The impact of corporate social and environmental practices on the cost of equity capital: UK evidence

• Pages: 425-441
• Published date: 05 August 2019
• Date: 05 August 2019
• DOI: https://doi.org/10.1108/IJAIM-11-2017-0141
• Author: Ahmed H. Ahmed,Yasser Eliwa,David M. Power
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

The impact of corporate social and

environmental practices on the

cost of equity capital: UK evidence

Ahmed H. Ahmed

School of Business, University of Dundee, Dundee, UK and

Faculty of Commerce, South Valley University, Qena, Egypt

Yasser Eliwa

School of Business and Economics, Loughborough University, Loughborough, UK

and Faculty of Commerce, Cairo University, Egypt, and

David M. Power

School of Business, University of Dundee, Dundee, UK

Abstract

Purpose –There has been an ongoing call from various groups of stakeholders for social and

environmentalpractices to be integrated into companies’operations.A number of companies have responded

by engaging in socially and environmentally responsible activities, whileothers choose not to participate in

these activities, whichincur additional costs. The absence of consensus regardingthe economic implications

of social and environmental practices provides the impetus for this paper. This study aims to examine the

association between corporate social and environmental practices (CSEP) and the cost of equity capital

measuredby four ex ante measures using a sample of UK listed companies.

Design/methodology/approach –First, we undertake a review of the extant literature on CSEP.

Second, using a sample of 236 companies surveyed in “Britain’s most admired companies”in terms of

“community and environmentalresponsibility”during the period 2010-2014, we estimate four implied a cost

of equity capital proxies. The relationship between a companies’costof equity capital and its CSEP is then

calculated.

Findings –The authors find evidencethat companies with higher levels of CSEP have a lower cost of equity

capital.This finding determines the significant role played by CSEP in helping usersto make useful decisions.

Also, it supports arguments that firms with socially responsible practices have lower risk and higher

valuation.

Practical implications –The finding encourages companies to be more socially and environmentally

responsible. Furthermore,it provides up-to-date evidence of the economicconsequences of CSEP. The results

should, therefore, be of interest to managers, regulators and standard-setters charged with developing

regulationsto control CSEP, as these practices are still undertaken on a voluntary basis by companies.

Originality/value –To the best of the authors’knowledge, this is the first study to investigate the

association between CSEP of British companies and their cost of equity capital. The study complements

Ghoul et al. (2011), whoexamine the relationship between CSR and the cost of equity capital of the US sample.

The authors extend Ghoul et al. (2011) by using a sample of the UK market after applying International

FinancialReporting Standards.

Keywords CSEP, The cost of equity capital, The UK

Paper type Research paper

The authors would like to thank Prof Mike Brown and his team for their great efforts to conduct the

BMAC survey and making the data available. The authors would also like to thank the anonymous

referees for detailed and constructive comments.

Cost of equity

capital

425

Received23 November 2017

Revised2 April 2018

Accepted3 May 2018

InternationalJournal of

Accounting& Information

Management

Vol.27 No. 3, 2019

pp. 425-441

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-11-2017-0141

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

1. Introduction

In recent years, there has been a growing demand among firms’stakeholders such as

customers, employees, communities, governments and shareholders of companies to adopt

policies regarding social and environmentalissues (McWilliams and Siegel, 2000;El Ghoul

et al., 2011;Hogan and Lodhia,2011;Kimbro and Cao, 2011;Clarkson et al., 2013;Eliwa et al.,

2019a). More importantly, investors’awareness of incorporating sustainable activities

within companies’operations has grown exponentially over the years (Yu and Zhao, 2015;

Kimbro and Cao, 2011). Alewine and Stone (2013) indicated that the costs and benefits of

environmental initiatives impact management strategies and investing activities. In line

with this, global investments managed according to socially and environmentally

responsible principles haveexpanded dramatically, rising from $13.3tn in 2012 to $21.4tn in

2014 (Global SustainableInvestment Alliance, 2014).

Therefore, various attemptshave been made to investigate the economic implications of

CSR practices; however, the results, to date, have not been conclusive (Cochran and Wood,

1984;McGuire et al., 1988;El Ghoul et al., 2011;Xu et al.,2015;Eliwa et al., 2019a). Such

inconclusiveness has led to calls for further research in this area (Mishra and Suar, 2010).

One strand of research discusses the link between CSR practices and a company’s

performance and suggests that corporations will face a trade-off between the costs of

adopting additional social, environmental and governance policies and the benefits from

improved financial performance (McGuire et al., 1988;Dhaliwal et al.,2011;Plumlee et al.,

2015).

Another strand of research argues that companies should play a positive role in

communities in which they operateas wealth maximisation should not be the sole objective

of companies (Tsoutsoura, 2004). Engaging in CSR activities involves costs, which may be

offset by benefits to a wide group of stakeholders(Tsoutsoura, 2004). In this regard, Hansen

and Mowen (2007) have argued that for firms, achievingfinancial objectives and resolving

environmental issues are not mutually exclusive. Even shareholders may gain from a

company’s CSR activitiesif any expenditures linked with these activities are associatedwith

a reduction in the company’s risk (Leeet al.,2013).

Although a sizeable body of literature exists on the link between corporate disclosure

and the cost of equity capital (Souissi and Khlif, 2012)[1], few studies focuson CSR. Only a

handful of studies have sought to examine the relationship between CSR practices and the

cost of equity capital and report mixed results including Connors and Silva-Gao (2008),

Sharfman and Fernando (2008), Ghoul et al. (2011), Cheng et al. (2014),Xu et al. (2015) and

Suto and Takehara (2017).

Therefore, the current study aims to examine the association between corporate social

and environmental practices (CSEP) and the cost of equity capital using a sample of UK

listed companies.In particular, this study investigates the relationshipbetween the extent to

which CSEP is adopted by companies –as determined by Britain’s Most Admired

Companies (BMAC) and published in ManagementToday –is associated with a lower cost

of equity capital. This study examines whether companies are rewarded for being socially

and environmentallyresponsible with a lower cost of obtaining funds from equity.

Our study contributes to the extant literaturein a number of ways. First, this study tests

the association between CSEP and the cost of equity capital in the UK. In this regard, most

of the previous studies that focus on the implication of CSR, test the association between

CSR disclosure and/or CSR practices and firms performance. However, few studies testthe

association between CSR practices and the cost of equity, and have been conducted

primarily in the USA (Sharfman and Fernando, 2008;El Ghoul et al.,2011), where CSR

practices are subject to a different regulatoryenvironment. In this regard, although the UK

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