Relationship between the Cost of Capital and Environmental, Social, and Governance Scores: Evidence from Latin America

Abstract

Environmental, social, and governance (ESG) scores play a pivotal role in the strategic design of firms. The literature has demonstrated the importance of sustainability issues in the financial performance of firms around the world. In particular, understanding the relationship between sustainability and the cost of capital is crucial for determining financial strategy and decision making. We identify an opportunity in the literature to analyze this relationship within Latin America (LatAm) firms. Thus, this study analyzes the relationship between ESG scores with the cost of capital of firms with headquarters in LatAm using a data set that includes 606 observations corresponding to information about 202 firms from 2017 to 2019. To conduct our analysis, two fixed effects panel data models were estimated. We model this relationship by taking ESG scores and each of its ESG Pillar scores—i.e., Environmental, Social, and Governance pillar scores—as independent variables and analyzing how they affect the cost of capital. According to the results, there is an inverse effect relationship between ESG scores and the cost of capital. Additionally, we did not find a relationship between the Social Pillar score and the Environmental Pillar score with the cost of capital. By contrast, the Governance Pillar score shows a negative relationship with the cost of capital. This indicates that the increase in transparency about internal processes and governance entities can be an essential driver of value creation for firms and higher financing confidence in LatAm firms. This study represents a breakthrough in explaining the impact of ESG scores on the cost of capital in LatAm. Ultimately, the current study presents the potential for further research in this field.

The impact of a firm’s ESG score on its cost of capital: can a high ESG score serve as a substitute for a weaker legal environment

“…Green investors might only be willing to invest in firms with higher ESG scores. This results in companies having a higher ESG score to be capable of attracting more investors at a lower cost (see also Mackey et al, 2007;Ramirez et al, 2022;Hong and Kacperczyk, 2009). Petersen and Vredenburg (2009) document that the majority of institutional investors now prefer high ESG firms, illustrating that high ESG scores can help firms obtain a wider range of investors.…”

ESG Performansı ile Borç Maliyeti Arasındaki İlişki Üzerine Bir Araştırma

“…In this direction, discussions on this effect continue in the empirical literature. Accordingly, some studies (Reverte, 2012;Houqe et al, 2020;Raimo et al, 2020;Eliwa et al, 2021;Apergis et al, 2022;Ramirez et al, 2022;Temiz, 2022) state that higher ESG performance results in lower COC. However, some studies (Atan et al, 2018;Gonçalves et al, 2022;Nazir et al, 2022) state the opposite.…”

Board gender diversity and cost of debt financing: Evidence from Latin American and the Caribbean firms

“…However, the economic consequences of having more women directors on the board have not been well understood, and their participation, although growing in recent years (Marquez-Cardenas et al 2022), has been under-represented (United Nations, 2019). Considering research trend topics on environmental, social, and governance (ESG) issues, studies have been conducted on ESG, cost of debt financing, and firms' performance relationships (Apergis et al 2022;Eliwa et al 2021;Lavin and Montecinos-Pearce, 2022;Raimo et al 2021;Ramirez et al 2022).…”

“…Hence, there are incentives for hiring women, given that it allows to upgrade their credit scores and benefit from a lower cost of debt financing (Datta et al 2021;Owusu and Zalata, 2023). Thus, a lower cost of debt financing would represent a competitive advantage for the firm compared to its peers (Garcia-Blandon et al 2022), which leads to a lower cost of capital (Ramirez et al 2022). In this line, based on corporate gover-nance attributes, most studies agree that when boards are more gender-diverse, it allows for reducing firm risk and agent costs given transparency by disclouring, strategic orientation, effective monitoring, and advising capability, which impact the cost of debt financing (Bradley and Chen, 2015;Ghouma et al 2018;Gul et al 2011;Hashim and Amrah, 2016;Sila et al 2016;Usman et al 2019).…”

“…2022), which leads to a lower cost of capital (Ramirez et al. 2022). In this line, based on corporate governance attributes, most studies agree that when boards are more gender‐diverse, it allows for reducing firm risk and agent costs given transparency by disclouring, strategic orientation, effective monitoring, and advising capability, which impact the cost of debt financing (Bradley and Chen, 2015; Ghouma et al.…”