Business sustainability and cost of equity

There have been many studies towards sustainability and its effect on the cost of equity of a firm. In the October issue of the Journal of Corporate Finance an interesting study is presented on this topic by Ng & Rezaee (2015). This study not only includes the individual dimensions of sustainability performance as prior research has done, but it also includes the overall relationship.

Based on the Environmental, Social and Governance (ESG) measures often used as measures of sustainability performance, the study shows that only environmental and governance sustainability performance reduce the cost of equity of a firm. This is in line with prior research. An explanation for this effect can be, that both measures have a direct effect on financial performance by lowering unnecessary costs, improved quality and customer satisfaction.

Social sustainability performance show more mixed results, which can be explained by the fact that these activities involve additional resources but do not always lead to shareholder value and is therefore difficult to relate to the cost of equity. However the study of Ng & Rezaee (2015) shows that social sustainability performance contributes more indirectly, whereby higher economic sustainability performance leads to even lower cost of equity.

Norbert Bol

Literature

Ng, A. C., & Rezaee, Z. (2015). Business sustainability performance and cost of equity capital. Journal of Corporate Finance, 34, 128-149.

Photo credit: Tax Credits / Foter / CC BY

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