Sustainability Performance and the Cost of Capital

Abstract

This study examines the association between firms’ environmental, social, and governance (ESG) performance and the cost of capital for the largest European firms listed on the STOXX Euro 600 in a large panel from 2002 to 2018. We find that ESG is priced by both debt and equity markets, although in different directions. While better ESG performance is associated with a lower cost of equity, the relationship is positive regarding the cost of debt. We also account for industry idiosyncrasies. The relationship with the cost of equity is penalized for firms lagging in ESG performance compared with industry peers, and the industry median corporate sustainability performance score is around optimal to balance the cost of equity and cost of debt. We also find that ESG is not influential in shaping firms’ cost of capital in periods of financial and sovereign crises. Overall, in the same research setting, we find that the channels of firms’ cost of capital composition behave differently in response to changes in sustainability performance.