Effect of entry into socially responsible investment index on cost of equity and firm value

Abstract

The purpose of this study was to identify the effect of a company's incorporation into the Socially Responsible Investment (SRI) index on its cost of equity (COE) and corporate value. The study collected and analyzed data about the four-year long changes of the component stocks of the Korea Exchange (KRX) SRI index from September 2010 to September 2013 to verify the correlation between the incorporation of the SRI index and the cost of equity or corporate value by using the Price-Earnings Growth (PEG), Modified PEG (MPEG) and Gode and Mohanram (GM) models for estimation of the implied costs of equity capital, as well as Tobin's Q ratio. The analysis results failed to show any significant relation between the incorporation of the SRI index and the cost of equity capital. Also, no statistically significant correlation between the incorporation of the SRI index and corporate value was observed. However, at an early phase of introduction of the SRI index, the included companies revealed a negative correlation with the cost of equity. However, after changing the listed stocks, they showed a positive correlation with the cost of equity capital. All in all, this can be ascribed to a mixed presence of optimistic and pessimistic investors about CSR activities, or there is a possibility that the KRX SRI index might not correctly reflect the CSR activities of companies.