Relationship between the Cost of Capital and Environmental, Social, and Governance Scores: Evidence from Latin America

Abstract

Environmental, social, and governance (ESG) scores play a pivotal role in the strategic design of firms. The literature has demonstrated the importance of sustainability issues in the financial performance of firms around the world. In particular, understanding the relationship between sustainability and the cost of capital is crucial for determining financial strategy and decision making. We identify an opportunity in the literature to analyze this relationship within Latin America (LatAm) firms. Thus, this study analyzes the relationship between ESG scores with the cost of capital of firms with headquarters in LatAm using a data set that includes 606 observations corresponding to information about 202 firms from 2017 to 2019. To conduct our analysis, two fixed effects panel data models were estimated. We model this relationship by taking ESG scores and each of its ESG Pillar scores—i.e., Environmental, Social, and Governance pillar scores—as independent variables and analyzing how they affect the cost of capital. According to the results, there is an inverse effect relationship between ESG scores and the cost of capital. Additionally, we did not find a relationship between the Social Pillar score and the Environmental Pillar score with the cost of capital. By contrast, the Governance Pillar score shows a negative relationship with the cost of capital. This indicates that the increase in transparency about internal processes and governance entities can be an essential driver of value creation for firms and higher financing confidence in LatAm firms. This study represents a breakthrough in explaining the impact of ESG scores on the cost of capital in LatAm. Ultimately, the current study presents the potential for further research in this field.

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Citation: Ramirez, A.G.; Monsalve, J.;
González-Ruiz, J.D.; Almonacid, P.;
Peña, A. Relationship between the Cost
of Capital and Environmental, Social,
and Governance Scores: Evidence from
Latin America. Sustainability 2022,14,
5012. https://doi.org/10.3390/
su14095012
Academic Editor: Ioannis Nikolaou
Received: 17 February 2022
Accepted: 11 April 2022
Published: 21 April 2022
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4.0/).
sustainability
Article
Relationship between the Cost of Capital and Environmental,
Social, and Governance Scores: Evidence from Latin America
Ana Gabriela Ramirez 1, Julián Monsalve 1, Juan David González-Ruiz 1, * , Paula Almonacid 2
and Alejandro Peña 3
1
Grupo de Investigación en Finanzas y Sostenibilidad, Departamento de Economía, Universidad Nacional de
Colombia, Sede Medellín, Medellín 050034, Colombia; agramirezl@unal.edu.co (A.G.R.);
jmonsalvea@unal.edu.co (J.M.)
2Grupo de Investigación en Finanzas y Banca, Departamento de Finanzas, Universidad EAFIT,
Medellín 050022, Colombia; palmona1@eafit.edu.co
3Grupo de Investigación en Información y Gestión, Escuela de Administración, Universidad EAFIT,
Medellín 050022, Colombia; japena@eafit.edu.co
*Correspondence: jdgonza3@unal.edu.co
Abstract:
Environmental, social, and governance (ESG) scores play a pivotal role in the strategic
design of firms. The literature has demonstrated the importance of sustainability issues in the
financial performance of firms around the world. In particular, understanding the relationship
between sustainability and the cost of capital is crucial for determining financial strategy and decision
making. We identify an opportunity in the literature to analyze this relationship within Latin America
(LatAm) firms. Thus, this study analyzes the relationship between ESG scores with the cost of capital
of firms with headquarters in LatAm using a data set that includes 606 observations corresponding
to information about 202 firms from 2017 to 2019. To conduct our analysis, two fixed effects panel
data models were estimated. We model this relationship by taking ESG scores and each of its ESG
Pillar scores—i.e., Environmental, Social, and Governance pillar scores—as independent variables
and analyzing how they affect the cost of capital. According to the results, there is an inverse effect
relationship between ESG scores and the cost of capital. Additionally, we did not find a relationship
between the Social Pillar score and the Environmental Pillar score with the cost of capital. By contrast,
the Governance Pillar score shows a negative relationship with the cost of capital. This indicates that
the increase in transparency about internal processes and governance entities can be an essential
driver of value creation for firms and higher financing confidence in LatAm firms. This study
represents a breakthrough in explaining the impact of ESG scores on the cost of capital in LatAm.
Ultimately, the current study presents the potential for further research in this field.
Keywords: cost of capital; ESG; LatAm; fixed effects; panel data; sustainability
1. Introduction
Due to the United Nations Development Program (UNDP), there is increasing pressure
on the global community to initiate efforts to achieve the Sustainable Development Goals
(SDGs) by 2030 [
1
], which are aligned with responsible investing. As a result, at the
launching of the initiative to develop the Principles for Responsible Investment (PRI), the
term “Environmental, Social, and Governance” (ESG) began to gain significant importance
in investment and, therefore, in the operation of firms [2].
In this way, investors have been concerned about incorporating ESG criteria in their
investment portfolios [
3
,
4
]. This has allowed firms’ behaviors and decisions toward sustain-
able development to become a fundamental factor in obtaining support for achieving the
SDGs [
5
,
6
]. In addition to this concern, firms’ cost of capital—also known as WACC—the
weighted average cost of capital—is crucial in determining financing strategy and decision-
making aligned to sustainability issues [
7
]. Thus, firms seek to establish strategies based on
sustainability to reduce their cost of capital.
Sustainability 2022,14, 5012. https://doi.org/10.3390/su14095012 https://www.mdpi.com/journal/sustainability

