As more and more capital flows into sustainable investing, there are two burning questions: one, does this lower the cost of capital for the underlying companies; and two, do these companies go on to affect the change investors are expecting to see (alongside financial performance)?
With both these questions in mind, is sustainable investing the biggest lever an investor has in creating a better future for people and planet?
In 2020, Alex Edmans, professor of finance at London Business School, stated that the first question’s answer isn’t a simple yes or no. He argued that the relationship between sustainability performance and the cost of capital is complex and depends on several factors. These included the level and nature of systemic risk, the amount of risk aversion in a company, and the cyclical behaviour of public trust in business, notwithstanding the nature of the business itself and the role of other factors in either managing risk or creating risk.
A different paper by the Multidisciplinary Digital Publishing Institute in 2022 found that while better ESG performance is associated with a lower cost of equity, the relationship is positive regarding the cost of debt. In other words, equity investments reward sustainability, fixed income investments don’t. Yet, the authors also found that the channels of a firm’s cost of capital composition also acts differently in response to changes in sustainability performance.
The answer to the first part of the question, therefore, is likely yes in equity markets (subject to the complex factors that can influence this cost) and in debt, no (again, subject to the complex factors that can influence this cost).
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