability 2020, 12, 3380.

Zhou, K. Z.; Li, C. B. How knowledge affects radical innovation: Knowledge base, market knowledge acquisition, and internal knowledge sharing. Strateg. Manage. J. 2012. 33, 1090-1102.

Aldieri, L.; Carlucci, F.; Vinci, C.P.; Yigitcanlar, T. Environmental innovation, knowledge spillovers and policy implications: A systematic review of the economic effects literature. J. Clean Prod. 2019, 239,118051.

Ode, E.; Ayavoo, R. The mediating role of knowledge application in the relationship between knowledge management practices and firm innovation. J. Innov. Knowl. 2020, 5, 210-218.

Halicioglu, F.H. The relationship between eco-innovation and sustainability in the construction industry: Exploring knowledge networks from the perspective of ANT. IOP Conf. Ser.: Earth Environ.Sci. 2020 , 588,052059.

Singh, S. K., Gupta, S., Busso, D., & Kamboj, S. Top management knowledge value, knowledge sharing practices, open innovation and organizational performance.J. Bus. Res. 2021, 128, 788-798.

Yousefi, S. R.; Ghanbari, M.; Amiri, O.; et al. Dy2BaCuO5/Ba4DyCu3O9. 09 S‐scheme heterojunction nanocomposite with enhanced photocatalytic and antibacterial activities. J. Am. Ceram. Soc. 2021, 104, 2952-2965.

Author Response File: Author Response.docx

Reviewer 2 Report

This research topic is interesting. However, it can be further improved with the following concerns:

1. The term "quantity and quality of innovation" stated must be clarified before it is mentioned in the research hypotheses.

2. Figure 1 fails to correctly represent the research hypotheses. Specifically, the hypotheses show that the internal governance mechanism and the external supervision mechanism work as moderators (moderating variables) instead of mediators (mediating variables).

3. The abbreviations of ST and * ST in Line 233 should be clarified.

4. A separate section should be added to discuss and benchmark the results with existing findings in other papers before Section 6 (Line 621).

5. Section 6.3 should be further strengthened to provide practical applicability.

Author Response

Response to Reviewer 2 Comments

Dear Reviewer 2,

We are glad that you find that our paper to be interesting and to raise five important issues. We greatly appreciate your insightful comments and suggestions. You are as devoted to improving this paper as we are. We have worked hard to improve the paper as much as possible. We hope you are pleased with our revised paper.

In the following, we document how we have addressed the points that you raise.

Point 1: The term "quantity and quality of innovation" stated must be clarified before it is mentioned in the research hypotheses.

Response 1: Thank you for raising this issue. We acknowledge that adding clarification of the quantity and quality of innovation to the research hypothesis will help the reader to understand the article. Thank you very much for pointing this out. We accordingly clarify the research hypothesis before the first place where the quantity and quality of innovation appears in the research hypothesis. Meanwhile, we strengthen the description of innovation quantity and innovation quality in the definition of variables. The specific details of the revision are as follows.

Revised section on page 4, line 200-203; page 7, line 306-322.

In addition, ESG distinguishes itself from compulsory institutional arrangements that produce a push-back mechanism for corporate innovation, leading to the problem that companies present in terms of quantity and quality of innovation, emphasizing quantity over quality [62]. Companies’ participation in ESG ratings is voluntary and can significantly alleviate the problem of slipping in the quality of innovation. That is, a company’s ESG performance promotes an increase in the quantity of corporate innovation while improving the quality of corporate innovation, showing the effect of increasing quantity while improving quality. Based on the above analysis, hypothesis 1 is proposed.

3.2.1. Corporate Innovation

In this study, we use granted invention patents to measure the quantity of innovation and citation of granted invention patents to measure the quality of innovation [77,78,79].

The reasons for this are mainly as follows: First, in terms of the quantity of innovation, the number of patents is an important indicator of innovation performance, which can objectively reflect the progress of innovation [80]. However, existing studies have found that patent applications contain a large number of strategic innovations in order to meet the demands of stakeholders, enterprises meet the annual patent application quota by splitting a single patent application into multiple applications [81]. Granted patents, on the other hand, undergo substantive examination by the relevant authorities, eliminating as much strategic innovation as possible. Therefore, we focus on granted patents. Secondly, in terms of innovation quality, invention patents are highly heterogeneous and their quantity is not a better measure of the quality of innovation [82,83]. In contrast, patent citations are direct feedback of the market value of patents, which can well represent the commercial value and technological impact of innovations [84,85], and thus better capture the dynamic changes of innovation quality [86]. Therefore, the article selects the number of citations of granted patents to measure quality.

