The Impact of ESG Disclosure on the Cost of Capital
Literature exploration on the negative relationship between the quality of Environmental, Social, and Governance (ESG) disclosure and the cost of equity and debt.
Information asymmetry theory predicts that companies providing high-quality disclosure will enjoy a lower cost of capital. In recent decades, investor focus has shifted from mere profit figures to long-term business sustainability. This is where the role of Environmental, Social, and Governance (ESG) disclosure becomes crucial.
The Mechanism of Lowering Cost of Equity (COE)
Comprehensive ESG disclosure reduces investor uncertainty regarding future risks (such as environmental fines, labor lawsuits, or management scandals). This reduced uncertainty lowers the risk premium demanded by investors, which mathematically culminates in a lower Cost of Equity. Measurement often modifies the Ohlson model or utilizes the Capital Asset Pricing Model (CAPM).
Impact on Cost of Debt (COD)
From the creditor's perspective, modern banking is increasingly adopting Green Banking principles. Companies with high ESG scores are deemed to possess a lower bankruptcy risk and better cash flow governance. As a result, these companies tend to receive better credit ratings and more competitive loan interest rates compared to environmentally damaging companies.
Variable Measurement in Research
To research this topic, the independent variable used is usually an ESG Score from rating agencies (like Refinitiv, Bloomberg, or MSCI) or a self-constructed disclosure index using content analysis on Sustainability Reports. The dependent variable WACC (Weighted Average Cost of Capital) is a proportional aggregation of COE and COD. In NgepetData, you can automatically extract the presence of specific ESG keywords (e.g., 'Carbon Emission', 'Waste Management') to build your own quantitative index.