Beyond Compliance: How ESG Reporting Influences the Cost of Capital in UK Firms

Round 1

Reviewer 1 Report

Comments and Suggestions for Authors

1.     The paper contains minor grammatical issues, improving it will enhance readability and coherence. The choice of words is also not appropriate at some instances. For example, the term “adverse association” between ESG disclosure and cost of capital is not clear. Similarity, the terms like “enhanced corporate governance” and “an explicit shift” are not clear. The author should use more precise terminologies to improve the quality and readability of the paper.

2.     Abstract should discuss the main findings of the paper followed by the specific policy implications. Authors states that “These findings are valuable for investors, companies, regulators, auditors, policy makers and academic and research community”. It is not clear how the findings are valuable for these stakeholders, author should give some clear and specific policy implications.

3.     The authors refer to stewardship theory and information asymmetry theory to support their proposed relationships. However, the discussion does not provide a sufficient basis to justify the relationship between ESG disclosure and the cost of capital using these theories. It is unclear how the authors concluded that firms with ESG disclosure will have a lower cost of capital based on these theories. Are there alternative pieces of evidence from previous research? If so, why were they not discussed? Additionally, the moderating role of corporate governance is not adequately explored and justified. The literature on the cost of capital is extensive, yet some relevant theories have not been addressed.

4.     The background section does not provide any information about the non-financial sector in the UK, ESG disclosure in the UK, or the cost of capital in the UK. Despite this, the authors suddenly formulate research questions without establishing the necessary context.

5.     Authors stated that “The research holds substantial theoretical and practical significance in the field of 79 accounting” Why? How?

6.     This is repetitive “To create value for its creditors and shareholders, a firm need to earn a minimum return that covers its financing costs. This return is the cost of capital, which has two components: the cost of debt and the cost of equity. The former is the interest rate that the firm pays on its loans, while the latter is the return that investors expect for buying its shares. The weighted average cost of capital (WACC) is the cost of capital that takes into account the proportion of debt and equity in the firm’s capital structure (Corporate Finance Institute, 2020; Frank and Shen 2016).”

7.     Author stated that “Some studies have also explored how corporate governance moderates the interaction amongst ESG reporting and the cost of capital, namely, Ng and Rezaee (2015)” So what is the contribution of this study?

8.     What does the following argument mean? Need more explanation? What was lacking in the previous research that this study particularly focused on “The current literature on ESG reporting and how it influences the cost of capital is unclear and scarce, as it relies on different measures and sources of ESG information and does not account for the role of corporate governance”

9.     These are the 3 gaps that authors stated that their study addressed

·       How does ESG reporting affect the cost of capital for companies in different countries and industries?

·        How does corporate governance moderate the association amongst ESG reporting and the cost of capital?

·       What are the implications of ESG disclosure and corporate governance for financial 189 decision-making and value creation?

Given these, how many countries are included in this study to address the first gap? What is the hypothesis for first one and third one?

10.  The Legitimacy Theory is mentioned on page 5 but is not discussed in the background of the study. The authors need to elaborate more on the theoretical justification of their proposed relationships. While the topic is important and the theories appear relevant, the discussion lacks the depth necessary to provide adequate justification.

11.  The number of observations for each variable are different. Authors should discuss more about the type of data used.

Comments on the Quality of English Language

Needs language improvement

Author Response

 

For research article

 