Point 2: Figure 1 fails to correctly represent the research hypotheses. Specifically, the hypotheses show that the internal governance mechanism and the external supervision mechanism work as moderators (moderating variables) instead of mediators (mediating variables).

Response 2: Thank you for raising this issue. We acknowledge that lack of clarity in the expression of the mechanism in the research hypothesis has caused misunderstanding to the reader. Thank you very much for pointing this out. We have revised the thesis section of the research hypothesis substantially and restated the parts that were not clearly expressed. The specific details of the revision are as follows.

Revised section on page 5, line 207-282.

2.2.2. The Mediating Role of Internal Control Effectiveness

Basic Norms for Enterprise Internal Control in China indicate that internal control is a management process that ensures the safety of corporate assets, improves operational efficiency and effectiveness, and promotes the realization of corporate development strategies [63]. It plays an effective role in internal supervision and risk-management mechanisms. The ESG concept emphasizes the long-term development ability of an enterprise. This is consistent with the sustainable development goal of the enterprise’s internal control. The design of enterprise internal control based on the ESG concept is conducive to reducing the financing and operating risks of the enterprise and promoting the improvement of internal control ability [64]. In recent times, the output and quality of enterprises are no longer the focus of enterprise competition and development but are more reflected in the internal management and strategic risk of enterprises. Therefore, enterprises must adopt the internal control mode of integrating sustainable development and ESG to improve the effectiveness and long-term development of their business activities.

The development of innovation in enterprises inevitably faces risks. Effective internal control can provide timely feedback to manage the risks arising from the innovation process and develop management counter-measures to cope with and prevent these risks [65]. First, effective internal control ensures that the innovation process is conducted in a normal and orderly manner, thus providing a conducive environment [66]. Second, effective internal control enables management to effectively identify risks and opportunities in the external environment and internal resources, reduce management’s short-sightedness toward innovation, and prevent long-term investment in innovation projects to target short-term performance [67]. Third, effective internal control reduces management’s incentive to capture private interests through innovation investments and mitigates agency conflicts between management and investors by improving the relevant monitoring and governance mechanisms [68]. The reduction in opportunistic behavior among executives improves capital use and management efficiency [69].

Since ESG performance has an indirect influence on corporate innovation without direct corporate governance [70], the intermediary factor of internal control is needed to influence the output activities of innovation: the design of corporate internal control based on the ESG concept, prompting management to reasonably control innovation risks, mitigating the hidden dangers caused by agency problems, and improving innovation efficiency, thus promoting an increase in the quantity of corporate innovation and improving innovation quality. Based on the above analysis, the second Hypothesis 2. is proposed.

Hypothesis 2 (H2). Internal control effectiveness mediates the relationship between ESG performance and corporate innovation.

2.2.3. The Mediating Role Analyst Coverage

As third-party intermediaries in the external market, analysts play a further role in the transmission and dissection of information by obtaining financial and non-financial information about enterprises and making independent analyses and predictions about enterprises based on their long-term development. Analysts have unique advantages in monitoring listed companies compared to traditional corporate governance, and are also recognized by investors for their objectivity, professionalism, and prudence [71]. In April 2002, the China Securities Regulatory Commission issued a Guidance on Investor Relationship Management for Listed Companies, which included ESG information consideration requirements for the first time in the communication content of investor relationship management. In recent years, ESG has become a popular investment concept and corporate evaluation standard in the capital market. Its content contains financial information about the company and integrates non-financial information, such as environmental, social, and corporate governance [72], which provides investors and financial analysts with incrementally useful information and thus attracts more attention from analysts.

Technological innovation has a certain professionalism, and shareholders’ lack of professional knowledge easily leads to information asymmetry between shareholders and management, increasing the cost of shareholder supervision [68]. Innovation technology has a certain degree of confidentiality, and because of limited information and energy, external information users can easily lead to a certain degree of asymmetry between the internal and external information of the enterprise. This makes investors interpret the information with errors, thus affecting the value assessment of innovation and investment decisions [73]. Information asymmetry between enterprises and investors can be mitigated by the level of analyst coverage, which provides effective and timely information to inform users through professional analysis capabilities, ensures effective interpretation of information on the value of innovation projects, and promotes investment in innovation [74].

