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SAMPJ
14,6
1242
Received 27 July 2022
Revised 15 January 2023
19 March 2023
16 May 2023
Accepted 22 May 2023
Sustainability Accounting,
Management and Policy Journal
Vol. 14 No. 6, 2023
pp. 1242-1267
© Emerald Publishing Limited
2040-8021
DOI 10.1108/SAMPJ-07-2022-0396
Cost of capital and firm
performance of ESG companies:
what can we infer from
COVID-19 pandemic?
Miranda Tanjung
Management Department, BINUS Business School, Bina Nusantara University,
Jakarta, Indonesia
Abstract
Purpose – Studies on sustainable finance examine how it is interrelated with economic, social, governance
and environmental issues. Using financial data on publicly traded firms in Indonesia, this study aims to
explore the interplay between the cost of capital, firm performance and the COVID-19 pandemic.
Design/methodology/approach – This study uses firm-level data sets of publicly listed firms from 2012
to 2021. The regression analysis reported in the study includes the Driscoll–Kraay estimator, propensity score
matching model and fixed-effects regression.
Findings – The study revealed three significant findings. First, on average, non-environmental, social and
governance (ESG) companies’ cost of capital is lower than that of ESG firms. Second, ROE in ESG enterprises
is significantly impacted by capital costs. Third, the cost of capital has a negative impact on the market value
(Tobin’s q) of non-ESG firms. The study specifically shows that after accounting for the pandemic, ESG firms
did not benefit during the troubled COVID-19 crisis after controlling for the pandemic dummy years of 2020
and 2021. These results indicate that the adoption of green or sustainable finance is still in its infancy and that
the sector requires more time to establish an enabling environment.
Research limitations/implications – This study benefits from capital structure and ESG theories. It
supports the argument that the debt utilization ratio is still relevant to a company’s value because it affects its
financial performance. Moreover, adopting ESG principles helps businesses survive crises. Thus, the analysis
confirms the superiority of ESG-based firms.
Practical implications – This study draws two conclusions. First, the results could be a reference for
academics and practitioners to understand the effect of pandemic-related crises on a firm’s capital structure
and performance. In terms of survival during a crisis, such as the COVID-19 pandemic, this study
demonstrates how firms with strong ESG may perform differently than those without ESG. Second, this
study supports the need for an empirical study and examination of the development of sustainable finance in
the country while considering setbacks.
Social implications – The results should be of interest to policymakers who focus on the ESG market and
academics conducting ESG-related research on emerging markets.
Originality/value – This study contributes to the literature by establishing empirical evidence on the
relationship between the cost of capital and firm performance of ESG- and non-ESG-rated enterprises in the
Indonesian setting while controlling for the impact of the pandemic.
Keywords Sustainable finance, Cost of capital, Environmental, social, and governance (ESG),
Capital structure
Paper type Research paper
The author benefited significantly from the useful comments and suggestions of three anonymous
reviewers. The author is grateful to the Editor-in-Chief and the Associate Editor of the journal. The
author also would like to thank the reviewers of LKISSK Bank Indonesia 2022 for their constructive
comments and feedback.
Conflict of interest: The authors declare no conflict of interest.
1. Introduction Cost of capital
Sustainable finance examines how finance (investment and lending) is related to economic, and firm
social and environmental issues. The economy and society were tested for resilience during
the crisis. Likewise, sustainability was tested during a crisis and the COVID-19 pandemic.
performance
The pandemic is unique in several respects, as it is exogenous, uncertain and global (Borio,
2020). The author was encouraged to analyze the scant research on the Indonesian setting;
capital structure; environmental, social and governance (ESG); COVID-19 and its
implications. The goal is to identify substantial differences in the cost of capital and the
1243
impact of the pandemic on enterprise performance, particularly in two groups: ESG
enterprises and non-ESG firms.
Previous studies conducted between 2020 and 2021 addressed the impact of the COVID-
19 crisis on global health, economic and social conditions; however, little is known about the
impact of the pandemic on financial performance differences between ESG and non-ESG
firms in emerging countries such as Indonesia. According to earlier data, high-ESG
enterprises have a lower cost of capital (Gholami et al., 2022), and ESG information and
disclosures negatively impact the cost of capital (Ng and Rezaee, 2015; Raimo et al., 2021).
Other studies on the corporate social responsibility dimension investigated the relationship
between firm value and CSR during the pandemic (Qiu et al., 2021). Hence, this study aims to
fill the deficiencies in the scant literature on Indonesian enterprises regarding the impact of
the pandemic on the relationship between the cost of capital and a firm’s financial
performance.
Specifically, this study investigates the relationship between company performance and
the weighted average cost of capital. In addition, it examines whether there are any
significant variations in how superior and inferior ESG performers are affected by the crisis
and the cost of capital. The conclusions serve as the basis for discussions and assessments
of how the cost of capital may impact the performance and sustainability of a firm in the
context of the Indonesian market. While there is existing research on this subject, it mainly
focuses on developed markets, with only a brief mention of Indonesian firms. Notably,
although this study’s objectives and results are in line with those of earlier empirical studies,
their importance and points of view are novel.
The investigation of the relationship between the WACC and the performance of ESG
and non-ESG firms during COVID-19 distinguishes this study from earlier studies. The
conclusions build on the knowledge gaps and may help future research in this area.
The remainder of this paper is structured as follows. Section 2 reviews the theoretical
foundations and previous empirical studies. Section 3 explains the data set and techniques
used in the study. Section 4 provides the findings of the empirical analysis. Finally, Sections
5 and 6 present the study’s discussion, conclusion, limitations and policy implications.

2. Literature review and hypotheses development

2.1 Green index in Indonesia
SRI–KEHATI is a sustainable and responsible investment (SRI) stock index published on
June 8, 2009, as a result of cooperation between the Indonesia Biodiversity Foundation
(KEHATI Foundation) and the Indonesia Stock Exchange (IDX). This stock index is used as
a measure of the Indonesian stock market development. Because the index plays a
significant role in Indonesia’s financial climate, investors and investment managers
frequently use it as a benchmark for constructing investment portfolios. Investors and
investment managers analyze public firms using SRI–KEHATI. Companies with strong
economic, social and environmental sustainability are also worthy of investment.
SAMPJ The SRI–KEHATI index is Southeast Asia’s first green investment index and the second
14,6 green investment index in the Asian market. Twenty-five companies were integral elements
of SRI–KEHATI. The issuer selection procedure was conducted in April and October of each
year. The IDX then published the names of issuers who passed the screening on its website,
www.idx.co.id. In addition, the issuer was permitted to create a subsequent SRI–KEHATI
index. To become a constituent of SRI–KEHATI, a publicly traded corporation must
1244 complete the following three selection steps: the component selection procedure for SRI–
KEHATI includes three criteria:
(1) the selection of the primary business element;
(2) the financial aspect; and
(3) the corporation’s basic evaluation (e.g. corporate governance, environment, society
participation, business behavior and human rights).

