How do corporate ESG practices impact required shareholders returns? Evidence from the implied cost of equity of European listed firms

Abstract

In this research, we explore the relationship between a firm’s ESG engagement, and the return required by its shareholders. Our hypothesis is that stronger ESG engagement is associated with a reduction in the return required by shareholders. We empirically test this hypothesis on a panel of publicly traded firms from a number of European countries during the period 2012-2023, using data obtained from Refinitiv Eikon. We use the implied cost of equity as a forward-looking measure of the return required by shareholders, which does not depend on any hypothesis about the type of risk involved or the appropriateness of any asset pricing model. This study provides empirical evidence that firms excelling in environmental, social, and governance practices can achieve financial benefits through reduced required returns, thereby highlighting the economic value of sustainable business practices. We also provide evidence for firms in European countries, which is still a relatively unexplored setting and which therefore allows us to offer a first insight into what influence the legal framework (common law versus civil law) has on the relationship between ESG engagement and required returns.