Better ESG performance attracts more attention from analysts, and analysts’ professional information interpretation and continuous tracking perform an external monitoring function that compensates for the lack of internal oversight. Therefore, the mediating factor of analyst coverage is required to influence innovation output activities. Professional information interpretation and continuous follow-up by analysts perform an external monitoring function and alleviate information asymmetry between companies and investors, thus better utilizing the market’s role in allocating credit funds and ensuring innovative inputs [75,76]. Based on the above analysis, this study proposes hypothesis 3.

Hypothesis 3 (H3). Analyst coverage mediates the relationship between ESG performance and corporate innovation.

Point 3: The abbreviations of ST and * ST in Line 233 should be clarified.

Response 3: Thank you for raising this issue. We acknowledge that a detailed explanation of ST and *ST would be better. Thank you very much for pointing this out. We explain it in detail in the text. The specific details of the revision are as follows.

Revised section on page 7, line 294-296.

The article uses the data of manufacturing listed companies in China A-shares from 2009 to 2020 for the study. In order to avoid the interference of existing data by other factors, the sample is treated as follows: (1) Companies that have suffered losses for two consecutive years, net assets below stock par value (ST) and losses for three consecutive years subject to delisting risk warning (*ST) are excluded; (2) Financial companies are excluded; (3) Companies with incomplete data are excluded, and the final sample of 18058 observations is obtained.

Point 4: A separate section should be added to discuss and benchmark the results with existing findings in other papers before Section 6 (Line 621).

Response 4: Thank you for raising this issue. In the revised version, we have added a new section that discusses the results and compares them with existing results in other studies. The specific details of the revision are as follows.

Revised section on page 22, line 668-704.

Discussion

Traditional valuation theories focus on measuring financial indicators while ignoring the long-term impact of ESG elements on enterprise value and are incapable of measuring corporate value comprehensively and scientifically. Constructing a more comprehensive ESG valuation theory can assist management and investors in making better decisions to improve business performance and investment returns. Therefore, this study explores the impact of ESG performance on the quantity and quality of corporate innovation from the perspective of corporate innovation and provides a scientific basis for companies to improve corporate governance to achieve sustainable development.

First, the study finds that ESG performance significantly improves firms’ innovation quantity and quality, with clear quantitative and qualitative improvements. Different from existing studies that only use patent applications to measure corporate innovation [11,18], this study uses authorized invention patents that have been substantively reviewed by relevant institutions to measure corporate innovation, which can maximize the elimination of strategic innovation and directly reflect true innovation that contributes to economic growth [4]. Further, the article not only uses the number of citations as a proxy variable for innovation quality but also examines the quality of patents from the perspective of patent IPC structure in the robustness test [97], which makes the conclusion of innovation quality more convincing. Compared to other studies that use invention patents as a proxy variable for innovation quality, citations are an important indicator of the market value of patents and are more appropriately used as a proxy variable for innovation quality in firm-level analysis [84,85].

Second, unlike existing ESG effects on innovation that are mostly tested from the internal mechanism of financing constraints [17,18], this study analyzes through a combination of two paths: the effect of internal control effectiveness on management decisions and analysts' external monitoring on investors' decisions. The Theory of Second Best believes that the combination of internal and external factors maximizes the effectiveness of governance. When internal controls are of high quality, a good internal environment, risk assessment, and the design and implementation of control activities can reduce the risk of agency problems. Meanwhile, a well-established external monitoring and feedback mechanism can reduce information asymmetry and align the goals of agents, shareholders, and investors.

Finally, this study explores the impact of multi-level heterogeneity from the individual to the whole. Corporate innovation is influenced by both internal and external factors [22], which are mainly reflected in differences in patent citations [23,24], corporate property rights, corporate size, management characteristics [25], industry competitiveness [26,27], and city class [28].

Point 5: Section 6.3 should be further strengthened to provide practical applicability.

Response 5: Thank you for raising this issue. We acknowledge the shortcomings in the previous version for practical applicability. In the revised version, we have strictly followed the requirements to strengthen the concept of practical applicability. The specific details of the revision are as follows.

Revised section on page 23, line 726-761.

7.2. Insights and Recommendations

ESG focuses on several aspects: environment (E), social responsibility (S), and corporate governance (G). In terms of connotations, G is mainly concerned with how well the company is doing. It is undeniable that if the E and S aspects are not done well, the business model will not last long. Therefore, the development of many industries is not long-lived because they do not have a deep understanding of E and S issues. This gives rise to the question of How should stakeholders use the ESG concept to create incremental value?