The IDX and KEHATI Foundation are responsible for the daily operations and
administrative procedures of the SRI–KEHATI index. In addition, the KEHATI Foundation
created a separate committee to manage the SRI–KEHATI index. The committee serves as
an advisory group for the selection and preparation of constituents. The purpose of
establishing the SRI–KEHATI index is to promote sustainable business practices for all
financial market players based on sound financial and sustainability considerations. The
SRI–KEHATI index’s functioning pattern is determined by global investment trends as
investors and market players increasingly consider not only economic but also social,
environmental and sustainable development principles. These factors heavily affect
investment decisions.
To compare ESG-rated firms, Group 2 comprises IDX30-rated public corporations. In the
regression model, Group 2 was coded as a dummy variable of 0. The dummy variable for
ESG firms is set to 1. The IDX30 tracks the stock price performance of the 30 most liquid
and market-capitalized Indonesian firms. Furthermore, companies have strong business
performance. The IDX30 is a popular index that acts as a benchmark for index-based mutual
funds and stock-based exchange-traded funds. Every six months, the IDX adjusts the
weighting and evaluation of the index, as well as the issuers entering and exiting the IDX30 list.
The evaluation is valid from February to July and August to January of the following year.

2.2 Theoretical review and hypothesis development

To examine the financial performance of the selected companies, we use three proxies:
return on assets (ROA) to assess profitability, Tobin’s q to measure a firm’s worth and the
revenue-to-total-assets ratio to reflect business efficiency. As indicated in the first part of
this work, we select two firm data sets comprising ESG and non-ESG enterprises to evaluate
the regression model for each group (Groups 1 and 2).
2.2.1 The nexus between cost of capital and firm performances. The cost of capital for a
company is influenced by its capital structure, which consists of debt, equity and retained
profits. Popular theories on optimum capital structure include the trade-off theory (Brennan
and Schwartz, 1978; Hackbarth et al., 2007), pecking order theory and asymmetric
information theory (Frank and Goyal, 2003; Jensen and Meckling, 1976; Myers and Majluf,
1984). According to the trade-off hypothesis, the optimal capital structure is determined by
weighing the costs and benefits of borrowing. According to the extant literature (Brennan
and Schwartz, 1978; DeAngelo and Masulis, 1980), the fundamental benefit of debt is the tax
shelter it offers. This is because the interest paid to lenders is deducted from the company’s
gross income before computing the tax.
 However, costs associated with debt, such as liquidation and bankruptcy fees, must also Cost of capital
be considered. Previous research weighed the benefits and drawbacks of debt to determine a and firm
company’s optimal capital structure. Chang and Rhee (1990) built on this concept, arguing
that the interaction between corporate tax and various income tax rates on interest and
performance
dividend income shapes an enterprise’s capital structure. As a result, trade-off theory
determines the optimal gearing ratio at which the WACC for the entire firm drops to the
lowest feasible level. Several empirical studies have tested the trade-off theory (Dierker et al.,
2019; Fama and French, 2002; Frank and Goyal, 2008).
1245
In the pecking order theory, Myers and Majluf (1984) and Myers and Majluf (1984)
contended that corporations would pay loans and internal equity first, followed by external
equity, to finance company development. According to this theory, asymmetric information
problems exist between agents and investors, with equity concerns presenting a greater
challenge than debt issues. This is because managers are more knowledgeable than outside
investors, who spend capital without actively participating in the management process.
Before investing in a company, investors would wish to account for this asymmetric
knowledge problem, and stocks will be discounted more than debt in the future. Finally,
companies rely on their equity to prevent discounts. Consequently, they use equity when
their financing is exhausted. As a result, companies attempt to issue money in a structured
manner. As debt issuances become more expensive, businesses opt to use retained earnings
instead. Thus, businesses use equity once all available financing is used.
The literature on corporate finance also includes asymmetric information theory.
According to this notion, firms can use their capital structure as a market signaling device.
Previous studies [see Ahmad et al. (2021) and Bharath et al.(2009)] demonstrated that
asymmetric knowledge between business players might influence the capital structure of
corporations. Empirical findings on the mix of debt and equity in capital structures are
inconclusive. On the one hand, businesses with greater debt levels are judged to be of higher
value than those with lower debt levels. This is reasonable given that companies with a
steady income stream may easily satisfy their interest commitments on schedule. Firms
with unpredictable or seasonal earnings are more susceptible to financial difficulties and
greater bankruptcy risk. However, other studies have suggested that a high gearing ratio
may be detrimental to a company’s performance and financial measures (Campello, 2006).
These two opposing pieces of evidence may benefit businesses by controlling their
upcoming capital supply through signals.
Owing to the COVID-19 outbreak, the global economy has been thrown into a state of
uncertainty. In March 2020, the World Health Organization announced that COVID-19 had
reached pandemic proportions, which shocked governments, public health systems,
businesses and financial markets (Gautam and Hens, 2020; Sohrabi et al., 2020).
Governments worldwide are being pushed to make choices that will affect the world in the
coming years, including dealing with the pandemic’s immediate effects and long-term
repercussions. No country was fully prepared to face the global pandemic, and Indonesia
was no exception.
For Indonesia, the biggest economy in Southeast Asia, the pandemic shook not only the
public health service system but also the economy. The economic impact of the COVID-19
outbreak can be divided into several categories:

a drop in consumer spending on goods and services, vulnerabilities in the private
sector, higher indebtedness and corporate failures (IMF, 2022);

supply chain disruptions (Chowdhury et al., 2021); and

a decline in global capital market investments and stock prices (Harjoto et al., 2021).
SAMPJ These consequences are relevant to uncertainty, liquidity and market efficiency theories.
14,6 The pandemic has damaged the global economy, causing uncertainty in economic
activities, such as investment and financing (Altig et al., 2020). According to the uncertainty
theory, investors may perceive greater risks during uncertain circumstances, which can
result in a higher cost of capital. Due to the increased risk of default, investors demand a
higher risk premium in exchange for a higher return on investment (Li et al., 2018). The
1246 pandemic has caused illiquidity in the market. Financial markets experienced a liquidity
crisis during the outbreak – investors had trouble selling their assets quickly without heavy
losses. This can lead to a higher cost of capital because investors require a higher return on
their investments to compensate for the liquidity risk (Komalasari et al., 2021; Nguyen et al.,
2021).
Businesses also face challenges in 2020–2021 due to sluggish consumer demand and
dismal sales forecasts. Creditors and financial institutions are worried about their
lenders’ financial and credit performance, as the market efficiency theory projected.
Creditors should anticipate risks by adjusting the required rate of return on their
investments. This was reflected in the higher cost of capital imposed on new loan
applications and the weakening of banking stability throughout the COVID-19
outbreak (Alghifari et al., 2022; Elnahass et al., 2021). Therefore, this study proposes the
following research questions. What is the link between the cost of capital and financial
performance during the COVID-19 crisis? Does the cost of financing vary significantly
between ESG-rated and non-ESG-rated firms?
Researchers have extensively tested the hypothesis that a firm’s cost of capital
significantly affects its financial performance. However, these results were inconclusive.
It has been established that the costs of debt and equity have negative, positive or no
effect on a company’s profitability. Studies have also examined whether crises affect
firms’ total leverage ratios and capital structures (D’Amato, 2020; Demirgüç–Kunt et al.,
2020).
The identification of a company’s ideal debt and capital structure has been a subject of
dispute, with academics and business players providing divergent solutions for the optimal
and least expensive costs of capital. The accompanying section underlines the significance
of the cost of capital for business organizations. In this regard, the question of determining
the effect of the cost of capital on the economic performance of ESG-rated and non-ESG-
rated enterprises has not yet been adequately examined, particularly in Indonesia. This
study seeks to prove that integrating ESG pays off as organizations function with less
expensive capital. Thus, we propose the following hypothesis:

H1. A lower cost of capital will increase a firm’s profitability ratio.

