Changes in the Relationship between Corporate Social Performance and Cost of Equity: Insights from a Multi-Decade Analysis of Sin Stocks and ESG Laggards

Financial theory suggests that exclusionary investing increases divested firms' cost of equity. With the surge in sustainable investing, the divergence between the cost of equity of firms prone to be targeted by divestment campaigns relative to their counterparts is expected to grow. Using panel regression and propensity score matching on a dataset of 6,336 U.S. firms from 1990 to 2023, this study presents a more nuanced view. While firms in carbon-intensive industries exhibit a growing cost of equity premium, no consistent premium is found for traditional sin stocks (i.e., alcohol, tobacco, gambling and military, firearms). Furthermore, recent years have seen a shift in how ESG scores affect the cost of equity. The relationship between ESG scores and the cost of equity has shifted from being positive to negative, suggesting a changing market perception of ESG risks. These findings challenge the investor base channel and suggest that the perception of risks, rather than exclusionary practices, drives higher equity costs.