Sustainability 2022,14, 5012 2 of 15
According to [
8
], firms that promote corporate social responsibility (CSR) practices
exhibit cheaper equity financing. Additionally, Ref. [
9
] suggested that adopting CSR
measures is essential to building a good reputation. Sustainable strategies, which ESG
scores can measure, benchmark CSR results derived from the best business practices and
socially responsible investment [10,11].
In this way, firms are becoming interested in the effect of a sustainable strategy on the
cost of capital. A study conducted by Ref. [
12
] has outlined some of the concerns that ESG
scores consider, such as climate change, the environmental impacts of operations, respect
for human rights, equality, workforce diversity, independence of the board of directors, fair
treatment of shareholders, transparency, and disclosure of business information.
Some of the main findings in the extant literature refer to the relationship between
sustainability and the cost of equity (a component of the cost of capital). Research conducted
by Ref. [
13
] has found that strong sustainability concerning ESG reinforces the negative
relationship between economic sustainability disclosure and the cost of equity. Conversely,
Refs. [
7
,
14
] agreed that CSR disclosure in annual reports reduces the cost of equity. Similarly,
Ref. [8] found that firms with better CSR performance have a lower cost of equity.
In addition, Ref. [
15
] found that sustainability reporting reduces both the cost of debt
and equity, which means that it generally has an inverse impact on firms’ cost of capital.
Regarding the relationship between ESG scores and firms’ cost of capital, certain advances
have been developed that lead to various conclusions. According to Ref. [
12
], in a study
conducted on panel data regressions such as the pooled ordinary least squares, fixed effect,
and random effect, none of the ESG Pillar scores were significant in firms’ cost of capital in
Malaysia. Conversely, based on the Swedish Stock Exchange’s research conducted from
2017 to 2019, Ref. [
16
] found no evidence that the ESG score is related to the cost of capital.
Finally, a study conducted by Ref. [
17
], which was based on 400 US firms listed in the stock
market, showed a negative correlation between ESG scores and the firms’ cost of capital.
Although empirical studies have mainly focused on the relationship between ESG
issues and financial performance [
6
,
18
–
20
], to the best of our knowledge, no elements
in the current literature explain the impact of ESG scores on the cost of capital in Latin
America (LatAm). Therefore, to fill this gap in the literature, the present study analyzes
the relationship between ESG scores and the cost of capital of firms with headquarters in
LatAm using a panel model and a data set that includes 606 observations corresponding to
information about 202 LatAm firms from 2017 to 2019. The current study makes a two-fold
contribution to the literature. First, to better understand the ESG scores—the cost of the
capital relationship, an in-depth scientometric assessment that allows the analysis of the
research areas, trending topics, and the evolution in this field is performed. Second, the
present study allows a better understanding of the effects of ESG scores on the cost of
capital of LatAm firms, providing critical new evidence and insights on this issue, especially
in the region where research on this topic has not yet been conducted. In this way, this
study provides a roadmap that researchers and professionals can use to improve their
understanding of the relationship between ESG scores and the cost of capital.
The remainder of the paper is organized as follows: In Section 2, we review the litera-
ture that discusses the theoretical foundations of the cost of capital, financial performance,
and corporate governance while focusing on CSR practices and ESG issues. In Section 3,
we explain the data and variables used in the present study; in Section 4, we discuss the
empirical results; in Section 5, we discuss our empirical results; in Section 6, we conclude
our study.
2. Literature Review
The present study shows a comprehensive, systematic, and holistic review of the
literature about the relationship between sustainable practices and the cost of capital. The
research papers reviewed are from the bibliographic databases of Scopus due to its excellent
academic reputation in research [
21
]. We performed our search starting from the following
search equation: TITLE-ABS-KEY (WACC OR “cost of capital” OR “firm valuation” OR

Sustainability 2022,14, 5012 3 of 15
“capital structure”) AND TITLE-ABS-KEY (ESG OR sustainab*) AND TITLE-ABS-KEY
(firm OR compan* OR corporati*). We found 177 documents related to the topic in this
database.
Afterward, we visualized and clustered the documents found using VOSviewer ver-
sion 1.6.13. This tool has been used by several studies for a comprehensive picture of
relevant research topics and trends (namely, [
6
,
22
–
25
]). The software built a bibliometric
network based on bibliographic coupling for the papers obtained from this database, includ-
ing information regarding journals, researchers, and individual publications. VOSviewer
uses natural language processing algorithms for identifying links, connections, or relations
between documents (represented by dots), and, thus, clusters are created by grouping
them in a network [
26
]. The size of the dots represents the author’s relevance measured
by cites. A cluster is a set of items included in a map, and an item may belong to only one
cluster [26].
Based on the results obtained from the search equation, we aimed to choose the most
relevant studies within the field to include in the literature review. In this line of thought,
we selected the number of citations as a criterion to evaluate relevance; specifically, we
decided to include only those papers with five or more citations. Then, those with a
minimum link strength of 10 were retained, thus obtaining 30 articles distributed in 4
clusters (Figure 1).
Sustainability 2022, 14, x 3 of 15
2. Literature Review
The present study shows a comprehensive, systematic, and holistic review of the lit-
erature about the relationship between sustainable practices and the cost of capital. The
research papers reviewed are from the bibliographic databases of Scopus due to its excel-
lent academic reputation in research [21]. We performed our search starting from the fol-
lowing search equation: TITLE-ABS-KEY (WACC OR “cost of capital” OR “firm valua-
tion” OR “capital structure”) AND TITLE-ABS-KEY (ESG OR sustainab*) AND TITLE-
ABS-KEY (firm OR compan* OR corporati*). We found 177 documents related to the topic
in this database.
Afterward, we visualized and clustered the documents found using VOSviewer ver-
sion 1.6.13. This tool has been used by several studies for a comprehensive picture of rel-
evant research topics and trends (namely, [6,22–25]). The software built a bibliometric net-
work based on bibliographic coupling for the papers obtained from this database, includ-
ing information regarding journals, researchers, and individual publications. VOSviewer
uses natural language processing algorithms for identifying links, connections, or rela-
tions between documents (represented by dots), and, thus, clusters are created by group-
ing them in a network [26]. The size of the dots represents the author’s relevance meas-
ured by cites. A cluster is a set of items included in a map, and an item may belong to only
one cluster [26].
Based on the results obtained from the search equation, we aimed to choose the most
relevant studies within the field to include in the literature review. In this line of thought,
we selected the number of citations as a criterion to evaluate relevance; specifically, we
decided to include only those papers with five or more citations. Then, those with a min-
imum link strength of 10 were retained, thus obtaining 30 articles distributed in 4 clusters
(Figure 1).
Figure 1. Most studies about the relationship between sustainability and the cost of capital are based
on bibliographic coupling. Source: Authors using VosViewer.
2.1. Cluster 1: CSR Practices on Financial Variables
The first cluster mainly addresses the impact of CSR practices on the performance of
variables in financial markets. Specifically, they mainly focus on how CSR affects inves-
tors’ cost of capital. There is evidence that a lack of sustainability will lead to a higher cost
of capital and limited access to private equity.
Figure 1.
Most studies about the relationship between sustainability and the cost of capital are based
on bibliographic coupling. Source: Authors using VosViewer.
2.1. Cluster 1: CSR Practices on Financial Variables
The first cluster mainly addresses the impact of CSR practices on the performance of
variables in financial markets. Specifically, they mainly focus on how CSR affects investors’
cost of capital. There is evidence that a lack of sustainability will lead to a higher cost of
capital and limited access to private equity.
One study [
27
] concluded that this increment in the price of capital would reduce
the value of a firm. However, Ref. [
12
] argued that even though ESG Pillar scores have
a relationship with the cost of capital, they do not have a significant relationship with
profitability and enterprise value. In addition, [
28
] claimed that CSR practices positively
and significantly affect a firm’s market value in emerging countries. The magnitude of this
relationship is affected by the financial and operating characteristics of the firm.
From investors’ perspective, studies conducted by Refs. [
29
,
30
] found that an invest-
ment strategy linked to CSR does not significantly influence risk or return. In comparison,