For management, it is important to look at the sustainability of technological and business model innovation from an ESG perspective. In the past, when developing an innovation project, companies only needed to study the feasibility of their business model, that is, whether it could make a profit. However, in recent times, Companies need multi-dimensional considerations: will it cause environmental and social problems while making money? This is a long-term solution for the sustainable development of corporate innovation [98], and thus more clearly reflects the incremental value created by management's capabilities to manage of all elements of ESG.

For investors, it is important to pay attention to corporate information in terms of financial reporting performance and in terms of ESG reports, where companies are comprehensively evaluated [99]. In April 2002, the China Securities Regulatory Commission issued Guidelines on Investor Relations Management for Listed Companies (2022), which included, for the first time, the requirement to consider ESG information in the communication content of investor relations management. ESG includes financial information and non-financial information, such as environmental, social, and corporate governance information [72], which is an important basis for investors to evaluate companies and make decisions.

For other sectors, Chinese ESG rating agencies should continue to strengthen two-way communication with mature international ESG rating agencies to promote the establishment of an ESG evaluation system that is in line with international standards and national conditions and better reflects the real situation of corporate ESG. Further, ESG data are mainly provided by statistical agency vendors and greatly affects the value of the data considering the different ESG standards used [17]. Regulators should gradually improve the ESG rating and information disclosure systems to effectively guide analysts, investors, and other stakeholders in providing more efficient financial services for sustainable areas such as corporate innovation. A fair and reasonable reward and punishment mechanism should be set up for ESG rating results to encourage enterprises to disclose ESG information and strive to improve their ratings to provide a real and effective decision-making basis for stakeholders.

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Liu, Y.; Lin, M. Research on The Influence of ESG Information Disclosure on Enterprise Financial Risk: Taking Pharmaceutical Industry as An Example. Front. Bus. Econ. Manag. 2022, 5, 264-271.

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Author Response File: Author Response.docx

Reviewer 3 Report

The study is original and has good potential to give valuable information supported by data. Definitely, its scope is very interesting to readers. It may provide a very interesting and representative dataset for future researches. However, the manuscript could be more concise and clearer. I have just a few small comments on the manuscript.

The overall level of the paper is good. But, the authors should revise better and more the current innovation literature. The relevance to innovation related issues should be enhanced. Authors should strengthen the introduction section by highlighting the knowledge gaps in the field of innovation, especially related to sustainability and its effects since the literature review is not clearly presented in the manuscript. There are many studies that are not cited and that serve to contextualize the study better. Furthermore, the main contribution of this study is not clearly explained, and for presenting the paper goals, the authors should answer the question: how this study differentiates itself from the existing ones in the innovation and sustainability literature? Also, the authors need to show how it fills a gap in the related literature for a better understanding of the contribution of the study. Please add more citations of scientific articles from the related literature. This helps the reader to clearly understand the contribution of the study. For example, authors should not ignore the following:

- Aldieri, L., Carlucci, F., Vinci, C. P., & Yigitcanlar, T. (2019). Environmental innovation, knowledge spillovers and policy implications: A systematic review of the economic effects literature. Journal of Cleaner Production, 239, 118051.

- Daugaard, D., & Ding, A. (2022). Global drivers for ESG performance: The body of knowledge. Sustainability, 14(4), 2322.

- Halicioglu, F. H. (2020, November). The relationship between eco-innovation and sustainability in the construction industry: Exploring knowledge networks from the perspective of ANT. In IOP Conference Series: Earth and Environmental Science (Vol. 588, No. 5, p. 052059). IOP Publishing.

- Ode, E., & Ayavoo, R. (2020). The mediating role of knowledge application in the relationship between knowledge management practices and firm innovation. Journal of Innovation & Knowledge, 5(3), 210-218.

- Singh, S. K., Gupta, S., Busso, D., & Kamboj, S. (2021). Top management knowledge value, knowledge sharing practices, open innovation and organizational performance. Journal of Business Research, 128, 788-798.

- Zhang, Q., Loh, L., & Wu, W. (2020). How do environmental, social and governance initiatives affect innovative performance for corporate sustainability?. Sustainability, 12(8), 3380.

- Zhou, K. Z., & Li, C. B. (2012). How knowledge affects radical innovation: Knowledge base, market knowledge acquisition, and internal knowledge sharing. Strategic management journal, 33(9), 1090-1102.

