Environmental Violation and Cost of Equity Capital—Evidence From Europe

Abstract

We examine the association between environmental violations and the cost of equity capital. We posit that firms that breach environmental compliance introduce firm‐specific risks and, consequently, elevate the costs associated with equity capital. Utilizing a dataset comprising publicly listed firms from the Bloomberg European 500 index spanning the period from 2005 to 2020, we present empirical evidence that environmental violations contribute to an increase in a firm's cost of equity capital. Our findings hold economic significance, revealing that a one standard deviation increase in environmental violations results in a 4.28–5.12 basis point increase in the cost of equity. Furthermore, we establish that the positive relationship between environmental violations and the cost of equity capital is more pronounced in firms lacking corporate social responsibility training and those operating within highly competitive industries. Importantly, our results withstand endogeneity concerns, affirming their robustness. The implications of our study extend to stakeholders, enhancing their understanding of the repercussions of environmental violations on investment decisions.