The Influence of Environmental, Social, and Governance Disclosure on Capital Structure: An Investigation of Leverage and WACC

Abstract

This paper seeks to examine the extent to which environmental, social, and governance (ESG) disclosure affects capital structure and cost of capital for non-financial Fortune 500 firms. With a sample period from 2007 to 2022 and a system (Generalized Method of Moments) GMM estimation method, we investigate the linkage between ESG disclosure scores and both leverage and the weighted average cost of capital (WACC). Thus, we find that firms with stronger ESG performance have higher ESG disclosure and lower leverage ratios and WACC, highlighting that firms with good ESG outcomes have better equity financing facilities and are perceived to be less risky. We also find the moderation effect where the effects of ESG disclosure depend on the level of ESG disclosure. The empirical results thus show that the environmental and social factors have significant influences on leverage and WACC than the governance factors. Furthermore, we show that firm size affects these relationships in that larger firms are more affected by the variables. These findings extend the literature on ESG, and provide relevant information for corporate financial managers, investors, and policymakers about the financial effects of ESG disclosure. This paper therefore provides evidence of the relevance of ESG factors in decisions on capital structure and cost of capital especially for large firms.