ESG Dynamics: Assessing the Link Between Sustainability Practices and the Cost of Capital

Abstract

This paper investigates the relationships between environmental, social, and governance performance and the cost of capital in the European context. Using data from 489 publicly listed companies in the STOXX Europe 600 index over an 8-year period (2015–2022), comprising 3317 firm-year observations, we analyze variations in this relationship over time. Our findings indicate that companies with strong ESG performance tend to enjoy lower costs of debt, reflecting favorable borrowing conditions perceived by debt financiers. Conversely, we observe a positive relationship between ESG performance and the cost of equity, suggesting higher expected returns for equity investors due to perceived long-term risk. Furthermore, temporal analysis reveals that the relationship between ESG performance and the cost of capital became more pronounced from 2020 to 2022, potentially driven by heightened attention to sustainability practices and regulatory interventions. This study contributes to the theoretical understanding of the evolving role of sustainability in financial markets and its implications for corporate finance decisions.