Sustainability 2022,14, 5012 4 of 15
Ref. [
30
] specified that although this type of strategy has led to positive abnormal returns
in the last decades, it will eventually change as firms with high ESG standards will be
correctly priced and have a lower expected cost of capital.
Finally, other researchers have shown how ESG and CSR have different impacts
on firms; Ref. [
31
] stated that firms that proactively support social responsibility and
environmental sustainability are characterized by better profitability measures, lower short-
term liquidity, higher long-term leverage, and better management efficiency than the entire
industry or sector. In addition, according to [
32
], a firm can access additional resources by
improving its CSR ratings.
2.2. Cluster 2: Sustainable Information Disclosure
This cluster highlights the determinants of sustainable information disclosure and how
it affects a firm. One study conducted by Ref. [
33
] suggested that the most critical drivers
of the disclosure of sustainability reports are media visibility and ownership structure.
Additionally, Ref. [
34
] revealed that size, media, country-specific factors, industry, and
sustainability performance significantly impact sustainable information disclosure. Both
results are supported by [35,36], who found a positive effect of sustainability engagement
and voluntary environmental disclosure on a firm’s market value. This relationship is more
robust in countries with high investor protection and disclosure levels [36].
In addition, Ref. [
37
] recommended that sustainability leadership should be a mandate
for strategic managers of publicly traded companies. According to their findings, conduct-
ing business using policies that integrate economic, social, and environmental principles
is a business differentiation strategy contributing to shareholder value creation. After all,
Ref. [
38
] highlighted that investors of firms that promote sustainability practices demand a
lower rate of return, i.e., a lower cost of capital.
2.3. Cluster 3: Sustainable Practices and Cost of Equity
This cluster studies the relationship between sustainable practices and the cost of
equity. According to [
13
], ESG Pillar scores have an inverse relationship with the cost of
equity, which is supported by only environmental and governance performance. In this
line, Ref. [
39
] found that environmental practices also reduce the implicit cost of equity,
which is more significant in countries where the government is weak. Conversely, Ref. [
16
]
found no evidence that the ESG score is related to the cost of capital; however, there is
a positive relationship between the ESG score and the credit default swap spread in the
Swedish stock market. In addition, Ref. [
17
] showed a negative correlation between ESG
scores and the cost of capital and found a positive relationship between capitalization and
free cash flow.
Furthermore, Refs. [
38
,
40
,
41
] found a negative relationship between quality sustain-
ability reporting and the cost of capital. Within this context, Ref. [
41
] found that by pro-
viding an assurance statement, the effect of this relationship increases through improved
credibility of the information. Additionally, Ref. [
40
] concluded that it also has a positive
relationship with expected future performance. Last but not least, Ref. [
38
] found that
the effect of carbon risk is directly related to the cost of equity. This relationship has been
shown to be independent of the voluntary disclosure of sustainability reports.
2.4. Cluster 4: Corporate Governance on Financial Performance
This cluster focuses on the importance of accounting practices, decisions based on
international standards, and the integration of CSR policies into the financial performance
of firms. One study conducted by Ref. [
42
] noted that screening for compliant versus
non-compliant companies allows investors to distinguish sustainable companies over the
long term, providing greater diversification when holding socially responsible investment
portfolios. The diversification is explained by the susceptibility of compliant firms to
increase book debt ratios in periods of declining equity value.