Considering the preceding statement, this study explores the relationship between the cost
of capital and company efficiency, as measured by the asset turnover ratio. However,
literature addressing this issue is limited, particularly in the context of Indonesian firms. A
company cannot start growing or expanding without assets that generate profits through
sales. These assets serve as benchmarks for a company’s sustainability and market
competitiveness. In contrast, the composition of assets and capital are inextricably linked.
Companies cannot borrow money without solid or productive assets. When deciding
whether to lend money, creditors prefer borrowers who can provide valuable physical assets
(Bae and Goyal, 2009). The efficiency of a business may be determined by how well it uses
its resources to increase stakeholder returns. The asset turnover ratio is an essential
financial measure used to evaluate managerial effectiveness. Therefore, we anticipate a
negative correlation between capital costs and asset turnover. In this example, the following Cost of capital
hypotheses were tested: and firm
H2. A lower cost of capital will increase a firm’s efficiency ratio. performance
2.2.2 Cost of capital and firm value. Following Atan et al. (2018), Tobin’s q was used to test
the impact of the WACC on company value. The theoretical and empirical relationships
between corporate financial sustainability and capital structure have been the focus of many 1247
scholarly studies. Discussions have concentrated on whether there is an optimal capital
structure for each company (Chen et al., 2014) and whether the debt utilization ratio is
important or irrelevant to the value of the company (Graham and Harvey, 2001)
Modigliani and Miller (1963) proposed two theories for ideal financial market conditions.
First, a company’s value is independent of its capital structure. The second asserts that the
cost of equity for a leveraged company is equivalent to the cost of equity for an unleveraged
company plus a financial risk premium. In addition, trade-off theory (Myers and Majluf,
1984), pecking order theory (Myers and Majluf, 1984) and agency cost theory (Jensen and
Meckling, 1976) contend that if capital structure decisions are irrelevant in a perfect market,
then deficiencies in the real world can be used to justify their significance. From this
perspective, the cost of capital determines a company’s value (Chowdhury and Mavrotas,
2006). The objective of the decision between debt and equity is to determine the capital
structure that maximizes stockholder wealth. The cost of capital is used to ascertain a firm’s
worth by discounting its future cash flows. Accordingly, a firm’s value is maximized if its
WACC is kept at a minimum (Bruner et al., 1998). Therefore, we propose the following
hypothesis:

H3. A lower cost of capital will increase firm value.

2.2.3 Cost of capital of environmental, social and governance firms and non-environmental,
social and governance firms. A well-established research subject that academics have
questioned over the past decade is the financial rewards of corporations using corporate
social programs. Several studies have stressed the significance of showing that better ESG
sustainability performance is correlated with better financial results. The importance of
ESG concerns in businesses has been widely debated among investors. Investors would
argue that a higher ESG rating benefits a company if it means less agency friction, less
information asymmetry, fewer regulatory and legal risks, more customer loyalty and a
better corporate image.
Based on Friede et al. (2015), most empirical data support the notion that ESG has a
beneficial influence on financial performance. According to Ferrell et al. (2016), businesses
that participate in greater CSR activities have fewer agency issues and less corporate
resource waste. Cassely et al. (2021) hypothesized that CSR participation might assist
businesses in mitigating the negative effects of economic crises. Similarly, Harjoto et al.
(2015) concluded that CSR activities are connected to improved internal and external
corporate governance. In another study, Deng et al. (2013) demonstrated that strong CSR
acquirers in M&A events receive better merger announcement returns and boost long-term
operating performance postmergers.
The opposing viewpoint contends that ESG damages shareholder value. ESG
investments divert precious resources, and companies with high ESG ratings face agency
issues. Managers engage in CSR for their gains at the expense of shareholders (Krüger,
2015). Moreover, several studies suggest that the advantages of CSR efforts for stakeholders
come directly from the price of business value (Chahine et al., 2019; Manchiraju and
SAMPJ Rajgopal, 2017), future profitability (Chen et al., 2018) and higher cost of equity (Dahiya and
14,6 Singh, 2020). Others provide evidence to support the claim that leaders of major firms
receive private rewards for investing in CSR (Barnea and Rubin, 2010).
The empirical research on the link between ESG and business value is contradictory,
leaving this question largely unresolved. Although theoretical research on this issue is
scarce, a few recent publications imply that superior ESG performance is associated with a
1248 reduced cost of capital. Pastor et al. (2021) developed a general equilibrium investing model
based on ESG criteria. Green assets have negative CAPM alphas due to investor preferences
for green holdings; however, green assets can outperform brown assets when the ESG
component performs well. Thus, outperformance may encourage corporations to undertake
green real investments with good social externalities. Derrien et al. (2021) showed that poor
ESG ratings negatively influence a company’s earnings estimate. Irawan and Tatsuyoshi
(2021) revealed that ESG ratings have a considerable beneficial effect on business
valuations. The authors present evidence that poor ESG ratings have a detrimental impact
on a company’s profit estimates. Another study revealed a strong beneficial effect of ESG
ratings and disclosures on firms’ cost of capital (Wong et al., 2021). Thus, the following
hypothesis is proposed:

H4. ESG firms have a lower cost of capital than non-ESG firms.
2.2.4 Crisis, cost of capital and firm performances. Research is relatively limited concerning
the specific importance of ESG performance during times of crisis. However, the global
financial crisis of 2008–2009 and the COVID-19 pandemic crisis of 2020–2021 have provided
some insights. Broadstock et al. (2020) discovered that US nonfinancial companies with high
ESG ratings had superior financial success over other companies over time. Using the
Refinitiv and MSCI environment and social data sets, Albuquerque et al. (2020) and Garel
and Petit-Romec (2020) examine the link between a firm’s stock return and its environmental
and social performance in the context of the COVID-19 pandemic. In light of this, the
following question is asked:

Q1. Did the 2020 and 2021 pandemics affect financial performance?
Because empirical data across nations and industries appear equivocal, this study uses
Indonesian ESG-rated and non-ESG-rated public enterprises as samples to evaluate whether
the pandemic has a substantial effect on corporate performance. Based on this premise, this
study investigated the following hypotheses:

H5. Crisis has a detrimental effect on a firm’s financial performance.