The study needs a better description of the research approach. More attention should be devoted to presenting and identifying the research methodology. A more detailed flow chart for the study is recommended for allowing a complete understanding of the methodological approach. This helps the reader to clearly understand the contribution of the study.

It may be better to highlight the limitations of the study. This would strengthen the discussion and the conclusions of the paper.

Captions for tables should be presented with a more specific description rather than a general sentence.

All tables and figures must be mentioned explicitly by number and appear in correct numerical order in the body of the text. Figures and Tables should be explained and correctly cited in the manuscript. Please correct it accordingly. However, notice that the manuscript contains up to 16 tables. These could be optimized.

More information about limitations of the study should be provided.

Also, there are a few typographical errors in the manuscript. Please check it.

Author Response

Please see the attachment.

Response to Reviewer 3 Comments

Dear Reviewer 3,

We are glad that you believe our article is interesting and may provide a representative dataset contribution to future research. We greatly appreciate your insightful comments and suggestions. You are as devoted to improving this paper as we are. We have worked hard to improve the paper as much as possible. We hope you are pleased with our revised paper.

In the following, we document how we have addressed the points that you raise.

Point 1: The overall level of the paper is good. But, the authors should revise better and more the current innovation literature. The relevance to innovation related issues should be enhanced. Authors should strengthen the introduction section by highlighting the knowledge gaps in the field of innovation, especially related to sustainability and its effects since the literature review is not clearly presented in the manuscript. There are many studies that are not cited and that serve to contextualize the study better. Furthermore, the main contribution of this study is not clearly explained, and for presenting the paper goals, the authors should answer the question: how this study differentiates itself from the existing ones in the innovation and sustainability literature? Also, the authors need to show how it fills a gap in the related literature for a better understanding of the contribution of the study. Please add more citations of scientific articles from the related literature. This helps the reader to clearly understand the contribution of the study.

Response 1: Thank you for raising this issue. We acknowledge that the previous version was insufficient in terms of documentation. With the guidance of you and three other reviewers, we revised the relevant parts of the literature. The main points include the following: (1) We have reorganized the relevant literature to enhance the discussion of studies related to sustainability and its impacts in the introduction and to summarize the knowledge gaps that exist. (2) We summarize the knowledge gaps in existing studies and then elaborate on how this study differs from existing studies and what changes have been made to build on existing studies. (3) We add two new chapters on corporate innovation behavior and ESG sustainability to the literature review section to enhance the reader's understanding of the context of the study. (4) In the revised version, we adopt more specific language to discuss the contribution. The specific details of the revision are as follows.

Revised section on page 2, line 49-75; page 3, line 101-158.

Previous discussions on ESG performance and corporate innovation concentrated on short-term financial performance and firm value. While these studies confirm a positive relationship between ESG, financial performance [6,7,8,9], and firm value [10,11,12], they also examine the role of their impact mechanisms from the perspective of stakeholders [2,13,14]. In recent years, some scholars have started to apply these discussions to corporate innovation activities [3,15,16], discovering that ESG performance can positively impact corporate innovation activities, but only through internal effects, such as alleviating financing constraints and agency costs. [17,18], The focus of internal and external governance mechanisms is different; the two are interdependent and complementary. A one-sided emphasis is unlikely to achieve the desired governance effect [19]. Relying solely on internal governance ignores the critical role of external oversight in interpreting information and promoting regulation; however, relying on external oversight alone does not bring the subjective role of internal governance into play [20].Therefore, according to the Theory of Second Best, this article discusses the mediating role of internal control effectiveness and analyst coverage in the relationship between ESG performance and corporate innovation.

The main contributions of this study are as follows. First, the study expands on the mediating role of ESG on innovation in terms of internal and external governance. Most existing ESG effects on innovation are investigated in terms of the internal mechanisms of financing constraints [17,18], ignoring the role of ESG as other factors of firm ratings, particularly external monitoring mechanisms. Therefore, this study analyses a combination of two paths: the effect of internal control effectiveness on management decisions and the effect of analysts’ external monitoring on investors’ decisions. Second, the connotations of technological innovation indicators are assessed. Most existing technological innovation indicators are measured using patent applications, which are not granted a certain percentage of strategic innovation [21]. In contrast, this study uses authorized invention patents to measure enterprise technological innovation, which has been thoroughly reviewed by relevant institutions and can maximize the elimination of strategic innovation while directly reflecting true innovation that contributes to economic growth. Thus, this study distinguishes the quantity and quality of corporate innovation by distinguishing between the number of granted invention patents and the number of granted invention patent citations, and the identification is more precise. Third, it deepens the multilevel impacts of heterogeneity. Contrary to previous studies that only considered the impact of the nature of the enterprise [22], this study explores the individual’s overall progressive moderating effects of differences in domestic and foreign patent citations [23,24], management duality characteristics [25], degree of industry competition [26,27], and level of urban economic development [28].

