Relationship between the Cost of Capital and Environmental, Social, and Governance Scores: Evidence from Latin America

Does sustainability lower the cost of capital in Latin America?

Ana Gabriela Ramirez, Julián Monsalve, Juan David González-Ruiz, Paula Almonacid, and Alejandro Peña study how ESG scores relate to the cost of capital in their paper "Relationship between the Cost of Capital and Environmental, Social, and Governance Scores: Evidence from Latin America".

They estimate two fixed-effects panel models on 606 observations covering 202 listed Latin American firms from 2017 to 2019, using ESG ratings from Refinitiv.

Their main conclusions include:

• The average firm scores 48.9/100 on ESG, a C+ grade, with governance the strongest pillar and the environmental and social pillars trailing behind.
• Firms with stronger sustainability scores tend to benefit from a lower cost of capital, with each additional Refinitiv ESG point associated with around 6 basis points of cost reduction on average.
• The result is driven almost entirely by the governance pillar, while the environmental and social pillars show no statistically meaningful link to the cost of capital in this sample.
• The governance pillar on its own carries more weight than all three ESG pillars combined, pointing to transparency and board quality as what financiers reward most in the region.
• Beyond sustainability, higher financial leverage and stronger growth opportunities are also associated with a lower cost of capital, while profitability shows no significant relationship.
• The authors read the governance effect as evidence greater transparency on internal processes and decision-making builds confidence with the market and lowers cost of capital.

This article shows environmental and social efforts bring no measurable financing benefit in this sample, but governance factors like board independence, transparency, and shareholder protection are priced in by markets.

Governance is often the most financially material pillar in emerging markets precisely because investor protection and enforcement are weaker, which may explain why it dominates here.

The sample is however small with just 202 firms over three years, and relies on third-party ratings. The null environmental and social results may reflect sparse early ESG data, not true irrelevance.