2.2.5 Would environmental, social and governance help to reduce costs? As shown in the
preceding section, the research suggests that there are benefits to having a strong ESG
organization due to the firm’s efforts and desire to include all three components of the
environment, social and governance into a short- and long-term plan. Based on this nexus,
this study anticipates that being an ESG business has a moderating effect on the linkages
between a firm’s financial performance and the cost of funding. Fundamentally, the present
study empirically explores the moderating effect of ESG on a business’s cost of capital and
whether this moderating effect results in greater firm efficiency, profitability ratio and
value. Unfortunately, no existing research has analyzed the moderating effect of ESG on the
cost of capital and the financial performance of Indonesian enterprises.
Nevertheless, the literature has identified a negative link between ESG disclosure and the
cost of capital in the Italian market (Gjergji et al., 2021), while other studies have reported the
cost-benefit dimension of ESG on the cost of equity (Dhaliwal et al., 2011; Ng and Rezaee, Cost of capital
2015). Breuer et al. (2018) reported that stronger CSR performance decreases firms’ cost of and firm
equity in countries with strong investor protection, whereas countries with weak investor performance
protection and CSR disclosures increase it. Another study examined the moderating effect of
a company’s debt ratio on the relationship between the cost of capital and corporate social
responsibility (Yeh et al., 2020). Chouaibi et al. (2022) examined the moderating influence of
social and ethical behaviors on the association between environmental disclosure and 1249
financial success. Therefore, the authors suggest that empirical research is required to
further investigate the function of consistent ESG implementation in times of crisis by
assisting corporate entities to achieve more profit and value while maintaining a lower cost
of capital.

H6. Being an ESG firm strengthens the relationship between the cost of capital and firm
performance.

3. Data and methodology

3.1 Construction of the data set
Databases extracted from SRI–KEHATI and IDX30 were used as the basis for the study
sample. As one of the aims of this study is to investigate the impact of the pandemic in
2020–2021, firm-level data from 2012 to 2021 were used. Financial data from the IDX and
corporate websites were derived from numerous sources. The sample comprises 25 firms
from the SRI–KEHATI index and 28 from the IDX30, which were extracted from
Bloomberg. Therefore, the data collection contained 580 firm-year observations when using
the methodology.
To evaluate the hypotheses, the study analyzes two sets of companies: those included in
the ESG index and those not listed in the ESG index. The data set coded as Group 1 consists
of 25 enterprises assessed in the ESG-based index of the IDX, while Group 2 comprises large
corporations rated by the IDX30. First, it examines whether there are substantial differences
in the influence of the cost of capital on the relative performances of Groups 1 and 2. Second,
this study examined the effect of the pandemic in 2020–2021 on the performance of these
firms by running different regression models on the two groups. Table 1 provides the
descriptive statistics and descriptions of the variables.

Variable Definition Mean SD Min Max

COC Firm’s weighted average cost of capital (%) 9.36 5.17 1.69 41.45
ROA Ratio of net earnings after tax over total assets 7.729 9.792 16.63 48.78
Efficiency Ratio of revenues over total assets 0.667 0.550 0 2.84
TQ Tobin’s q (ratio of market value to total asset) 0.731 0.309 0.11 1.93
Dummy_ESG “1” for ESG, “0” otherwise 0 1
Dummy_COVID “1” for year 2020–2021 and “0” otherwise 0 1
Debt Total debt 9.276 13.271 0 75.106
Equity Total equity (in billion IDR) 23.7 0.966 21.289 25.998
Rev Revenues (in billion IDR) 29.665 36.867 1.002 239.205
Size Total assets (in billion IDR) 113.044 252.783 0.08221 1,725.611
Age Total assets of the firm (in billion IDR) 49.78 33.645 1 162
Table 1.
Source: Created by author Descriptive statistics
SAMPJ 3.2 Measurement of variables and model specifications
14,6 The independent variable was the cost of capital (derived using the weighted average cost of
capital estimate) from 2012 to 2021. The cost of capital proxied by the WACC is a
fundamental concept in corporate finance (Farber et al., 2006). The basic explanation is easy
to understand; it involves simply averaging the cost of capital arising from stocks and debt.
This work focuses on the tax shield valuation, developing a universal method that applies to
1250 any debt structure; thus, the formula is as follows:
 
WACCi ¼ weightd * kd * ð1  tÞ þ ½ke * we 

where wd is the percentage of interest-bearing debt participation in total capital; kd is the

rate of interest-bearing debt cost before tax; we is the percentage of common equity
participation in total capital; ke is the cost of equity; and t is the corporate tax rate.

3.3 Regression model for the tests

3.3.1 Propensity score matching model. This study examines whether ESG-rated enterprises
have a lower cost of capital than non-ESG-rated ones using the propensity score matching
(PSM) model with the STATA-based command psmatch2. A nonexperimental PSM method
by Rosenbaum and Rubin (1983) conducted a nonexperimental PSM method. The PSM
method identified the most appropriate comparison group to close the gap between the
treated and control groups. Incorporating sufficient variables to measure treatment quality
can reduce selection bias. Theoretically, the values of the explanatory variables are
combined to pair participants in the treatment and control groups.
However, if there are many controlling variables, this combination may have a wide
range of possible solutions. As a result, the PSM method is useful because it combines all
characteristics into a single score. To test H4, we use the PSM approach to compare the
WACC of environmentally responsible and nonresponsible businesses. In the first stage, the
PSM procedure involves logistic regression to estimate the probability of being a treatment
or ESG-rated firm. Tables 2 and 3 present the regression results.
3.3.2 Fixed-effects model and Driscoll–Kraay estimator. To test these hypotheses, this
study uses two regression approaches. The first method uses the STATA-based command
xtscc, which calculates the standard error for panel regression with cross-sectional
dependency using the Driscoll–Kraay estimator (Driscoll and Kraay, 1998). Following prior
research (Le et al., 2020; Wan Mohammad et al., 2022), the method was selected because it is
heteroskedasticity consistent, and the standard error estimates are robust to general forms
of cross-sectional and temporal dependence, surpassing the shortcomings of traditional
panel data statistical approaches (Hoechle, 2007). This study also provides a fixed-effects
regression with a robust standard error for comparative analysis. The following criteria
were applied in the tests:

Variable WACC

ESG 3.582*** (0.757)

Table 2.
Observations 530
PSM estimator: ESG
and non-ESG firms’ Note: Standard errors in parentheses: *** p < 0.01
cost of capital Source: Created by author
Variables ESG
Cost of capital
and firm
Rev 0.0155*** performance
0.00312
Age 0.0390***
0.0044
Constant 2.1413***
0.2234 1251
Observations 530
R-sq 0.20
Treatment assignment WACC
Treated 10.7264
Control 8.1469
Difference 2.5794
t-stat 5.91
ATT difference 2.944
t-stat 4.92
ATE difference 3.582
Treated 250 (on support)
280 (on support)

Notes: The model is generated using STATA-based command psmatch2. Standard errors in parentheses: Table 3.
***p < 0.01 Logit regression
Source: Created by author results

Firm Performancei;t ¼ ai þ a1 CoCi;t þ a2 Control Variablesi;t þ «i (1)

Following previous research (Grewatsch and Kleindienst, 2017; Nirino et al., 2021; Tanjung,
2022), the present study explores the two-way interactions between the variables.
Specifically, this study uses ESG to moderate the relationship between capital costs and firm
performance. The following interactions are accounted for in the second model:
Firm Performancei;t ¼ ai þ a1 CoC * ESG þ a2 COVID * i:Groupi;t þ an Xi;t þ «i (2)

Since the investigation requires pandemic and current business information, data sets
covering from 2012 to 2021 were obtained. Therefore, this study uses the years 2020 and
2021 as dummy variables (coded as “1”) to represent the pandemic, whereas the remaining
observation periods (2012–2019) are coded as “0.”

