ESG Ratings, Profitability and Cost of Capital: A Firm-Level Analysis

This study investigates the relationship between Environmental, Social, and Governance (ESG) ratings and firm financial performance across a comprehensive global sample of over 10,000 companies from more than 80 countries observed in 2015–2022. Using panel data analysis, we examine how overall ESG scores and their components affect the Return on Assets (ROA), Return on Equity (ROE), and Weighted Average Cost of Capital (WACC). We employ several econometric approaches designed for panel data, including the univariate approaches; static (Pooled OLS; Fixed Effects) and a multivariate approach (Panel Vector Autoregression; PVAR) to address potential endogeneity concerns and provide robust findings. Our results revealed a complex relationship between ESG performance and financial outcomes. While OLS models generally show positive associations between ESG scores and profitability measures, Fixed Effects models indicate some negative relationships, suggesting that unobserved firm-specific factors are crucial. PVAR results highlight important dynamic interactions between ESG performance and financial metrics over time. These findings contribute to stakeholder theory by demonstrating that the financial implications of ESG performance are contingent on methodological approaches, time horizons, and specific contexts. Our research has important implications for corporate managers, investors, and policymakers seeking to understand the financial consequences of sustainability practices.