Re-Examining The Link Between ESG Performance And The Corporate Cost Of Capital

Abstract

This study examines the fundamental asymmetry in how debt and equity markets price Environmental, Social, and Governance (ESG) performance. Using a large sample of US corporations (S&P 100 and S&P 500), we simultaneously analyze the impact of ESG performance on the cost of debt and the cost of equity. Our core finding is that stronger ESG performance significantly reduces the cost of debt, with an economically meaningful effect of approximately 11 basis points per standard deviation improvement in ESG. In stark contrast, we find no statistically significant relationship between ESG performance and the cost of equity. This asymmetry persists across robustness checks, including alternative asset pricing models and industry analyses. We reconcile these divergent findings by emphasizing the distinct risk appetites of debtholders and equity holders. Debtholders, focused on downside protection and repayment certainty, reward ESG-driven risk mitigation as a signal of lower default risk. Equity holders, prioritizing growth prospects, do not perceive aggregate ESG performance as sufficiently material to their required returns in the current US market context. Our results resolve key contradictions in the literature, demonstrating that ESG's financial materiality is not uniform across capital markets. This has significant implications: firms gain a clear financial justification for ESG investments through reduced debt costs, while investors require differentiated approaches—integrating ESG into credit analysis but needing more granular metrics for equity valuation. The study underscores the critical importance of understanding the specific conditions under which ESG performance translates into tangible financial value.