Sustainability 2022,14, 5012 5 of 15
By contrast, Ref. [
43
] identified the need to improve corporate governance and social
responsibility to create an appropriate balance between sustainability, competitiveness,
productivity, and financial and non-financial performance of firms. Lastly, Ref. [
44
] found
that Nigerian firms’ adoption of International Financial Reporting Standards does not
significantly influence the relationship between capital structure and profitability of firms.
2.5. Hypothesis Development
The literature exemplifies research efforts that researchers have made to understand
how sustainability affects firms’ financial variables such as market value [
19
,
26
,
27
] and
profitability [
31
]. In particular, there is evidence of an inverse relationship between sustain-
able practices and the cost of capital [
18
,
29
,
30
]. However, in these studies, ESG scores were
not used as an indicator to measure sustainability. Other authors have shown interest in
understanding how ESG scores relate to the cost of capital [
9
,
12
,
13
]. Nevertheless, there is
a scarcity of studies that explain their relationship in LatAm. Consequently, an opportunity
is evident in the literature to evaluate ESG scores and the cost of capital in LatAm firms.
Therefore, we propose the following research question: How are ESG scores related to
the cost of capital in LatAm? Since we have found evidence in the literature of a statistically
significant inverse effect of sustainability and cost of capital on firms [
9
,
18
,
29
,
30
], we
propose the following hypotheses to address our research question (Figure 2):
Sustainability 2022, 14, x 6 of 15
where EPS corresponds to the Environmental Pillar score, SPS to the Social Pillar score,
and GPS to the Governance Pillar score.
Figure 2. Research framework.
3. Data and Variables
Dependent variable: the variable of interest is the cost of capital. The cost of capital
is calculated as the weighted average cost of financing an enterprise through debt, equity,
and preferred shares.
Independent variables: the present study uses the ESG score calculated by Thomson
Reuters Refinitiv, based on publicly reported information. It contains firm-level measures
grouped into ten categories that reformulate the three pillar scores of ESG and the final
ESG scores, reflecting a firm’s ESG performance, commitment, and effectiveness [45].
The impact of each one of the three ESG Pillar scores is also studied. The Environ-
mental Pillar score covers a firm’s actions related to environmental responsibility, includ-
ing resource use, emissions, and innovation. The Social Pillar score reflects a firm’s com-
mitment to the community—where it operates and all areas of its supply chain—covering
the workforce, human rights, community, and product responsibility. The governance
score measures the degree to which all processes and systems of a firm ensure that its
workers and management act in the best interests of its shareholders by providing for
long-term operations, including management, shareholders, and CSR strategy [10].
Control variables: to define the variables that can significantly impact the cost of
capital, we reviewed the literature to identify variables mainly used as control variables.
The selected variables and their literature sources are shown in Table 1. First, we include
firm size, measured by the natural logarithm of total assets (TA), and firm risk [46]. Sec-
ond, we use return on assets (ROA) to measure firms’ profitability [15]. Moreover, we
include the financial leverage ratio (LR), which is calculated as total debt divided by TA,
to model the effects of capital structure decisions on firms’ cost of capital [47]. As a natural
logarithm, the market-to-book ratio is used to proxy for both the distress risk and the level
of firms’ growth opportunities [40,41].
Table 1. Financial variables and their literature.
Variable Denotation
Measurement Literature Sources
Firm size TA Natural logarithm of total assets [46]
Profitability ROA Return on assets [15]
Financial leverage LR Total debt divided by total assets [48]
Firm’s growth opportunities PBR Natural logarithm of the market-to-book ratio [48,49]
Data Sources
Data were extracted from Thomson Reuters’ ESG database using Datastream, which
provides a comprehensive source of data about ESG issues, covering approximately 70%
of the world market capitalization. This data set contains financial information from
Figure 2. Research framework.
Hypothesis 1 (H1).
The relationship between the ESG scores and the cost of capital is significant
and inverse.
We proposed the following model to test this hypothesis in LatAm:
WACCit =α0+α1PBRit +α2ROAit
+α3LRit +α4TAit +α5ESGit
+α6Year.2018it +α7Year.2019it +υit +eit
Hypothesis 2 (H2).
The relationship between each ESG Pillar score and the cost of capital
is significant.
Hypothesis 2.1 (H2.1).
The relationship between the Environmental Pillar score and the cost of
capital is inverse.
Hypothesis 2.2 (H2.2).
The relationship between the Social Pillar score and the cost of capital
is inverse.
Hypothesis 2.3 (H2.3).
The relationship between the Governance Pillar score and the cost of
capital is inverse.

Sustainability 2022,14, 5012 6 of 15
We proposed the following model to test this hypothesis in LatAm:
WACCit =α0+α1PBRit +α2ROAit
+α3LRit +α4TAit +α5EPSit +α6SPSit +α7GPSit
+α8Year.2018it +α9Year.2019it +υit +eit
where EPS corresponds to the Environmental Pillar score, SPS to the Social Pillar score, and
GPS to the Governance Pillar score.
3. Data and Variables
Dependent variable:
the variable of interest is the cost of capital. The cost of capital
is calculated as the weighted average cost of financing an enterprise through debt, equity,
and preferred shares.
Independent variables:
the present study uses the ESG score calculated by Thomson
Reuters Refinitiv, based on publicly reported information. It contains firm-level measures
grouped into ten categories that reformulate the three pillar scores of ESG and the final
ESG scores, reflecting a firm’s ESG performance, commitment, and effectiveness [45].
The impact of each one of the three ESG Pillar scores is also studied. The Environmen-
tal Pillar score covers a firm’s actions related to environmental responsibility, including
resource use, emissions, and innovation. The Social Pillar score reflects a firm’s commit-
ment to the community—where it operates and all areas of its supply chain—covering the
workforce, human rights, community, and product responsibility. The governance score
measures the degree to which all processes and systems of a firm ensure that its workers
and management act in the best interests of its shareholders by providing for long-term
operations, including management, shareholders, and CSR strategy [10].
Control variables:
to define the variables that can significantly impact the cost of
capital, we reviewed the literature to identify variables mainly used as control variables.
The selected variables and their literature sources are shown in Table 1. First, we include
firm size, measured by the natural logarithm of total assets (TA), and firm risk [
46
]. Second,
we use return on assets (ROA) to measure firms’ profitability [
15
]. Moreover, we include
the financial leverage ratio (LR), which is calculated as total debt divided by TA, to model
the effects of capital structure decisions on firms’ cost of capital [
47
]. As a natural logarithm,
the market-to-book ratio is used to proxy for both the distress risk and the level of firms’
growth opportunities [40,41].
Table 1. Financial variables and their literature.
Variable Denotation Measurement Literature Sources
Firm size TA Natural logarithm of total assets [46]
Profitability ROA Return on assets [15]
Financial leverage LR Total debt divided by total assets [48]
Firm’s growth
opportunities PBR Natural logarithm of the market-to-book ratio [48,49]
Data Sources
Data were extracted from Thomson Reuters’ ESG database using Datastream, which
provides a comprehensive source of data about ESG issues, covering approximately 70% of
the world market capitalization. This data set contains financial information from public
information sources collected and audited by ESG specialists for annual and CSR reports of
firms worldwide [45].
The initial data set consists of 344 firms from LatAm countries, including Argentina,
Brazil, Chile, Colombia, Cayman Islands, Virgin Islands, Panama, Peru, Puerto Rico, and
Uruguay. Records are available from 2012 to 2019. Data from 2012 to 2016 were excluded
due to the unavailability of information. Thus, the study period is from 2017 to 2019,
consistent with firms’ growing interest in recent years to incorporate ESG issues into their

