ESG performance and the cost of debt: exploring the role of internal audit

Abstract

ABSTRACT This study investigates the effect of Environmental, Social, and Governance (ESG) performance on capital-raising costs in the debt market. The study also examines the role of internal audit organizations in this relationship. The results of the current study show that firms with high ESG performance have lower cost of debt. More importantly, when ESG is classified into sub-factors (E, S, and G), all three are negatively associated with the cost of debt. Next, the current study documents that the presence of an audit committee, the increase in the number of internal audit members, and the higher independence of the internal audit organization incrementally weaken the negative relationship between ESG and the cost of debt. The results remain robust across various additional tests and when endogeneity concerns are mitigated. Overall, these findings suggest the possibility that, as a primary risk assessment function, an independent and large internal audit organization exposes and highlights ESG risks to external credit rating agencies. The findings of this study offer valuable practical insights into how internal audit organizations can effectively assess and contribute to the evaluation of ESG performance.