Analyzing the Incentive Effect of Cost of Capital on ESG Score, A GMM Panel Estimation

Abstract

This thesis investigates whether differences in the cost of capital between high and low ESG performers influence future changes in ESG scores. We develop a novel factor, the ESG cost of capital-discount, calculated by subtracting the average WACC of the lowest ESG quintile from the highest ESG quintile. Our study employs both CAPM and implied cost of equity to measure this discount across a sample of S&P 500 firms from 2002 to 2022. We find that firms with lower ESG scores tend to improve their ESG performance to benefit from lower financing costs. Additionally, we observe that the ESG cost of capital-discount is consistently negative, indicating that higher ESG performance is associated with a lower cost of capital. Our findings contribute to the understanding of the financial incentives for firms to enhance their ESG scores and provide insights for policymakers and stakeholders on fostering sustainable corporate practices.