Sustainability 2022,14, 5012 7 of 15
corporate strategy. Moreover, 119 firms that did not disclose financial, environmental,
social, and corporate governance information or provide sufficient data in the given years
were excluded.
As a result, a longitudinal database consisting of 202 firms was obtained. Some of
examples of firms under consideration are Petroleo Brasileiro SA Petrobras, JBS SA, America
Movil SAB de CV, Grupo Bimbo SAB de CV, Falabella SA, Ecopetrol SA, Almacenes Exito
SA, Telecom Argentina SA, InRetail Peru Corp, Avianca Holdings SA, Herbalife Nutrition
Ltd., and Triple-S Management Corp. There are values for each variable considered in
the study period, resulting in 606 observations distributed in the economic sectors shown
in Figure 3. Financials (23.8%), utilities (16.3%), non-cyclical consumption (15.3%), and
industrial (13.9%) sectors represent more than 60% of the firms.
Sustainability 2022, 14, x 7 of 15
public information sources collected and audited by ESG specialists for annual and CSR
reports of firms worldwide [45].
The initial data set consists of 344 firms from LatAm countries, including Argentina,
Brazil, Chile, Colombia, Cayman Islands, Virgin Islands, Panama, Peru, Puerto Rico, and
Uruguay. Records are available from 2012 to 2019. Data from 2012 to 2016 were excluded
due to the unavailability of information. Thus, the study period is from 2017 to 2019, con-
sistent with firms’ growing interest in recent years to incorporate ESG issues into their
corporate strategy. Moreover, 119 firms that did not disclose financial, environmental, so-
cial, and corporate governance information or provide sufficient data in the given years
were excluded.
As a result, a longitudinal database consisting of 202 firms was obtained. Some of
examples of firms under consideration are Petroleo Brasileiro SA Petrobras, JBS SA, Amer-
ica Movil SAB de CV, Grupo Bimbo SAB de CV, Falabella SA, Ecopetrol SA, Almacenes
Exito SA, Telecom Argentina SA, InRetail Peru Corp, Avianca Holdings SA, Herbalife
Nutrition Ltd., and Triple-S Management Corp. There are values for each variable consid-
ered in the study period, resulting in 606 observations distributed in the economic sectors
shown in Figure 3. Financials (23.8%), utilities (16.3%), non-cyclical consumption (15.3%),
and industrial (13.9%) sectors represent more than 60% of the firms.
Figure 3. Data distribution by sector. Source: Authors based on data from Refinitiv Thomson Reu-
ters.
Regarding the country in which the firms’ headquarters are located, 35.1% are in Bra-
zil, 16.3% in Chile and Mexico, 10.9% in Argentina, 8.9% in Peru, 6.9% in Colombia, 2.0%
in the Cayman Islands and Puerto Rico, 1.0% in Panama, and 0.5% in the Virgin Islands,
as shown in Figure 4. Despite these results, the prominent characteristic of Brazil, Chile,
and Mexico is the development of their capital markets.
Figure 3.
Data distribution by sector. Source: Authors based on data from Refinitiv Thomson Reuters.
Regarding the country in which the firms’ headquarters are located, 35.1% are in Brazil,
16.3% in Chile and Mexico, 10.9% in Argentina, 8.9% in Peru, 6.9% in Colombia, 2.0% in
the Cayman Islands and Puerto Rico, 1.0% in Panama, and 0.5% in the Virgin Islands, as
shown in Figure 4. Despite these results, the prominent characteristic of Brazil, Chile, and
Mexico is the development of their capital markets.
Sustainability 2022, 14, x 8 of 15
Figure 4. Data distribution by the country of the firm’s headquarters. Source: Authors based on data
from Refinitiv Thomson Reuters.
4. Empirical Results
4.1. Descriptive Statistics
The descriptive statistics are presented in Table 2. Financial leverage, profitability,
and firms’ growth opportunities have the highest coefficient of variation, suggesting sig-
nificant differences within the firms due to the periods or economic sectors.
The average ESG score is 48.937, representing a C+ grade in the Refinitiv classifica-
tion. According to Ref. [45], this score indicates a satisfactory relative ESG performance
and a moderate degree of openness in publicly available ESG data. A firm’s highest grade
is an A grade, implying an excellent relative ESG performance and a high degree of trans-
parency in publicly reporting ESG data. Regarding the three ESG Pillar scores, Govern-
ance Pillar has the highest average score for LatAm firms (9a B grade), indicating good
performance. The Environmental and Social pillars have the lowest values (C grade).
These scores suggest that there is still much work to improve ESG levels in LatAm firms.
Table 2. Descriptive statistics of model’s variables.
Variable Mean
Std. Dev.
Min 25% 50% 75% Max CV
WACC 0.089 0.050 0.021 0.057 0.073 0.106 0.338 0.562
ESG 48.937 19.342 6.700 33.552 52.069 64.626 89.523 0.395
EPS 48.781 23.542 4.915 27.998 50.580 67.997 97.246 0.483
GPS 50.383 21.700 6.279 32.383 52.424 67.464 92.233 0.430
SPS 47.843 23.991 3.002 27.164 51.569 66.553 95.014 0.500
PBR 0.507 0.859 −2.743 0.003 0.483 1.006 3.481 1.694
ROA 0.044 0.085 −0.696 0.014 0.038 0.077 0.466 1.932
LR 1.223 3.673 0.000 0.191 0.487 0.984 46.240 3.003
TA 8.409 1.554 3.128 7.463 8.380 9.514 12.980 0.185
The correlation matrix of the variables in the model is presented in Figure 5. Because
the data are time-series and cross-sectional, it is impossible to draw an accurate conclusion
by considering only correlation effects. However, specific patterns can be inferred as a tool
to understand the results better. The estimations do not show signs of collinearity among
the independent variables due to low correlation coefficients. Among all the correlations
with ESG, firm size, measured as the natural logarithm of TA, is the strongest, suggesting
a positive relationship between these two variables. Moreover, in each of the pillar scores
of ESG, this relationship is decisive.
Figure 4.
Data distribution by the country of the firm’s headquarters. Source: Authors based on data
from Refinitiv Thomson Reuters.

