Sustainability Managed against Downside Risk and the Cost of Equity: Evidence in Korea

Truong Thuy,Jungmu Kim

doi:10.3390/su10113969

Abstract

This study examines the relationship between sustainability managed against downside risk and the cost of equity in the Korean stock market during the 2000–2016 period. We employ downside co-skewness and downside beta as a measure of downside risk, to analyze the cross-sectional relationship between them and average portfolio stock returns. We have also carried out Fama–MacBeth regressions to find the required return for bearing downside risk. The results show that downside co-skewness can be used more effectively than downside beta to explain a cross-section of stock returns or cost of equity. The required premium for bearing downside risk, as measured by downside co-skewness, is approximately 19% per annum in the Korean stock market. This finding suggests that sustainable companies can raise their capital in the form of equity at 19% lower costs, and also implies that increasing sustainability can reduce the cost of capital.

Highlights

Emerging stock markets are vulnerable to market downside risk compared to developed countries
Based on the suggestions of previous studies, this study examines whether higher sustainability leads to lower cost of equity by testing the relation between downside risk measures and stock returns
The results show that, downside beta is better for asset pricing than conventional capital asset pricing model (CAPM), only 75–80% of stocks can be explained by downside beta

Summary

Introduction

Emerging stock markets are vulnerable to market downside risk compared to developed countries. Emerging market economies suffered from the Asian financial crisis in 1997. The U.S subprime loan defaults transmitted the crisis to emerging markets during the 2008 global financial crisis. The 2009 Greek debt crisis affected emerging stock markets. The ongoing 2018 China–United States trade war has been crashing emerging markets. The management of sustainability against downside risk is of importance, to companies in emerging markets

Objectives

Results

Conclusion