The Impact of ESG Performance on the Cost of Capital: Evidence from JSE-Listed Firms in South Africa

Abstract

This study examines the relationship between environmental, social, and governance (ESG) performance and the cost of capital among firms listed on the Johannesburg Stock Exchange (JSE), using a dynamic panel approach via the two-step System Generalized Method of Moments (System GMM). The analysis explores whether the impact of environmental, social and governance (ESG) factors varies depending on firm size (large, medium or small) and economic sector (financial services, consumer services, industrials and basic materials). The findings reveal that aggregate ESG performance does not have a statistically significant effect on the cost of capital for the full sample or across firm size categories. Disaggregated ESG components (environmental, social and governance) also demonstrate limited influence, though there are some exceptions specific to certain sectors. For example, in the financial sector, the governance pillar is associated with a reduction in capital costs, whereas in the basic materials sector, it is the social pillar that reduces capital costs. However, ESG efforts in most sectors are either perceived as neutral or potentially costly, especially where the financial benefits are not immediately observable. These results suggest that ESG activities are not yet fully priced by capital markets in South Africa as risk-reducing or value-enhancing. Traditional financial indicators such as leverage and book-to-price ratios remain better predictors of financing costs. The study highlights the need for improved ESG disclosure practices, stronger regulatory frameworks and greater investor awareness to ensure that ESG considerations are effectively integrated into decisions in the capital markets. Overall, while ESG initiatives are important for corporate legitimacy and sustainability, they currently offer limited financial benefits in the form of lower capital costs. ESG initiatives need to be tailored to specific sectors and supported by clear financial linkages if they are to deliver measurable economic benefits.