3.4 Robustness check

Several robustness tests were conducted. First, the analysis includes additional company-
level controlling variables such as total debt, revenues, assets and firm age. Second, this
study provides a comprehensive firm-year database, as shown in Tables 7 and 8. This was
performed to compare the results of the regressions performed on Groups 1 and 2 with the
data sample for the entire year. Finally, this study presents the results of the OLS regression
model using firm-fixed effects. These results are similar to those reported in Table 9.

4. Estimation results
4.1 Propensity score matching estimator result
The fourth hypothesis aims to determine whether ESG companies have a lower WACC than
non-ESG companies. Therefore, to find evidence, we performed a t-test and PSM model.
SAMPJ Table 1 presents the t-test results. This proves substantial differences in financing costs
14,6 between ESG-rated- and non-ESG-rated enterprises. This study estimates the PSM model
using the STATA-based command psmatch2. Figure 1 depicts the propensity score
differences between ESG and non-ESG firms (see Figure 1). Next, Table 2 presents the result
of the PSM estimator. Based on Table 2, there is evidence that ESG-based firms (the treated
firm sample) have higher costs of capital than the nontreated firm sample (non-ESG
1252 companies).
Table 3 presents the results of the logit regression using the PSM estimator. These
results are inconsistent with those from Chava (2014) and Kim et al. (2015). This study
reports that lenders penalize ESG enterprises for their ESG strategies at higher capital costs.
These findings may support the overinvestment theory (Jensen, 1986; Morgado and
Pindado, 2003). Scholars have suggested that firms may pursue unproductive and costly
sustainability and CSR initiatives to improve their reputation. These engagements waste
company resources and, as a result, financiers penalize firms with a greater cost of debt.

4.2 Cost of capital and profitability

To test H1, this study uses the financial performance of ROA as a dependent variable and
regresses the control variables and the COVID-19 dummy variable on them. The outcomes
of the fixed-effect model and the Driscoll–Kraay estimator for the firm’s ROA are presented
in Tables 4 (Models 1–2) and 5 (Models 1–2), respectively. According to Table 5, the
corporate cost of capital significantly influences assets (ROA) using the fixed-effects model
with Driscoll–Kraay standard errors (see Model 1). The regression result rejects the null

Figure 1.
Sustainable finance
roadmap Phase 2
 (1) ROA (2) ROA (3) Efficiency (4) Efficiency (5) TQ (6) TQ
Variables ESG Non-ESG ESG Non-ESG ESG Non-ESG

COC 0.122 (0.0826) 0.563* (0.315) 0.00878* (0.00454) 0.0312*** (0.0101) 0.00542* (0.00284) 0.00383 (0.00251)
Age 0.722*** (0.251) 0.00191 (0.00125) 0.0179* (0.0102) 0.000398*** (6.16e-05) 0.000396 (0.00764) 2.45e-05 (1.45e-05)
Debt 0.112 (0.0718) 0.143 (0.104) 0.00205 (0.00142) 0.00656 (0.00565) 0.00132*** (0.000430) 0.00458** (0.00202)
Rev 0.0512** (0.0246) 0.0204 (0.0542) 0.00470* (0.00243) 0.0159*** (0.00361) 0.00208** (0.000841) 0.00227* (0.00118)
Size 0.00131 (0.00306) 0.0244 (0.0604) 7.01e-05 (0.000193) 0.0105*** (0.00319) 0.000115 (7.29e-05) 0.00314*** (0.000986)
Equity 1.716 (1.063) 1.659 (1.240) 0.145* (0.0777) 0.0140 (0.0607) 0.0765*** (0.0251) 0.0457*** (0.00931)
COVID 1.582** (0.699) 4.095** (1.501) 0.0229 (0.0402) 0.0792* (0.0447) 0.0184 (0.0281) 0.00714 (0.0139)
Constant 35.21*** (8.683) 10.79 (9.835) 2.984*** (0.524) 0.342 (0.489) 0.00201 (0.358) 0.452*** (0.0810)
Observations 250 278 250 278 250 278
R-sq 0.242 0.122 0.464 0.393 0.162 0.131
No. of firm 25 28 25 28 25 28

Notes: Standard errors in parentheses: ***p < 0.01; **p < 0.05; *p < 0.1
Source: Created by author

model
using fixed-effects
Table 4.
1253
Cost of capital
and firm

Regression result
performance
 14,6

1254

estimator
Table 5.
SAMPJ

Regression results
using Driscoll–Kray
(1) ROA (2) ROA (3) Efficiency (4) Efficiency (5) TQ (6) TQ
Variables ESG Non-ESG ESG Non-ESG ESG Non-ESG

COC 0.122** (0.0450) 0.563* (0.299) 0.00878*** (0.00125) 0.0312** (0.0120) 0.00542*** (0.00152) 0.00383 (0.00280)
Age 0.722*** (0.0743) 0.00191** (0.000728) 0.0179 (0.0104) 0.00039*** (6.47e-05) 0.000396 (0.00339) 2.45e-05 (3.22e-05)
Debt 0.112** (0.0359) 0.143* (0.0757) 0.00205*** (0.000200) 0.00656** (0.00209) 0.00132* (0.000625) 0.00458** (0.00149)
Rev 0.0512*** (0.0139) 0.0204 (0.0621) 0.00470** (0.00188) 0.0159*** (0.00296) 0.00208*** (0.000635) 0.00227*** (0.000661)
Size 0.00131 (0.00328) 0.0244 (0.0468) 7.01e-05 (9.63e-05) 0.0105*** (0.00127) 0.000115* (6.25e-05) 0.00314** (0.00102)
Equity 1.716** (0.534) 1.659 (0.922) 0.145** (0.0618) 0.0140 (0.0413) 0.0765*** (0.0228) 0.0457 (0.0280)
COVID 1.582** (0.639) 4.095*** (1.185) 0.0229 (0.0293) 0.0792*** (0.0140) 0.0184* (0.00964) 0.00714 (0.00551)
Constant 35.21*** (5.447) 10.79 (10.52) 2.984*** (0.497) 0.342 (0.457) 0.00201 (0.0994) 0.452 (0.256)
Observations 250 278 250 278 250 278
No. of firms 25 28 25 28 25 28
R-sq 0.2421 0.1223 0.4642 0.3929 0.1618 0.1306