Sustainability 2022,14, 5012 8 of 15
4. Empirical Results
4.1. Descriptive Statistics
The descriptive statistics are presented in Table 2. Financial leverage, profitability, and
firms’ growth opportunities have the highest coefficient of variation, suggesting significant
differences within the firms due to the periods or economic sectors.
Table 2. Descriptive statistics of model’s variables.
Variable Mean Std. Dev. Min 25% 50% 75% Max CV
WACC 0.089 0.050 0.021 0.057 0.073 0.106 0.338 0.562
ESG 48.937 19.342 6.700 33.552 52.069 64.626 89.523 0.395
EPS 48.781 23.542 4.915 27.998 50.580 67.997 97.246 0.483
GPS 50.383 21.700 6.279 32.383 52.424 67.464 92.233 0.430
SPS 47.843 23.991 3.002 27.164 51.569 66.553 95.014 0.500
PBR 0.507 0.859 −2.743 0.003 0.483 1.006 3.481 1.694
ROA 0.044 0.085 −0.696 0.014 0.038 0.077 0.466 1.932
LR 1.223 3.673 0.000 0.191 0.487 0.984 46.240 3.003
TA 8.409 1.554 3.128 7.463 8.380 9.514 12.980 0.185
The average ESG score is 48.937, representing a C+ grade in the Refinitiv classification.
According to Ref. [
45
], this score indicates a satisfactory relative ESG performance and a
moderate degree of openness in publicly available ESG data. A firm’s highest grade is an A
grade, implying an excellent relative ESG performance and a high degree of transparency in
publicly reporting ESG data. Regarding the three ESG Pillar scores, Governance Pillar has
the highest average score for LatAm firms (9a B grade), indicating good performance. The
Environmental and Social pillars have the lowest values (C grade). These scores suggest
that there is still much work to improve ESG levels in LatAm firms.
The correlation matrix of the variables in the model is presented in Figure 5. Because
the data are time-series and cross-sectional, it is impossible to draw an accurate conclusion
by considering only correlation effects. However, specific patterns can be inferred as a tool
to understand the results better. The estimations do not show signs of collinearity among
the independent variables due to low correlation coefficients. Among all the correlations
with ESG, firm size, measured as the natural logarithm of TA, is the strongest, suggesting a
positive relationship between these two variables. Moreover, in each of the pillar scores of
ESG, this relationship is decisive.
4.2. Construction of the Model
To evaluate the hypotheses, two static panel data models were estimated. As shown
in Figure 2, the first model examines the relationship between the cost of capital of the set
of firms with their overall ESG score. The second model analyses the relationship between
the cost of capital and each of the individual ESG pillar scores.
To select the appropriate panel model for the data, we first conducted a Breusch–Pagan
Lagrangian test. We used this test to determine whether to use pooled OLS or random
effects (RE) models. The null hypothesis in the LM test is that the variances between entities
are zero. There are no significant differences between units (i.e., no panel effect). According
to the results shown in Table 3, we rejected the null hypothesis with a significance of 5%. We
concluded that the assumptions for running a pooled OLS regression model were not met.

Sustainability 2022,14, 5012 9 of 15
Sustainability 2022, 14, x 9 of 15
(a) (b)
Figure 5. (a) Correlation matrix between ESG overall score and the explanatory variables. (b) Cor-
relation matrix between ESG pillar scores and the explanatory variables.
4.2. Construction of the Model
To evaluate the hypotheses, two static panel data models were estimated. As shown
in Figure 2, the first model examines the relationship between the cost of capital of the set
of firms with their overall ESG score. The second model analyses the relationship between
the cost of capital and each of the individual ESG pillar scores.
To select the appropriate panel model for the data, we first conducted a Breusch–
Pagan Lagrangian test. We used this test to determine whether to use pooled OLS or ran-
dom effects (RE) models. The null hypothesis in the LM test is that the variances between
entities are zero. There are no significant differences between units (i.e., no panel effect).
According to the results shown in Table 3, we rejected the null hypothesis with a signifi-
cance of 5%. We concluded that the assumptions for running a pooled OLS regression
model were not met.
Table 3. Model selection tests.
Statistic p-Value
Breusch–Pagan
Lagrangian test
18.1855 ***
(LM Statistic) 0.0027
Hausman test 54.5311 ***
(Chi-squared) 0.0000
*** Significantly different from zero at 1% level.
Subsequently, we applied the Hausman test to determine the appropriateness of the
method used to estimate our model. According to [50], the critical issue in deciding
whether to use fixed effects (FE) or random effects (RE) is whether we can plausibly as-
sume the FE method is uncorrelated with all covariates. Following what [51] stated, the
null hypothesis of this test implies that the preferred model is RE. Moreover, rejecting the
null hypothesis establishes that the FE method is selected.
According to Table 3, as the null hypothesis is rejected, under a significance level of
5%, the RE model will violate the Gauss–Markov theorem and end up with biased and
inconsistent estimates. Therefore, we applied an FE model, which is unbiased and con-
sistent. According to [52], “the key insight for the FE model is that if the unobserved var-
iable does not change over time, then any changes in the dependent variable must be due
to influences other than these fixed characteristics” (p. 289). In our model, “firm”
Figure 5.
(
a
) Correlation matrix between ESG overall score and the explanatory variables. (
b
) Corre-
lation matrix between ESG pillar scores and the explanatory variables.
Table 3. Model selection tests.
Statistic p-Value
Breusch–Pagan
Lagrangian test
18.1855 ***
(LM Statistic) 0.0027
Hausman test 54.5311 ***
(Chi-squared) 0.0000
*** Significantly different from zero at 1% level.
Subsequently, we applied the Hausman test to determine the appropriateness of the
method used to estimate our model. According to [
50
], the critical issue in deciding whether
to use fixed effects (FE) or random effects (RE) is whether we can plausibly assume the FE
method is uncorrelated with all covariates. Following what [
51
] stated, the null hypothesis
of this test implies that the preferred model is RE. Moreover, rejecting the null hypothesis
establishes that the FE method is selected.
According to Table 3, as the null hypothesis is rejected, under a significance level
of 5%, the RE model will violate the Gauss–Markov theorem and end up with biased
and inconsistent estimates. Therefore, we applied an FE model, which is unbiased and
consistent. According to [
52
], “the key insight for the FE model is that if the unobserved
variable does not change over time, then any changes in the dependent variable must be
due to influences other than these fixed characteristics” (p. 289). In our model, “firm”
represents the entities or panels (i), and “year” represents the time variable (t). To control
the impact of the macroeconomic changing conditions on all firms, we included time
dummy variables for 2018 and 2019.
4.3. Model Results
This section employs the Fixed Effect model estimators to present the results. We
estimated both models using a panel ordinary least squares (OLS) algorithm that includes
entity effects, which controls for factors that differ across entities but are constant over
time. Moreover, we controlled for constant variables across entities that varied over time
by including time-fixed effects. Additionally, clustered covariance of the entities was used
to address correlation across time.

