Corporate social irresponsibility: The relationship between ESG misconduct and the cost of equity

Abstract

Reputational risk arising from environmental, social, and governance (ESG) conduct is increasingly relevant. This paper studies the role of media coverage related to corporate social irresponsibility (measured by RepRisk) as a source of reputational risk for public companies by verifying the relationship with the cost of equity. The research covers a decade of data, from 2007 to 2017, relative to 731 firms included in the MSCI USA Index. Our results show a positive relationship between reputational risk and the cost of equity capital, demonstrating a positive effect of corporate misconduct on the cost of equity for all three categories of risk: environmental, social, and governance. Moreover our results underline that shareholders are more sensitive to social misconducts. We also find that the cost of misconduct is higher for companies with higher ESG scores than for those with lower ESG scores. Our findings are relevant for practitioners and policy makers, since the cost of equity is one of the channels through which capital markets can encourage firms to make effective efforts aimed at reducing their ESG incidents.