Cost of debt and equity in BRICS countries: can better ESG perfomance decrease corporate financing costs?
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Abstract 3
Introduction 5
1. Literature review 6
1.1. ESG and cost of debt 6
1.2. ESG and cost of equity 7
1.3. ESG and cost of capital in emerging markets 9
1.4. Research gap 10
1.5. Problem statement and hypotheses 11
3. Data 13
3.1. Why drop I and C from BRICS? 13
3.2. Data sourcing and sampling 14
3.3. Variables 15
3.4. Descriptive statistics 16
3.5. VIF test 17
3.6. Modelling cost of equity 20
3.7. Modelling cost of debt 21
3.8. WACC 21
4. The model 22
4.1. Statistical significance and robustness tests 23
4.2. Addressing potential Endogeneity 24
4.3. Choosing the right model 25
5. Results and discussion 25
5.1. Managerial implications 39
6. Conclusion 42
7. Appendix 45
7.1. Descriptive statistics for country breakdown 45
7.2. Robustness checks 50
8. List of references 55
Introduction 5
1. Literature review 6
1.1. ESG and cost of debt 6
1.2. ESG and cost of equity 7
1.3. ESG and cost of capital in emerging markets 9
1.4. Research gap 10
1.5. Problem statement and hypotheses 11
3. Data 13
3.1. Why drop I and C from BRICS? 13
3.2. Data sourcing and sampling 14
3.3. Variables 15
3.4. Descriptive statistics 16
3.5. VIF test 17
3.6. Modelling cost of equity 20
3.7. Modelling cost of debt 21
3.8. WACC 21
4. The model 22
4.1. Statistical significance and robustness tests 23
4.2. Addressing potential Endogeneity 24
4.3. Choosing the right model 25
5. Results and discussion 25
5.1. Managerial implications 39
6. Conclusion 42
7. Appendix 45
7.1. Descriptive statistics for country breakdown 45
7.2. Robustness checks 50
8. List of references 55
The ever-growing interest in Environmental, Social, and Governance (ESG) factors has fundamentally transformed the landscape of corporate finance, influencing investment and corporate strategy globally. This shift towards Corporate Social Responsibility (CSR) marks a significant departure from Milton Friedman's postulates, which emphasized profit maximization as the sole responsibility of business (1975). Today, stakeholders increasingly recognize that sustainable business practices are essential for long-term value creation, leading to a growing integration of ESG criteria in financial decision-making. This thesis aims to elucidate the intricate relationship between ESG performance and the cost of capital within the BRICS markets, specifically focusing on Russia, Brazil, and South Africa. By exploring the distinct economic, regulatory, and market environments of these emerging economies, this research endeavors to bridge the existing gap in literature that predominantly centers on developed markets such as the United States and the European Union. The impetus for this research stems from the growing recognition that ESG factors are not merely concerns of activist investors but integral elements influencing a firm's financial performance and risk profile. Prior studies, such as those by Giese et al. (2019), have demonstrated that firms with superior ESG performance tend to exhibit lower systematic risk, leading to a reduced cost of equity. Similarly, Chen et al. (2023) have shown that enhanced ESG scores in Chinese markets are associated with lower equity costs, further highlighting the risk mitigation benefits of robust ESG practices. These findings underscore the need for a nuanced understanding of how ESG factors interplay with financial metrics in different market contexts.
Despite the wide array of research on developed markets, the BRICS nations present a unique case for examination due to their diverse institutional structures, varying levels of market maturity, and distinct regulatory landscapes. The BRICS economies, characterized by rapid industrial growth and significant environmental and social challenges, offer a fertile ground for investigating the potential of ESG factors to influence corporate financing costs. The limited scholarly focus on these markets, particularly on Russia, Brazil, and South Africa, highlights the substantiality of the research gap.
The primary objective of this thesis is to determine whether ESG disclosures impact the cost of equity and debt in the selected BRICS markets. This study will also explore the differential impact of ESG scores on top ESG performers versus underperformers within these markets. To reach this objective, this study employs a comprehensive dataset spanning multiple years and incorporates panel regression models to analyze the relationship between ESG scores and cost of capital across the selected BRICS nations. By distinguishing between top ESG performers and underperformers and examining country-specific contexts, this research aims to provide valuable insights for both academic inquiry and practical applications in corporate finance and investment strategies.
Despite the wide array of research on developed markets, the BRICS nations present a unique case for examination due to their diverse institutional structures, varying levels of market maturity, and distinct regulatory landscapes. The BRICS economies, characterized by rapid industrial growth and significant environmental and social challenges, offer a fertile ground for investigating the potential of ESG factors to influence corporate financing costs. The limited scholarly focus on these markets, particularly on Russia, Brazil, and South Africa, highlights the substantiality of the research gap.
