Sustainability in company valuation: A study on the impact of ESG factors on the cost of equity

This study examines the impact of ESG factors on the cost of equity by providing a review of recent literature on ESG and sustainability as determinants of expected equity returns. It also presents an overview of my empirical analysis on the relationship between ESG factors and expected returns, prepared as part of my Master’s thesis titled “The impact of ESG factors on the cost of equity” (Kreslin, 2026). This study sets out to examine how the overall level of sustainability of a company’s business operations (hereinafter referred to as “level of sustainability”) impacts the expected return on an equity investment in the company, with the objective of establishing whether ESG ratings, as currently available, represent a reliable proxy for a company’s overall level of sustainability. The aim of my research was to position ESG as a risk premium to be considered in private company valuations. The literature review presented in chapter 2, identifies ESG as a significant determinant of expected returns although it provides mixed evidence regarding the direction of its impact. In contrast, my empirical analysis (presented in chapter 3), performed on a sample of 877 European listed companies, on the other hand provides strong evidence on the significant negative relation between ESG ratings and expected returns, implying that companies with stronger sustainability of operations tend to exhibit a lower expected return, i.e. lower cost of equity. Despite the strong evidence of my empirical analysis, I have concluded that ESG ratings, as currently available, do not provide a sufficiently reliable basis for establishing an ESG risk premium to be used in private company valuations, primarily due to largely voluntary nature of sustainability reporting, as well as methodological differences between ESG rating agencies. Based on the Corporate Sustainability Reporting Directive, it can be reasonably assumed that the scope and quality of sustainability reporting by European companies will improve in the future, which is expected to significantly improve the reliability of ESG ratings. In my Master’s thesis, I have also developed a methodological approach that offers a simple yet elegant solution for estimating an ESG risk premium to be incorporated into private company valuations, which however represents only one of several possible approaches. My suggested approach is presented in chapter 4 of the study.

Simon Kreslin

SIR*IUS 4/2026