How ESG Changes a Company’s Cost of Capital

For years, a company’s cost of capital has been determined by familiar variables—market risk, size, industry, and firm-specific factors. But in today’s evolving business environment, Environmental, Social, and Governance (ESG) factors are beginning to reshape the equation.

ESG doesn’t just impact branding or customer loyalty—it affects risk. And where there’s a change in risk, there’s a change in capital costs in business valuations.

The ESG–Risk–Capital Chain

Business valuation models, including the widely used Build-Up Method, rely on various inputs to estimate the cost of equity. These inputs include the risk-free rate, equity risk premium, size premium, industry premium, and most importantly for this discussion, the Company-Specific Risk Premium (CSRP).

This is where ESG enters the picture.

A company with robust ESG practices may face fewer regulatory issues, lower reputational risk, and stronger long-term stability. That’s why valuation professionals sometimes reduce the CSRP for companies with strong ESG performance. This, in turn, lowers the cost of equity—and by extension, the Weighted Average Cost of Capital (WACC).

Quantifying the Difference

In a recent ESG valuation scenario analysis, a 0.50% decrease in the cost of equity (from 19.00% to 18.50%) was assumed for companies with successful ESG strategies. This small adjustment had a notable impact on value, increasing projected equity by over 8%.

On the flip side, a 0.50% increase (to 19.50%) was applied for companies with poor ESG compliance or higher exposure to ESG-related risks. The result was a sharp drop in value—by more than 50% in some models—driven in part by a higher WACC.

The Takeaway for Business Owners

Whether you're preparing for a valuation, pitching to investors, or negotiating with lenders, ESG may affect more than your public image. It can influence your capital structure, your interest rates, and your long-term financial strategy.

Integrating ESG, or not integrating ESG, may very well change your company’s cost of capital. And in valuation terms, that can be a game changer.