Sustainability 2022,14, 5012 10 of 15
4.3.1. ESG Overall Performance and Cost of Capital
According to Table 4, all the variables included, except profitability (ROA), are sta-
tistically significant, at least at the 10% level, against a two-sided alternative. Regarding
the joint F-test for the significance of all the variables, we get a p-value of approximately
zero (0.0000). Thus, our variables are jointly significant, although the ROA is individually
insignificant. The R-squared given in Table 3is based within the transformation. It is
interpreted as the time variation in the dependent variable, which implies that 40.13% is
explained by the time variation in the explanatory variables.
Table 4. Fixed effects regressions result in the cost of capital.
Variable (1) (2)
Constant 0.0065
(0.0614)
0.0129
(0.0615)
PBR −0.0321 ***
(0.0056)
−0.0323 ***
(0.0055)
ROA 0.0328
(0.0252)
0.0315
(0.0250)
LR −0.0017 **
(0.0008)
−0.0017 *
(0.0009)
TA 0.0149 *
(0.0080)
0.0146 *
(0.0080)
ESG −0.0006 **
(0.0003)
GPS −0.0003 **
(0.0001)
SPS −0.0000
(0.0002)
EPS −0.0003
(0.0002)
Year 2018 0.0143 ***
(0.0023)
0.0142 ***
(0.0023)
Year 2019 −0.0075 ***
(0.0021)
−0.0076 ***
(0.0021)
R-squared 0.4013 0.4044
F-statistic (robust) 20.849 *** 16.797 ***
Number of observations 606 606
Note: Numbers in parentheses are standard errors. * Significantly different from zero at 10% level. ** Significantly
different from zero at 5% level. *** Significantly different from zero at 1% level.
Regarding the relationship of interest, the overall ESG score negatively influences the
cost of capital. Thus, holding other variables constant, for a unit increase in the overall ESG
score, the cost of capital is expected to decrease by 0.0006.
Interestingly, the estimated effect of the firm size (natural logarithm of TA) is substan-
tially smaller than the ESG effect. For a 1% increase in a firm’s size, the cost of capital is
expected to increase by 0.00006439 (0.0149 ×log(1.01)), ceteris paribus.
However, the firms’ growth opportunities coefficient (measured as the natural log-
arithm of the market-to-book ratio) shows that for a 1% increase in a firm’s growth op-
portunities, the cost of capital is expected to decrease by 0.0001387 (0.0321
×
log(1.01)),
holding all other variables constant. Finally, LR has a negative impact on the cost of capital.
Specifically, holding all other factors constant, a unit increase in LR will decrease the cost
of capital by 0.0017. Regarding the time dummy variables, we observe a positive impact
on the contextual conditions in 2018 and a negative impact on the conditions in 2019. In
addition, the error term includes only things that vary over time.
4.3.2. ESG Pillar Scores and Cost of Capital
Table 4presents the model results for the ESG pillar scores using the same control
variables. The model has a within R-squared of 40.44%, which is a slight improvement in

Sustainability 2022,14, 5012 11 of 15
the percentage variation in the dependent variable explained by the time variation in the
explanatory variables. Regarding the joint F-test for the significance of all nine variables,
we obtained a p-value of approximately zero (0.0000). Therefore, our group of variables is
jointly significant, although ROA, Social Pillar Score (SPS), and Environmental Pillar Score
(EPS) are individually insignificant.
As mentioned before, the Social and Environmental pillar scores are not statistically
significant in explaining the dependent variable. By contrast, the Governance pillar score
shows a significant and negative relationship with the independent variable. For a unit
increase in the overall GPS score, the cost of capital is expected to decrease by 0.0003,
holding other variables constant. Similar to the earlier results, the estimated effect of firm
size (natural logarithm of TA) is substantially smaller than the previous variable. For
a 1% increase in a firm’s size, the cost of capital is expected to increase by 0.00006309
(0.0146 ×log(1.01)), ceteris paribus.
Firms’ growth opportunities coefficient (measured as the natural logarithm of the
market-to-book ratio) shows that for a 1% increase in a firm’s growth opportunities, the
cost of capital is expected to decrease by 0.0001395 (0.0323
×
log(1.01)), holding all other
variables constant. Finally, the results confirm that LR has a negative impact on the cost of
capital. Specifically, holding all other factors constant, a unit increase in financial leverage
will decrease the cost of capital by 0.0017. Finally, regarding the time dummy variables,
there is a positive impact on the contextual conditions in 2018 and a negative impact on the
conditions in 2019. The error term includes only variables that change over time.
The initial hypothesis of a negative relationship between ESG and cost of capital (H1)
is supported. In the second regression, the negative relationship between the Governance
pillar score and cost of capital (H2.3) is also supported. A comparison of the magnitude of
the impacts between ESG and GPS shows that the individual influence of the GPS pillar
score is superior to the effect of all the ESG Pillar scores combined. Moreover, we could
not find sufficient evidence to support hypotheses H2.1 and H2.3 since the relationships
between the cost of capital and EPS and SPS variables are not statistically significant. It
would be vital for further research on this topic to explore the relationship between these
ESG pillar scores and the cost of capital.
5. Discussion
We examined the relationship between overall ESG scores and the cost of capital in
LatAm firms. As we reviewed in Section 2, studies on sustainability have reported that
there is a significant and negative impact of sustainable practices on the cost of capital
or any of its pillars [
13
,
27
,
38
,
39
]. Along the same line, we found that LatAm firms with
higher ESG scores benefit from a lower cost of capital. Based on our results, our findings
corroborate literature claims that firms that praise sustainability have a higher valuation
and a lower risk.
There may be some valid arguments for explaining why sustainability could reduce
the cost of capital. On one hand, as found by [
18
,
25
], investors are interested in managing
sustainability issues in the firms they invest in. Managers who do not deal with environ-
mental, social, and governance issues are expected to undergo restricted access to private
equity with a higher cost of capital. Showing the evaluations of this kind of matter to the
market would mean better access to capital. On the other hand, higher ESG scores could be
explained by regulations in the market that lead to better sustainable practices. This would
have a negative effect on systemic risk (i.e., less risk), translating into lower costs of capital.
If sustainability reduces the cost of capital, then sustainable firms may be counter-cyclical.
It would be interesting to see whether this kind of situation could happen in the context of
LatAm markets.
Secondly, we examined the relationship between each ESG pillar score and the cost of
capital in LatAm firms. We found evidence that there is a negative relationship between
the Governance Pillar score and the cost of capital. In other words, our results highlight the
contribution of Governmental practices to lowering the cost of capital. Our results agree