Notes: Standard errors in parentheses: ***p < 0.01; **p < 0.05; *p < 0.1
Source: Created by author
hypothesis that “There is no significant link between ROA and WACC” since it suggests a Cost of capital
positive relationship between ROA and WACC. This study demonstrates that a higher and firm
WACC improves ESG companies’ ROA. Previous studies documented debt advantages and
disadvantages regarding a firm’s optimal capital structure, including the advantage of the
performance
tax benefits of corporate debt (Chang and Rhee, 1990). Trade-off theory states a positive
relationship between leverage ratios and financial profitability. According to Hennessy and
Whited (2005) and Strebulaev (2007), a positive relationship exists between leverage ratios
and financial profitability. The trade-off theory provides an optimal gearing ratio at which 1255
the entire firm’s WACC decreases to its lowest feasible level (Dierker et al., 2019; Frank and
Goyal, 2008).
The findings of this study reflect that firms with a suboptimal capital structure in which
increased gearing levels can bring higher efficiency and profitability to the company. This
implies that Indonesian corporations have lower debt levels than expected. The positive
relationship may also be because if the equity is maintained at a constant level, the issuance
of additional debt does not immediately increase financial distress. Consequently, an
additional debt with increased financial costs is still paid off with the additional benefit of an
interest tax shield and a higher profitability ratio. However, we find no comparable evidence
for companies that are not ESG.
In addition, Table 5 demonstrates that the age of a non-ESG business has a substantial
negative relationship with ROA. This finding indicates that older companies fail to
maximize their asset profitability. On the other hand, less debt would also be beneficial in
improving ROA for ESG firms. In addition, the two controlling variables, revenue and
equity, have positive and sizeable impacts on ROA (Model 1). We also examine the influence
of the crisis on ROA. As shown in Tables 4 and 5, the pandemic year dummy (Coded 1) for
Group 1 is positive and statistically significant. Interestingly, the pandemic enhanced ESG
firms’ ROA while the crisis was detrimental to the non-ESG group.

4.3 Cost of capital and business efficiency

Tables 4 and 5 (see Models 3–4) display the results of the fixed-effects (with robust standard
errors) and the Driscoll–Kraay estimator used to test H2. The ratio of total revenue to total
assets was used as a proxy for efficiency. Companies included in the socially responsible
investing (SRI) rating group (Group 1) and those not included in the SRI index (IDX30 index)
were analyzed using regression analysis (Group 2). The study finds that the WACC
correlates positively with business efficiency (measured by asset turnover). This implies
that a higher WACC results in higher efficiency and benefits the firm’s operation.
Moreover, this finding shows that if the financing of companies through debt and stock
capital increases, the profits resulting from the use of assets would increase. This indicates
the transfer of financial resources to assets. Similar to Models 1 and 2, lower debt is
negatively correlated with efficiency for ESG firms; however, for Group 2, the relationships
are inverse. Similarly, for non-ESG-rated companies, firm size (proxied by total assets)
affects performance. This implies that they must deal with operational inefficiencies.
Additionally, we find that a crisis harms the efficiency of non-ESG firms.

4.4 Cost of capital and firm value

The WACC and firm value regression results (H3) are presented in Tables 4 and 5 (Models
5–6). The cost of capital in Group 1 harms firm value (1% statistical significance); however,
this is not the case for Group 2. This suggests that, at least under some conditions, as
revealed in this study, ESG measures and related costs are rewarded with increased market
valuation, reflecting that ESG enterprises enjoy larger Tobin’s q with each falling level of
SAMPJ WACC. This is consistent with the empirical evidence that financially fragile firms are more
14,6 likely to cut external investment when facing an increased cost of capital (Carluccio et al.,
2018; Frank and Shen, 2016).
Since equity holders are incentivized to invest suboptimally in debt contracts, conflicts
between the two types of investors often arise. However, if debt holders correctly anticipate
the behavior of equity holders, they must bear this cost when debt is issued. Here, equity
1256 holders receive a lower return on their investments through lower debt service costs.
Therefore, the expense of the incentive to invest in value-reducing initiatives is borne by the
equity holders who issue debt. This is the hidden cost of debt financing, commonly called
the “asset-substitution effect.” For example, investors may have different opinions on how to
continue with a business decision that maximizes economic value (Harris and Raviv, 1990;
Stulz, 1988).
According to the literature, managers are expected to see the status quo maintained at all
times, even if shareholders see the company being liquidated. Managers are assumed to
want to invest all available funds at all times (Stulz, 1988), even if paying out cash is better
for investors. It is assumed that cash flow and investment expenditure contracts are
insufficient in both cases to resolve the conflict. This risk is reduced because debt gives
creditors the right to force liquidation in the event of insufficient cash flow (Harris and
Raviv, 1990). To determine the optimal capital structure, a company must weigh the
advantages of debt against the associated costs. In our estimation, the debt-to-equity ratio
(DER) for Group 1 is 0.44 and 0.80 for Group 2. To maintain agency cost risk and satisfy the
expectation of the low leverage policy of stakeholders, ESG firms may have chosen a
suboptimal debt level and capital structure, as evidenced by their low DER. As debt
payments eat away at free cash flows (Jensen, 1986), it makes sense for businesses to
maintain low leverage levels.
Group 2 gets higher TQ from higher gearing and sale revenues. Table 3 shows no
immediate influence of the pandemic on the TQ ratio for both groups. Finally, the COVID-19
years have not been shown to have any substantial impact on the value of firms. Once again,
the results contradict prior research on US-based firms (El Ghoul et al., 2011).

4.5 Estimation results: full sample

This study examines regression models using data from a complete sample of companies.
The results are presented in Table 6. We run the entire data set to determine whether there
is a link between the cost of capital and firm performance. Observing 53 firm-level data sets
from 2012 to 2021 adds up to 530 observations. According to Model 2 shown in Table 6, the
WACC has only a marginal effect on the efficiency ratio. WACC, ROA and TQ were entirely
uncorrelated. We also found no significant impact of the interaction term between the
WACC and ESG on firm performance in our model. The study found that firm age and debt
substantially negatively influence ROA and efficiency. Models 1–3 show a significant crisis
impact on firm performance and a negative impact on ROA, efficiency ratio and TQ. The
largest coefficient of the crisis year dummy is found for a company’s ROA, as presented in
Model 1. This finding suggests that businesses have difficulty maintaining profitability in
the face of declining demand and lower revenue.

