Impact of ESG performance on the cost of capital in the energy, utilities, and basic materials sectors

Abstract

This paper explores the presence of an environmental, social, and governance (ESG) premium for firms operating in the energy, utilities, and basic materials sectors. Specifically, we examine the influence of ESG performance on firms’ cost of capital in both debt and equity markets. We apply a measure of the ex ante implied cost of equity and the cost of debt to a global sample of over 24,000 firm-year observations spanning the period from 2010 to 2021. We also investigate the financial impact of each component of the aggregated ESG score. We employ a pooled ordinary least squares with robust standard errors, controlling for firm-specific and macroeconomic factors.

Contrary to the prevailing view in recent literature, our results indicate no evidence supporting an ESG premium for energy, utilities, and basic materials firms. However, we find an inverse relationship between environmental performance and the cost of capital. This finding supports the existence of a “green premium,” which can be attributed to green investor preferences and sustainable operations, reducing regulatory and other environmental risks. In contrast, the social score is positively related to the cost of debt, suggesting that lenders view investments in social efforts as risk-enhancing or a waste of resources. We argue that the aggregated ESG score is too broad, but its components adequately capture investors’ risk-return preferences. Firms can benefit from reduced financing costs by improving their environmental efforts, although social investments may result in higher borrowing costs.