The Impact of ESG Performance on Cost of Capital: Evidence from U.S. Public Firms

Author

• Abdur Rehman, East Tennessee State UniversityFollow

Honors Program

Global Citizen Scholars

Date of Award

5-2026

Thesis Professor(s)

Dr. William J. Trainor

Thesis Professor Department

Economics and Finance

Abstract

This paper examines whether firms with higher MSCI ESG ratings face lower costs of capital. Using a panel of U.S. public firms from 2013 to 2023, we test whether ESG scores predict three separate measures: market beta, implied cost of equity capital (ICC), and corporate bond credit spreads. Credit spreads are measured as the yield premium over a duration-matched Treasury bond. ICC is estimated using analyst earnings forecasts from I/B/E/S and the Easton (2004) PEG model, which measures the cost of equity directly from market prices without requiring an assumed equity risk premium.

The findings reveal an important distinction. In portfolio sorts, higher-ESG firms have substantially lower ICC (2.87 percentage points lower in the top quintile versus the bottom) and narrower credit spreads (8.5 basis points tighter), with both differences statistically significant. However, when firm fixed effects are used to examine within-firm changes over time, the composite ESG score does not significantly predict any of the three measures. The governance pillar marginally reduces systematic equity risk (p = 0.052), and ESG improvements in energy-intensive industries are associated with higher beta (p = 0.009), consistent with near-term transition costs increasing operational risk.

These results suggest that markets are pricing the stable firm characteristics that correlate with ESG quality, rather than responding to year-to-year changes in ESG scores. The distinction between cross-sectional and within-firm effects has direct implications for how investors and managers interpret the ESG-cost of capital relationship.

Publisher

East Tennessee State University

Document Type

Honors Thesis - Open Access

Creative Commons License

This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 License.

Recommended Citation

Rehman, Abdur, "The Impact of ESG Performance on Cost of Capital: Evidence from U.S. Public Firms" (2026). Undergraduate Honors Theses. Paper 848. https://dc.etsu.edu/honors/848

Copyright

Copyright by the authors.