2.1. Literature Review

2.1.1. ESG’s Concept of Sustainability

2.1.2. Corporate Innovation Behavior

Point 2: The study needs a better description of the research approach. More attention should be devoted to presenting and identifying the research methodology. A more detailed flow chart for the study is recommended for allowing a complete understanding of the methodological approach. This helps the reader to clearly understand the contribution of the study.

Response 2: Thank you for raising this issue and advising accordingly. We acknowledge that it would be better to use more detailed flowcharts to demonstrate the approach used in this paper. It also helps the reader to understand the contributions of this paper. This is an excellent suggestion. Following your suggestion, we have provided a more detailed flow chart in the revised version.

Revised section on page 6, line 284-289.

The theoretical model of this research is shown in Figure 1. These tests include the H1 baseline test, the H2 and H3 mediating effect tests, and the heterogeneity tests.

Figure 1. Theoretical Framework. Notes: [+] plus sign indicates positive relationships, and [-] negative sign indicates negative relationships.

Point 3: It may be better to highlight the limitations of the study. This would strengthen the discussion and the conclusions of the paper.

Response 3: Thank you for raising this issue. We are sorry for our negligence of discussing the limitations. Thank you very much for pointing this out. We have added limitations to the revised version. The specific details of the revision are as follows.

Revised section on page 24, line 762-773.

7.3. Limitations and Future Research

First, the study in the article focuses on Chinese manufacturing listed companies, and the selected industries are not fully representative of other industries. Since the focus of this study is on the Chinese manufacturing sector, future research could extend the analysis to Chinese companies in other industries, and even overseas. Second, the ESG performance in this paper is measured by selecting the composite rating data of ESG companies. ESG contains three dimensional scores of environmental, social, and corporate and future research can explore the impact of the three dimensions separately on innovation. Finally, this study focuses on the issue of innovation quantity and innovation quality without directly responding to the economic value of innovation. Future research could discuss the economic value of innovation with consideration of the current patent contracts signed between firms.

Point 4: Captions for tables should be presented with a more specific description rather than a general sentence.

Response 4: Thank you for raising this issue. We acknowledge that it would be better to use more specific descriptions for the headings of the tables. Thank you very much for pointing this out. We have adopted more specific descriptions for the table headings in the revised version. The specific details of the revision are as follows.

Line 417, the statements of “ESG performance and corporate innovation” were corrected as “ESG performance and corporate innovation regression results”.

Line 475, Merge Table “Mediation effect test of internal control” and Table ”Mediation effect test of analyst coverage” change the title to “Results of the mediating effect of internal control effectiveness and analyst coverage”.

Line 504, the statements of “Patent level heterogeneity test” were corrected as “Test of domestic and foreign patent citations”.

Line 548, Merge Table “Heterogeneity test of enterprise ownership” and Table “Heterogeneity test of enterprise scale” change the title to “Tests of the ownership and size of firms”.

Line 572, the statements of “Heterogeneity test of management characteristics” were corrected as “Test of management duality”.

Line 629, Merge Table “Industry level heterogeneity test” and Table “Heterogeneity test at urban level” change the title to “Test of industrial competition degree and city level”.

Line 683-684, Merge Table “Tests for explanatory variables with a one-period lag”, and Table “Instrumental variable test”, and Table “Replacement of explanatory variables” change the title to “Tests for lags of variables, instrumental variables method and replacement of explanatory variables”.

Line 697, the statements of “Statistical Year Test of Changed Samples” were corrected as “Test for statistical year of change sample”.

Line 714, the statements of “Other robustness tests” were corrected as “Test of change regression models and control joint fixed effects”.

Point 5: All tables and figures must be mentioned explicitly by number and appear in correct numerical order in the body of the text. Figures and Tables should be explained and correctly cited in the manuscript. Please correct it accordingly. However, notice that the manuscript contains up to 16 tables. These could be optimized.

Response 5: Thank you for raising this issue. We fully accept your views on the tables and figures. We checked the charts in the paper several times and corrected them accordingly. At the same time, we have combined some tables in order to reduce the number of tables. The number of forms decreased from the original 16 to 11.

