ESG disclosure, heterogeneous valuations and cost of equity capital

This paper develops a rational expectations equilibrium model with heterogeneous valuations. We analyze how the ESG disclosure quality affects the firms’ cost of equity capital under the setting that the traditional value investors and the ESG investors have related but different valuations of the same risky assets. We show that given the endogenous information acquisition by traditional value investors, improving the ESG disclosure quality leads to a decrease in the firm’s cost of equity capital when the optimal information acquisition is corner solution; when there exists the interior solution, the relationship between the ESG disclosure quality and the cost of equity capital is non-monotonic. The parameter conditions for the corresponding relationships are given by the analytical expressions. The results of the model reconcile the current empirical research with conflicting findings, and also reveal the possible negative effects of mandatory ESG disclosure, i.e., improving the quality of ESG disclosure does not always lead to a decrease in the firm’s cost of equity capital. © 2024 Systems Engineering Society of China. All rights reserved.