Environmental Performance and the Cost of Equity Capital

Abstract

This study examines a potential benefit associated with firm environmental performance: a reduction in implied cost of equity capital. Based on the three separate implied cost of equity capital measures and an average-based measure, I find that firms with superior environmental performance (measured by the number of environment strengths they attain) experience a reduction in their implied cost of equity capital. Moreover, I find that the cost of equity reduction benefit is more pronounced in environmentally sensitive industry firms, and less pronounced for firms with ineffective governance structure. Finally, I find that the negative relationship between environmental performance and cost of equity capital is unaffected by the presence of environmental concerns. My finding is consistent with the view that firms with superior environmental performance are associated with a larger investor base and lower perceived risks, resulting in lower required return on equity capital. My findings suggest that investment in improving environment performance contributes substantially to reducing firm implied cost of equity capital.