Do Companies Have an Extrinsic Motivation to Adopt Sustainable Practices: Evidence from an Event Study on the Relationship Between Cost of Capital and ESG Performance

Abstract

The growing emphasis on sustainability and Environmental, Social, and Governance (ESG) factors is transforming the corporate landscape, influencing both operational strategies and financial evaluations. This thesis investigates the relationship between sustainable business practices and financial performance, with a specific focus on how ESG performance impacts a firm's cost of capital, to determine if firms have an extrinsic motivation to improve their sustainable performance. Utilizing event study methodology, the research examines the market reactions to the announcements of major sustainable initiatives, namely the Paris Agreement, the EU Taxonomy, and the Complementary Climate Delegated Act, on firms listed in the STOXX 600 index. The study employs various financial models, including the Mean Adjusted Model, Market Adjusted Model, and the Capital Asset Pricing Model, to assess abnormal returns. Further analysis incorporates ESG scores and the Fama-French 3 Factor Model to validate findings and explore the correlation between ESG performance and market reactions. Results indicate significant negative market responses to sustainable announcements, with negative correlation to ESG scores. The findings offer valuable insights for investors and especially policymakers, as they must improve their communication and improve current regulations in order to give incentives for firms to improve their sustainable performance.