4.6 Moderating impact of environmental, social and governance on performance

Specifically, to test H6, we perform a regression to determine whether having an ESG business
makes a difference relative to a non-ESG business. Using this method, this study builds a
model that includes the interplay between the ESG company dummy and the cost of capital.
The findings of using a model with interaction terms are presented in Tables 7 and 8.
 (1) (2) (3)
Cost of capital
Variables ROA Efficiency TQ and firm
performance
COC 0.599* (0.319) 0.0288** (0.0123) 0.00483* (0.00252)
Age 0.00322*** (0.000549) 0.000453*** (5.15e-05) 4.15e-05* (2.07e-05)
Debt 0.112*** (0.0181) 0.00576*** (0.000738) 0.000355 (0.000622)
Rev 0.0143 (0.0402) 0.00722*** (0.00122) 0.000756*** (0.000176)
Size 0.00148 (0.00289) 0.000383** (0.000147) 0.000113 (6.88e-05) 1257
Equity 1.102* (0.579) 0.0812*** (0.0235) 0.0419** (0.0171)
COVID 2.537** (0.888) 0.0728*** (0.0149) 0.0162*** (0.00370)
ESG*COC 0.485 (0.370) 0.0137 (0.0143) 0.000915 (0.00319)
Constant 4.983 (7.080) 1.163*** (0.266) 0.388** (0.169)
Observations 528 528 528
Number of groups 53 53 53
R-sq 0.1025 0.2866 0.0896
Table 6.
Notes: The table reports the results of the Driscoll–Kray estimator using a full sample of the data set.
Dependent variables are the firm performances (ROA, efficiency and Tobin’s q). Standard errors in Regression results
parentheses: ***p < 0.01; **p < 0.05; *p < 0.1 using Driscoll–Kray
Source: Created by author estimator: full sample

(1) ROA (2) Efficiency (3) TQ

Variables Full sample Full sample Full sample

COC 0.347** (0.113) 0.0215*** (0.00400) 0.00512*** (0.00147)

Age 0.00294*** (0.000627) 0.000445*** (5.85e-05) 4.18e-05* (2.06e-05)
Debt 0.118*** (0.0146) 0.00589*** (0.000831) 0.000327 (0.000620)
Rev 0.0255 (0.0400) 0.00750*** (0.00120) 0.000698*** (0.000166)
Size 0.00514 (0.00404) 0.000559*** (0.000124) 8.78e-05 (5.05e-05)
Equity 1.270* (0.660) 0.0768** (0.0266) 0.0425** (0.0170)
COVID 3.717*** (1.137) 0.102*** (0.0174) 0.0231*** (0.00383)
ESG*COVID 2.906** (0.902) 0.0726* (0.0346) 0.0163** (0.00605)
Constant 6.279 (7.586) 1.130*** (0.281) 0.381* (0.169)
Observations 528 528 528
Number of groups 53 53 53
R-sq 0.1086 0.2884 0.0913 Table 7.
Notes: The table presents regression result of the Driscoll–Kray estimator. Standard errors in parentheses: Impact of WACC,
***p < 0.01; **p < 0.05; *p < 0.1 crisis and ESG on
Source: Created by author firm performance

According to the model in Table 6, the cost of capital considerably impacts firm performance,
as Table 7 shows. Using a full corporate database, Table 7 shows that the pandemic negatively
impacted performance. However, the interaction term between ESG and the crisis dummy
provides considerable evidence that ESG significantly improves the negative effects of the
crisis on ROA and firm value (Models 1 and 3). This finding answers H6 that becoming an
ESG firm benefits the firm.
Table 8 provides another finding on the links between the WACC, firm performance,
ESG and crises. Model 3 shows that the WACC correlates negatively with firm value. The
crisis dummies also have a significant negative impact on firm performance. Using two
interaction terms, Table 8 shows that ESG does not impact the cost of capital and
SAMPJ (1) ROA (2) Efficiency (3) TQ
14,6 Variables Full sample Full sample Full sample

COC 0.184 (0.121) 0.0276* (0.0134) 0.00373** (0.00142)

Age 0.00284* (0.00131) 0.000452*** (5.79e-05) 1.87e-05 (2.13e-05)
Debt 0.00396 (0.00281) 0.000476** (0.000152) 6.32e-05 (5.35e-05)
Rev 0.0385 (0.0327) 0.00586*** (0.000703) 2.83e-05 (0.000727)
1258 Size 0.0756*** (0.0177) 0.00743*** (0.00123) 0.000318** (0.000134)
Equity 13.30*** (1.848) 0.0510*** (0.0127)
COVID 2.252*** (0.337) 0.0787** (0.0295) 0.0385** (0.0137)
COC 2.282** (0.755) 0.0982*** (0.0147) 0.0281*** (0.00388)
ESG*COVID 1.699*** (0.447) 0.0606* (0.0312) 0.0195*** (0.00492)
ESG*COC 0.204 (0.126) 0.0102 (0.0147) 0.000478 (0.00182)
Constant 21.20*** (4.907) 1.136*** (0.333) 0.439** (0.138)
Observations 528 528 528
Number of groups 53 53 53
Table 8. R-sq 0.2825 0.2907 0.1016
Moderating impact of Notes: The table reports the results of the interaction terms of the cost of ESG with crisis and the firm’s
ESG on COC and cost of capital. Standard errors in parentheses: ***p < 0.01; **p < 0.05; *p < 0.1
COVID-19 crisis Source: Created by author

performance metrics and being an ESG-based firm is beneficial during the COVID-19 crisis.
Based on these findings, we conclude that ESG firms have superior financial performance
during a crisis; however, ESG compliance does not influence firms’ total financing costs.
This finding is consistent with that reported by Boubaker et al. (2022) and Gjergji et al.
(2021).
Research and market sentiment suggests that SRI and ESG-derived companies might
benefit from adhering to ESG values, confirming the expectation that such companies would
thrive during economic and health crises. Considering previous studies (Koçak et al., 2022;
Schroders, 2020), the findings offer new supporting evidence. The study’s findings suggest,
at the very least in the short term, a company’s efforts to apply ESG values and become
“greener” could potentially translate into monetary gains and act as a “buffer” during a
troubled crisis.

5. Discussion
Through an examination of corporate financial data spanning the years 2012–2021, the
purpose of this study examines whether the cost of capital paid by a company has any
impact on its performance. The data sets used in this study include both ESG and non-ESG
publicly listed enterprises rated by the two indices in the IDX. The results of previous
empirical studies on this topic have been inconclusive.
Only a small amount of research has been conducted on Indonesian corporations, where
the ESG market and sustainable financing are still in their infancy. Therefore, we believe
that this is one of the first studies to show how the cost of capital affects firm performance
when considering the effects of being an ESG-based company is taken into account.
The study addresses the question, “During a crisis, is it beneficial to be an ESG
company?” The results presented in this study are expected to make significant theoretical
and practical contributions to the sustainable finance literature. First, it compares the
financial performance of ESG-based and non-ESG organizations by analyzing their capital
costs. The second aspect of the pandemic’s impact on businesses was also investigated. Our
 (1) ROA (2) ROA (3) Efficiency (4) Efficiency (5) TQ (6) TQ
Variables ESG Non-ESG ESG Non-ESG ESG Non-ESG

