As freshwater scarcity becomes increasingly severe under climate change, physical water risk has emerged as a critical financial concern for firms in water-intensive industries. This study explores whether and how physical water risk influences firms’ cost of equity, and whether corporate social responsibility (CSR)—both its overall level and structural differentiation—modulates this relationship. Using panel data from 849 Chinese listed companies in water-intensive sectors between 2011 and 2022, we find that physical water risk significantly elevates equity capital costs. While a strong CSR performance buffers this effect, CSR differentiation—reflected in uneven CSR engagement across different domains—undermines or even reverses this moderating role. Additional heterogeneity analyses show that these patterns are more pronounced in large and non-state-owned enterprises. These findings deepen our understanding of how environmental risks are priced in capital markets and offer strategic insights for firms seeking to manage sustainability-related financial exposures.