Sustainability 2022,14, 5012 12 of 15
with [
43
], who emphasizes the importance of improving corporate governance to achieve
an appropriate balance between sustainability, competitiveness, productivity, and financial
and non-financial performance.
Access to equity information has improved over the past decade, and as a result, firms
have become more transparent. Following the advent of the financial scandals that shattered
the business world, the impact of ESG on the cost of capital has gained interest. Therefore,
a corporate government that shows commitment and improvement of transparency and
accountability within existing systems will be recognized by stakeholders. Furthermore,
as found by Ref. [
38
], ESG issues impact reputation, and Ref. [
41
] showed that they are
related to changes in the cost of capital. With this in mind, there could be a situation where
market risk increases due to a political or economic crisis; therefore, reputation is affected.
This could be due to possible immoral or inadequate governance actions in response to
the situation mentioned. If that were the case, firms with sound governance policies (i.e.,
higher scores on the Governance Pillar score) would be considered less risky and, thus,
have a lower cost of capital.
Regarding the effect of the environmental and social scores, we did not find statistical
evidence of a relationship between them and the cost of capital in LatAm countries. How-
ever, it is vital to continue the research on the possible relationship between pillar scores
and the cost of capital to disseminate better the effects of aligning social and environmental
aspects with a company’s core business. Thus, firms will be able to identify new business
opportunities leading to an increase in corporate value.
As discussed in Section 3, we included four variables that, according to the literature,
could significantly impact the cost of capital and, therefore, be used as control variables.
The statistical results show that three of these four variables significantly affect the cost of
capital. The results also show a negative and significant relationship between the financial
leverage ratio and the cost of capital, implying that capital structure decisions inherently
affect the firms’ cost of capital. The control variable, denoted as the natural logarithm of
the market-to-book ratio, also shows a negative and significant relationship with the cost of
capital, which indicates that the cost of financing decreases for a firm with higher growth
opportunities and lower distress risk.
On the other hand, differently from what was performed by [
15
], the ROA does not
show a significant relationship with the cost of capital in our model.
Overall, it is not clear-cut which mechanisms lead to the relationships found between
ESG scores and the cost of capital. Some thoughts were discussed during this section,
but there can be many different sources that can explain them. These open the door to
a broad research field that will drive us to understand what markets are most valuable
regarding sustainability practices. However, there is also the opportunity to find which
other issues may have a chance to be more valued both by the firms and investors to fulfill
their objectives while contributing to a more sustainable society.
6. Conclusions
The relationship between the cost of capital and the ESG Pillar scores has not been
extensively explored, especially in emerging markets. Therefore, we fill this research gap
by studying the relationship between ESG Pillars scores and the cost of capital in LatAm.
This paper makes several contributions to the existing literature. First, one remarkable
finding of the present study is that the empirical results, which are based on the FE
regression model, indicate that the overall ESG score is negatively related to the cost of
capital of LatAm firms. From the firms’ perspective, this relationship suggests that the
greater the ESG practice, the lower the economic price of the firm for attracting capital
to the firm. Second, since ESG scores are derived from three pillars—Social, Governance,
and Environmental—we also examine the individual effects of each pillar score on the
cost of capital. From this analysis, we find that governance practices explain the negative
relationship between ESG scores and the cost of capital. This indicates that the increase in
transparency about internal processes and governance entities can be an essential driver

Sustainability 2022,14, 5012 13 of 15
of value creation for firms and higher investor confidence. Thus, based on these results,
executives of LatAm firms can direct part of their decisions toward the adoption of more
efficient and sustainable ESG practices, especially corporate governance. These actions
would allow for increased visibility and stakeholder recognition. There are also implications
for managers and policymakers.
Finally, researchers and professionals may use the present study’s findings to broaden
the central aspects of ESG related to financial performance and cost of capital. Moreover,
implementing incentives that highlight the importance and promote ESG practices would
contribute to sustainability and the competitiveness of organizations in the region.
Despite the contributions of the present study, it has some limitations. First, only
a limited sample of LatAm firms and years are considered. Because ESG scores were
introduced recently, the number of firms in the region that have this information is restricted.
However, to the best of our knowledge, this paper contributes to the body of knowledge
and practice by analyzing the relationship between ESG scores and the cost of capital in
LatAm. Second, data were obtained from secondary sources. Although the variables used
are employed in the literature, it is advisable to use direct financial information from the
firms. It would be interesting to conduct a future study where more firms from more
countries are involved. The present results can be contrasted with others that employ
variables from different sources of information.
Thus, to better understand the relationship between ESG scores and financial results,
it is essential to analyze specific variables such as gas emission, board gender diversity,
independent board members, sustainability compensation incentives, human rights, and
workforce. These issues should be addressed in future research.
Author Contributions:
A.G.R., J.M. and J.D.G.-R. conceived and designed the experiments, analyzed,
and interpreted the data. P.A. and A.P. performed the experiments and interpreted the data. All
authors have read and agreed to the published version of the manuscript.
Funding: This research received no external funding.
Data Availability Statement:
The study data are available on special request from the correspond-
ing author.
Acknowledgments:
We would like to thank the editorial team and anonymous reviewers who
contributed to improving this paper’s quality. They help us to improve the significance of the paper.
Conflicts of Interest: The authors declare no conflict of interest.
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