The primary objective of this thesis is to determine whether ESG disclosures impact the cost of equity and debt in the selected BRICS markets. This study will also explore the differential impact of ESG scores on top ESG performers versus underperformers within these markets. To reach this objective, this study employs a comprehensive dataset spanning multiple years and incorporates panel regression models to analyze the relationship between ESG scores and cost of capital across the selected BRICS nations. By distinguishing between top ESG performers and underperformers and examining country-specific contexts, this research aims to provide valuable insights for both academic inquiry and practical applications in corporate finance and investment strategies.
This thesis set out to explore the complex relationship between Environmental, Social, and Governance (ESG) performance and the cost of capital within the BRICS markets, specifically focusing on Russia, Brazil, and South Africa. By employing a robust dataset and sophisticated panel regression models, this study aimed to show how ESG scores impact the cost of equity and debt, and how these effects vary across different market environments and performance percentiles.The findings of this research reveal an uneven and quite unexpected interaction between ESG performance and corporate financing costs. Contrary to the expectations set forth in Hypothesis 1, the analysis shows that higher ESG scores are generally associated with an increased cost of equity across the board. This counterintuitive result suggests that while ESG improvements are valued, they may also be perceived as involving higher initial costs and risks, thereby increasing the required returns from equity investors.In the case of Russia, the results show that ESG scores do not significantly impact the cost of capital. This finding contrasts with the expectations and highlights the relatively lower emphasis on ESG factors within the Russian investment landscape. In Brazil, the analysis demonstrates a notable positive relationship between ESG scores and the cost of equity, suggesting that higher ESG scores lead to higher equity costs. This aligns with the notion that while better ESG performance might enhance corporate governance and investor protection, the associated costs and perceived risks could elevate equity returns. This finding corroborates insights from Nga &Rezaee (2015) and Giese et al. (2019), emphasizing the complex trade-offs in the Brazilian market.Conversely, the results for South Africa indicate a modest positive impact of ESG scores on the cost of equity. Although higher ESG performance correlates with increased equity costs, the effects are less pronounced compared to Brazil. This may be attributable to the varying levels of market maturity and regulatory frameworks within the BRICS countries, as well as differences in industry composition and corporate governance standards.
Importantly, the study also uncovers that the relationship between ESG performance and cost of capital is stronger for top performers (top 25%) than for underperformers (bottom 25%). This finding, supported by Cardoso (2020) and Fatemi et al. (2018), suggests that the benefits of high ESG performance are more pronounced for firms already excelling in ESG metrics. These firms experience more significant reductions in financing costs, highlighting the importance of achieving and maintaining high ESG standards. These insights carry some implications for corporate managers and investors. For equity investors, particularly in emerging markets like Brazil, prioritizing ESG factors can significantly mitigate risks and enhance portfolio performance. Debt holders, while benefiting to a lesser extent, still gain from improved creditworthiness and reduced borrowing costs associated with better ESG scores. For corporate managers, the findings advocate for a strategic focus on ESG improvements, especially for firms lagging in ESG performance, to leverage the financial benefits of enhanced sustainability practices.
Overall, this thesis contributes to the growing body of literature on ESG and corporate finance by providing a detailed comparative analysis of the BRICS markets. It highlights the importance of context-specific strategies and the potential for significant financial gains through improved ESG performance. Future research should continue to explore these dynamics, considering additional variables and broader datasets to further refine our understanding of ESG impacts on financial outcomes in diverse economic and regulatory environments.
Importantly, the study also uncovers that the relationship between ESG performance and cost of capital is stronger for top performers (top 25%) than for underperformers (bottom 25%). This finding, supported by Cardoso (2020) and Fatemi et al. (2018), suggests that the benefits of high ESG performance are more pronounced for firms already excelling in ESG metrics. These firms experience more significant reductions in financing costs, highlighting the importance of achieving and maintaining high ESG standards. These insights carry some implications for corporate managers and investors. For equity investors, particularly in emerging markets like Brazil, prioritizing ESG factors can significantly mitigate risks and enhance portfolio performance. Debt holders, while benefiting to a lesser extent, still gain from improved creditworthiness and reduced borrowing costs associated with better ESG scores. For corporate managers, the findings advocate for a strategic focus on ESG improvements, especially for firms lagging in ESG performance, to leverage the financial benefits of enhanced sustainability practices.
Overall, this thesis contributes to the growing body of literature on ESG and corporate finance by providing a detailed comparative analysis of the BRICS markets. It highlights the importance of context-specific strategies and the potential for significant financial gains through improved ESG performance. Future research should continue to explore these dynamics, considering additional variables and broader datasets to further refine our understanding of ESG impacts on financial outcomes in diverse economic and regulatory environments.
