The link between environmental, social and corporate governance disclosure and the cost of capital in South Africa

Abstract

Orientation: Ignoring environmental, social and corporate governance (ESG) aspects exposes firms to risks that diminish value, shrink returns and even lead to failure. Firms considering ESG aspects are perceived as less risky by capital providers. Such capital suppliers accept lower returns and lending rates when providing capital to firms with superior ESG practices and disclosure.Research purpose: To investigate the link between ESG disclosure and the cost of capital.Motivation for the study: Although there has been a growing interest in responsible corporate practices in emerging markets, limited research on ESG has been conducted in South Africa.Research approach/design and method: A positivistic paradigm was employed. A sample of 68 firms from six Johannesburg Stock Exchange sectors over the period 2011–2018 (478 firm-year observations) was examined using panel regression analyses.Main findings: A significant negative relationship was observed between composite ESG disclosure scores and weighted average cost of capital (WACC) for both consumer goods and consumer services sectors. In addition, a significant positive regression coefficient was obtained between composite ESG disclosure scores and WACC for firms from the industrials sector.Practical/managerial implications: A growing number of capital providers consider a firm’s ESG practices and disclosures which could offer a firm the opportunity to raise additional sources of capital.Contribution/value-add: Local firms that had improved ESG disclosure seemed to benefit from a lower overall WACC and cost of debt. Equity capital providers, however, seem to perceive increased ESG disclosure as additional risk and require a higher return from such firms in South Africa.

ESG–CFP Linkages: A Review of Its Antecedents and Scope for Future Research

“…The examination of industry and cost of capital on ESG-CFP association also shows a negative impact. These results related to the cost of capital are in contrast with those of the previous study (Atan et al, 2018;Johnson, 2020). They also imply that more disclosure does not necessarily lead to less information asymmetry in the market.…”

“…Extant literature examining the impact of corporate governance on the cost of debt shows positive results. There exists a positive correlation between good corporate governance and lower borrowing rates with lesser credit spreads (Atan et al, 2018;Johnson, 2020). Some facets of corporate governance, namely institutional investor ownership, have been reported to have a significant effect on the company's debt costs (Bhojraj & Sengupta, 2003;Cremers & Nair, 2005), the proportion of external directors (Bhojraj & Sengupta, 2003) and the quality of information being disclosed (Schauten & Dijk, 2011).…”

Effects of integrated reporting on the cost of capital and analysts’ forecasts errors: A study of Johannesburg Stock Exchange listed mining firms

“…The 'BAIR' coefficient is both negative and significant (p = 0.000). Similar to related studies, the results confirm that the adoption of IR may assist a reporting firm in reducing the cost of equity (Johnson 2020;Vitolla et al 2019;Zhou et al 2017). Sustainability reporting (SRI) also has a significant (p = 0.10) negative relationship with cost of equity.…”

“…These studies suggest benefits such as improved forecasts of cash flows, improvement of investor loyalty and mitigation of agency costs. Previous studies suggest a theoretical link between the extent to which disclosures affect non-diversifiable risk and COE (Botosan 1997;Johnson 2020;Mazzotta & Veltri 2014;Petrova et al 2012;Poshakwale & Courtis 2005). Similarly, Lambert, Leuz and Verrecchia (2007) suggest that the assessed level of risk associated with future cash flows can be influenced by accounting information.…”

The financial consequences of human capital disclosure as part of integrated reporting

“…For example, Lemma et al (2019) find that voluntary carbon disclosure is associated with a lower WACC, while Gjergji et al (2021) show that environmental disclosure in the context of small and medium-sized enterprises (SMEs) increases the WACC, unless the firm is a family SME. Johnson's (2020) results are mixed: the author finds a negative relationship between environmental, social, and corporate governance (ESG) disclosure and WACC in the consumer goods and consumer services sectors and a positive relationship in the industrial sector. Atan et al (2018) instead reveal the existence of a positive relationship between composite ESG disclosure and the WACC, while they find a non-significant effect of the three individual pillars.…”