Point 6: More information about limitations of the study should be provided.

Response 6: Thank you for raising this issue. We acknowledge that it is important to provide more information about the limitations of the study. Thank you very much for pointing this out. We provide possible future research directions in the revised version. The specific details of the revision are as follows.

Revised section on page 24, line 762-773.

7.3. Limitations and Future Research

Point 7: Also, there are a few typographical errors in the manuscript. Please check it.

Response 7: Thank you very much for pointing this out. We are very sorry for our incorrect writing. We proofread the paper several times in its entirety and also had native English-speaking colleagues proofread it. typographical errors have been corrected. We hope that the revised paper is seen as a significant improvement.

Daugaard, D.; Ding, A. Global Drivers for ESG Performance: The Body of Knowledge. Sustainability 2022, 14, 2322.

Zhang, Q.; Loh, L.; Wu, W. How do Environmental, Social and Governance Initiatives Affect Innovative Performance for Corporate Sustainability? Sustainability 2020, 12, 3380.

Zhou, K. Z.; Li, C. B. How knowledge affects radical innovation: Knowledge base, market knowledge acquisition, and internal knowledge sharing. Strateg. Manage. J. 2012. 33, 1090-1102.

Ode, E.; Ayavoo, R. The mediating role of knowledge application in the relationship between knowledge management practices and firm innovation. J. Innov. Knowl. 2020, 5, 210-218.

Singh, S. K., Gupta, S., Busso, D., & Kamboj, S. Top management knowledge value, knowledge sharing practices, open innovation and organizational performance.J. Bus. Res. 2021, 128, 788-798.

Jones, P.; Comfort, D.; Hillier, D. Materiality in corporate sustainability reporting within UK retailing. J. Public Aff. 2016,16, 81-90.

Calabrese, A.; Costa, R.; Levialdi, Ghiron, N.; Menichini, T. Materiality analysis in sustainability reporting: a tool for directing corporate sustainability towards emerging economic, environmental and social opportunities. Technol. Econ. Dev. Econ. 2019,25, 1016-103831 Calabrese, A.; Forte, G.; Ghiron, N.L. Fostering sustainability-oriented service innovation (SOSI) through business model renewal: The SOSI tool. J. Clean Prod. 2018, 201,783-791.

Landrum, N. E.; Ohsowski, B. Identifying worldviews on corporate sustainability: A content analysis of corporate sustainability reports. Bus. Strateg. Environ.2018,27, 128-151.

Rantala, T.; Ukko, J.;Saunila, M.; Havukainen, J. The effect of sustainability in the adoption of technological, service, and business model innovations. J. Clean Prod. 2018 172, 46-55.

França, C. L.; Broman, G.; Robert, K. H.;Basile, G.; Trygg, L. An approach to business model innovation and design for strategic sustainable development. J. Clean Prod. 2017,140, 155-166.

Mahdi, M. A.; Yousefi, S. R.; Jasim, L. S.; et al. Green synthesis of DyBa2Fe3O7. 988/DyFeO3 nanocomposites using almond extract with dual eco-friendly applications: Photocatalytic and antibacterial activities. J. Financ. Econ. 2022, 47, 14319-14330.

De Lucia, C.; Pazienza, P.; Bartlett, M. Does Good ESG Lead to Better Financial Performances by Firms? Machine Learning and Logistic Regression Models of Public Enterprises in Europe. Sustainability 2020, 12, 5317. 11 Zhang, F.; Qin, X.; Liu, L. The Interaction Effect between ESG and Green Innovation and Its Impact on Firm Value from the Perspective of Information Disclosure. Sustainability 2020, 12, 1866.

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Author Response File: Author Response.docx

Reviewer 4 Report

1. The relevance/novelty of the work needs to be highlighted.
2. Check the grammar throughout the article and correct it. Proofread the article as many language errors were identified.
3. There must be more explanation in results.
4. The title is not catchy and does not reflect essential contents.

5. There is not any graphical abstract. 6. The introduction needs to be further revised to highlight the purpose of the study, You need to introduce what others have studied and what needs further research. Besides, the following all of references are recommended to be cited:

https://www.sciencedirect.com/science/article/abs/pii/S0360319922008126
https://ceramics.onlinelibrary.wiley.com/doi/abs/10.1111/jace.17696

Author Response

Response to Reviewer 4 Comments

Dear Reviewer 4,

We appreciate the time and the energy you have spent on this paper. We are glad to receive the six important issues you raised about our paper. We greatly appreciate your insightful comments and suggestions. You are as devoted to improving this paper as we are. We have worked hard to improve the paper as much as possible. We hope you are pleased with our revised paper.