COC 0.122 (0.0761) 0.570 (0.390) 0.00878*** (0.00280) 0.0324*** (0.0121) 0.00542** (0.00265) 0.0324*** (0.0121)
Age 0.722*** (0.151) 0.00193* (0.00105) 0.0179** (0.00866) 0.000399*** (5.38e-05) 0.000396 (0.00542) 0.000399*** (5.38e-05)
Debt 0.112*** (0.0388) 0.142 (0.104) 0.00205*** (0.000747) 0.00673* (0.00350) 0.00132*** (0.000487) 0.00673* (0.00350)
Rev 0.0512*** (0.0181) 0.0209 (0.0523) 0.00470** (0.00219) 0.0160*** (0.00223) 0.00208*** (0.000562) 0.0160*** (0.00223)
Size 0.00131 (0.00266) 0.0240 (0.0628) 7.01e-05 (0.000148) 0.0106*** (0.00209) 0.000115 (7.47e-05) 0.0106*** (0.00209)
Equity 1.716** (0.675) 1.644 (1.192) 0.145** (0.0570) 0.0130 (0.0410) 0.0765*** (0.0294) 0.0130 (0.0410)
COVID 1.582** (0.697) 4.070*** (1.274) 0.0229 (0.0307) 0.0772** (0.0312) 0.0184 (0.0190) 0.0772** (0.0312)
Constant 21.59*** (6.104) 15.09 (12.35) 2.598*** (0.365) 0.308 (0.402) 0.198 (0.239) 0.308 (0.402)
Firm fixed effects Yes Yes Yes Yes Yes Yes
Observation 250 278 250 278 250 278
R-sq 0.910 0.731 0.959 0.928 0.961 0.928

Notes: This is the result of the pooled OLS model. Observations are divided into two firm groups with firm performance as the dependent variable: ROA,
efficiency and Tobin’s q; Standard errors in parentheses: ***p < 0.01; **p < 0.05; *p < 0.1
Source: Created by author

companies
OLS model: ESG
Table 9.
1259
Cost of capital
and firm

versus non-ESG
performance
SAMPJ data and tests show that the two groups have different financing costs. We find evidence
14,6 that non-ESG firms have a lower cost of capital than ESG firms do.
According to the existing literature, companies considering ESG issues have a better
chance of creating value for their stakeholders. Companies that focus on ESG values are
likelier to see increases in their top-line and turnover ratios (Ahmad et al., 2021; De Lucia
et al., 2020). Companies that strongly emphasize ESG concerns will likely attract consumers
1260 and investors who prioritize these factors in their research and decision-making processes.
Alternatively, governments and financial institutions could be compelled to provide ESG
businesses with easier and cheaper access to funding. This may happen if governments,
regulators and participants in the financial industry work together to promote sustainable
financing and green investment. Our findings provide inconsistent evidence on this matter
as we find the higher cost of capital for the ESG companies, which shows that being a
“green” company did not guarantee access to a cheaper funding alternative from the market.
Can we conclude by stating that it is insignificant to be an ESG-rated firm, or does ESG
matter to business? This study posits that it is beneficial to be an ESG company since we
found that ESG firms are more resilient during a crisis. How can an ESG-rated company
outperform its non-ESG-rated counterparts? We propose that businesses optimize their
assets and increase their efficiency ratio by carefully considering environmental and social
issues in capital budgeting and investment decision-making, thereby avoiding investments
and projects that do not pay off in the long run because of long-term social and
environmental concerns. Consistent with previous empirical studies, we believe that ESG
can create long-term financial value for corporations through higher productivity, cost
reduction, access to green finance and new revenue streams from the market (Adeneye et al.,
2022; Xie et al., 2019). This study shows that ESG enterprises can reap financial benefits by
increasing their firm value. Although ESG enterprises in Indonesia may achieve improved
ROA, efficiency and market valuation by maintaining lower capital costs, there is limited
evidence to draw such conclusions.

6. Conclusion
This study reviews the interrelationships between the cost of capital and firm performance
in two distinct groups: ESG and non-ESG corporations. In conclusion, the results of this
study validate the current development of the ESG market in Indonesia and support the
claims made in the introduction. The green financing sector in the country is currently
limited in size owing to the following factors:

the limited availability of viable projects in the market;

a lack of standardized green finance guidelines to validate the quality of a green
project:

the small number of sustainable projects or green financing instruments; and

the absence of a subsidy and incentive scheme for companies’ green initiatives.

In addition, there is concern about inadequate reporting standards and benchmarks for
estimating ESG-related financial risks in green finance projects. Existing literature has
already discussed these problems, including the Indonesian Financial Service Authority
(FSA) (Durrani et al., 2020; Liebman et al., 2019; Volz, 2018). This study found that the FSA
has provided recommendations to help achieve the country’s goal of expanding its green
and sustainable finance market (see Figure 2, Indonesia Sustainable Finance Roadmap
Phase 2).
 Cost of capital
and firm
performance

1261

0.2 0.4 0.6 0.8 1 Figure 2.

Propensity Score
Propensity score:
Untreated Treated
WACC of ESG versus
non-ESG firms
Source: Created by author. Data analysis used STATA 16

Focusing on firm-level performance, this study was conducted based on two indices for 55
companies in the Indonesian market. This study discusses the connection between the cost
of capital and performance in ESG- and non-ESG-rated firms while considering the negative
impact of the pandemic. This study finds that there is no significant difference in the cost of
capital between ESG and non-ESG firms, ESG does not have any impact on the cost of
capital and performance metrics and ESG firms performed better than their peers during the
pandemic. However, the coverage of the study is limited because SRI- or ESG-based indices
are still limited in Indonesia. Therefore, future studies should examine larger data sets that
include more firms in Indonesia and other countries to gain a global perspective.
This study provides insight into how ESG factors influence the cost and effectiveness of
firm performance. As for the theoretical contributions of this study, the capital structure and
ESG theories benefit from this study in two ways. First, the research supports the idea that
the debt utilization ratio is still relevant to a company’s value because the DER affects a
company’s financial performance, and ESG firms have a less-than-optimal DER. Second,
companies would fare better if they adopted ESG principles because they would be more
resilient in times of crisis. In the short term, the study’s results suggest that a company’s
efforts to apply ESG values could translate into economic gains and act as a “buffer” during
a crisis. The findings of this study support this view and provide empirical evidence of the
superiority of ESG-based firms.
Likewise, this study has several practical implications. First, the data can assist
researchers and business owners evaluate how a global pandemic can affect a
company’s ability to sustain its capital structure and bottom line. Second, it explains
why businesses prioritizing ESG are more likely to survive crises such as the current
COVID-19 outbreak than those that do not. Given the complexity of ESG criteria and
measures and their link to economic performance, this study seeks to contribute to the
literature by examining the relationship between ESG and a company’s performance;
further research is advised to evaluate other ESG metrics in the model. We believe that
analyzing a larger data set can better understand the link between ESG news-based
ratings and stock market performance.
Third, we emphasize the importance of policymakers, regulators and financial
institutions adopting comprehensive policies and guidelines for the growth of the nation’s
green and sustainable finance industry. In the first section of this study, we discuss the
SAMPJ challenges in developing Indonesia’s relatively small green financing sector. In conclusion,
14,6 this is a call for further studies in this area.

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Further reading 1267

OJK (2021), “Sustainable finance roadmap phase II (2021 – 2025)”, Https://Ojk.Go.Id/Id/Berita-Dan-Kegiatan/
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Tahap-II-(2021-2025)/Roadmap%20Keuangan%20Berkelanjutan%20Tahap%20II%20(2021%20-
%202025).pdf (accessed 8 June 2023).

Corresponding author
Miranda Tanjung can be contacted at: miranda.hotmadia@binus.ac.id

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