In the following, we document how we have addressed the points that you raise.

Point 1: The relevance/novelty of the work needs to be highlighted.

Response 1: Thank you for raising this issue. We acknowledge that the previous version was lacking in relevance/novelty of the paper. Thank you very much for pointing this out. With the guidance of you and the other three reviewers, we emphasized the relevance/novelty of the paper. The specific details of the revision are as follows.

Revised section on page 2, line 49-75; page 3, line 123-158

2.1.1. ESG’s Concept of Sustainability

2.1.2. Corporate Innovation Behavior

Point 2: Check the grammar throughout the article and correct it. Proofread the article as many language errors were identified.

Response 2: Thank you very much for pointing this out. We are very sorry for our incorrect writing. We proofread the paper several times in its entirety and also had native English-speaking colleagues proofread it. grammar errors have been corrected. We hope that the revised paper is seen as a significant improvement.

Point 3: There must be more explanation in results.

Response 3: Thank you for raising this issue. We acknowledge that more interpretation of the results would help to fully explore the contribution of the article. Thank you very much for pointing this out. In the revised version, we explain more about the text in relation to the actual situation. The specific details of the revision are as follows.

Revised section on page 22, line 668-704; page 23, line 726-761.

Discussion

Second, unlike existing ESG effects on innovation that are mostly tested from the internal mechanism of financing constraints [17,18], this study analyzes through a combination of two paths: the effect of internal control effectiveness on management decisions and analysts' external monitoring on investors' decisions. The Theory of Second Best considers that the combination of internal and external factors maximizes the effectiveness of governance. When internal controls are of high quality, a good internal environment, risk assessment, and the design and implementation of control activities can reduce the risk of agency problems. Meanwhile, a well-established external monitoring and feedback mechanism can reduce information asymmetry and align the goals of agents, shareholders, and investors.

7.2. Insights and Recommendations

ESG focuses on several aspects: environment (E), social(S), and corporate governance (G). In terms of connotations, G is mainly concerned with how well the company is doing. It is undeniable that if the E and S aspects are not done well, the business model will not last long. Therefore, the development of many industries is not long-lived because they do not have a deep understanding of E and S issues. This gives rise to the question of How should stakeholders use the ESG concept to create incremental value?

For investors, it is important to pay attention to corporate information in terms of financial reporting performance and in terms of ESG reports, where companies are comprehensively evaluated [99]. In April 2002, the China Securities Regulatory Commission issued Guidelines on Investor Relations Management for Listed Companies (2022), which included, for the first time, the requirement to consider ESG information in the communication content of investor relations management. ESG includes financial information and non-financial information, such as environmental, social, and corporate governance information [72], which is an important basis for investors to evaluate companies and make decisions.

Point 4: The title is not catchy and does not reflect essential contents.

Response 4: Thank you for raising this issue. We acknowledge the shortcomings in the title. Thank you very much for pointing this out. In consideration of catchy and generalization, we rectify the title of the text accordingly. The specific details of the revision are as follows.

Revised section on page 1, line 3-4

Does ESG Performance Improve the Quantity and Quality of Innovation？The Mediating Role of Internal Control Effectiveness and Analyst Coverage

Point 5: There is not any graphical abstract.

Response 5: Thank you for raising this issue. We acknowledge the previous neglect of the graphical abstract. Thank you very much for pointing this out. In our revised version, we have provided a full-text analysis framework graph in the revised version, with a short description of the graph. The specific details of the revision are as follows.

Revised section on page 6, line 284-289

The theoretical model of this research is shown in Figure 1. These tests include the H1 baseline test, the H2 and H3 mediating effect tests, and the heterogeneity tests.

Figure 1. Theoretical Framework. Notes: [+] plus sign indicates positive relationships, and [-] negative sign indicates negative relationships.

Point 6: The introduction needs to be further revised to highlight the purpose of the study, You need to introduce what others have studied and what needs further research.

Response 6: Thank you for raising this issue. We acknowledge the inadequacies of previous discussions in existing studies. Thank you for the correction and providing the key literature. We have revised the relevant contents in the revised version to summarize what needs to be further studied through the discussion of existing studies, to emphasize the improvement of existing studies in this paper, and to highlight the purpose of the study. The specific details of the revision are as follows.

Revised section on page 2, line 49-75; page 3, line 101-121