Response to Reviewer 1 Comments
1. Summary
Thank you for your thorough review of this manuscript. Enclosed, you will find detailed responses to your comments, along with the corresponding revisions and corrections, which are highlighted and tracked in the re-submitted files.
2. Point-by-point response to Comments and Suggestions for Authors
Comments 1:   Comments and Suggestions for Authors: 1.     The paper contains minor grammatical issues, improving it will enhance readability and coherence. The choice of words is also not appropriate at some instances. For example, the term “adverse association” between ESG disclosure and cost of capital is not clear. Similarity, the terms like “enhanced corporate governance” and “an explicit shift” are not clear. The author should use more precise terminologies to improve the quality and readability of the paper. 2.     Abstract should discuss the main findings of the paper followed by the specific policy implications. Authors states that “These findings are valuable for investors, companies, regulators, auditors, policy makers and academic and research community”. It is not clear how the findings are valuable for these stakeholders, author should give some clear and specific policy implications. 3.     The authors refer to stewardship theory and information asymmetry theory to support their proposed relationships. However, the discussion does not provide a sufficient basis to justify the relationship between ESG disclosure and the cost of capital using these theories. It is unclear how the authors concluded that firms with ESG disclosure will have a lower cost of capital based on these theories. Are there alternative pieces of evidence from previous research? If so, why were they not discussed? Additionally, the moderating role of corporate governance is not adequately explored and justified. The literature on the cost of capital is extensive, yet some relevant theories have not been addressed. 4.     The background section does not provide any information about the non-financial sector in the UK, ESG disclosure in the UK, or the cost of capital in the UK. Despite this, the authors suddenly formulate research questions without establishing the necessary context. 5.     Authors stated that “The research holds substantial theoretical and practical significance in the field of 79 accounting” Why? How? 6.     This is repetitive “To create value for its creditors and shareholders, a firm need to earn a minimum return that covers its financing costs. This return is the cost of capital, which has two components: the cost of debt and the cost of equity. The former is the interest rate that the firm pays on its loans, while the latter is the return that investors expect for buying its shares. The weighted average cost of capital (WACC) is the cost of capital that takes into account the proportion of debt and equity in the firm’s capital structure (Corporate Finance Institute, 2020; Frank and Shen 2016).” 7.     Author stated that “Some studies have also explored how corporate governance moderates the interaction amongst ESG reporting and the cost of capital, namely, Ng and Rezaee (2015)” So what is the contribution of this study? 8.     What does the following argument mean? Need more explanation? What was lacking in the previous research that this study particularly focused on “The current literature on ESG reporting and how it influences the cost of capital is unclear and scarce, as it relies on different measures and sources of ESG information and does not account for the role of corporate governance” 9.     These are the 3 gaps that authors stated that their study addressed · How does ESG reporting affect the cost of capital for companies in different countries and industries? ·  How does corporate governance moderate the association amongst ESG reporting and the cost of capital? · What are the implications of ESG disclosure and corporate governance for financial 189 decision-making and value creation? Given these, how many countries are included in this study to address the first gap? What is the hypothesis for first one and third one? 10.  The Legitimacy Theory is mentioned on page 5 but is not discussed in the background of the study. The authors need to elaborate more on the theoretical justification of their proposed relationships. While the topic is important and the theories appear relevant, the discussion lacks the depth necessary to provide adequate justification. 11.  The number of observations for each variable are different. Authors should discuss more about the type of data used.   Comments 1: The paper contains minor grammatical issues, improving it will enhance readability and coherence. The choice of words is also not appropriate at some instances. For example, the term “adverse association” between ESG disclosure and cost of capital is not clear. Similarity, the terms like “enhanced corporate governance” and “an explicit shift” are not clear. The author should use more precise terminologies to improve the quality and readability of the paper.
Response 1: [Grammatical Issues and Terminology]   Thank you for the feedback on areas where the writing could be improved for clarity and readability. We appreciate you taking the time to provide these constructive comments. We have carefully reviewed the manuscript and implemented the following changes in response to your suggestions: Replaced the term "adverse association" with "negative relationship" to more precisely describe the observed connection between ESG disclosure and cost of capital. Revised the phrase "enhanced corporate governance" to "robust corporate governance practices" to use more specific terminology. Changed "explicit shift" to "observable change" to improve the clarity of the language. Additionally, we have addressed minor grammatical issues throughout the paper to enhance the overall coherence and readability. We agree that careful attention to grammar and word choice is essential in academic writing, and we have made these improvements based on your feedback. We believe these revisions have strengthened the clarity and precision of the language used in the manuscript. Please let us know if you have any other suggestions for further improving the quality of the writing.]
Comments 2: [Abstract should discuss the main findings of the paper followed by the specific policy implications. Authors states that “These findings are valuable for investors, companies, regulators, auditors, policy makers and academic and research community”. It is not clear how the findings are valuable for these stakeholders; author should give some clear and specific policy implications.]
Response 2:  Agree. We have, accordingly, revised the abstract to emphasize the specific policy implications of our findings, as suggested. On page 1, we have added a new paragraph to the abstract highlighting how the study's insights can benefit various stakeholders. We have revised the abstract to address this point. Here's the revised section: This research examines the effect of ESG disclosure on the cost of capital for non-financial firms in the UK, indexed on the FTSE All Share Index, during the period from 2014 to 2018. Using multivariate analysis with ordinary least squares (OLS), fixed effects, robust regression, and Tobit models, the research assesses the effect of ESG reporting, governance, and cost of capital, including robustness checks with an alternative ESG indicator, the Environment Pillar Score. Contrary to expectations, ESG reporting is positively associated with the cost of capital. However, corporate governance moderates this relationship, weakening the positive correlation and reversing it to a negative as-sociation for firms with strong governance practices, consistent with the hypotheses. The research also finds that firm size, liquidity, profitability, and leverage positively affect the cost of capital, while board size, independent board composition, audit committee independence, and auditor type do not significantly influence it. Notably, non-executive directors on the audit committee have a significant negative effect on the cost of capital. These findings are valuable for investors, companies, regulators, auditors, policymakers, and the academic and research community. Specifically, for investors, the study provides insights into how ESG disclosures can influence investment risks and returns, highlighting the importance of robust corporate governance. Companies can leverage these insights to enhance their governance practices and optimize their capital costs. Regulators and policymakers can use the findings to develop guidelines that encourage transparent ESG reporting and strong governance frameworks, thereby improving market stability and investor confidence. Auditors can utilize the results to better un-derstand the effect of non-financial reporting on financial metrics, aiding in more accurate audits and assessments. These findings inform investors, companies, regulators, auditors, and academia, fostering a more sustainable and transparent financial environment. We believe this revised abstract provides clearer and more specific implications of our study's findings for various stakeholders, as per your suggestion. Please let me know if you have any other feedback or require further clarification.   Comments 3: [The authors refer to stewardship theory and information asymmetry theory to support their proposed relationships. However, the discussion does not provide a sufficient basis to justify the relationship between ESG disclosure and the cost of capital using these theories. It is unclear how the authors concluded that firms with ESG disclosure will have a lower cost of capital based on these theories. Are there alternative pieces of evidence from previous research? If so, why were they not discussed? Additionally, the moderating role of corporate governance is not adequately explored and justified. The literature on the cost of capital is extensive, yet some relevant theories have not been addressed. Response 3: Thank you for the feedback on the discussion section. We appreciate you taking the time to provide constructive suggestions to improve the quality of the paper. We would like to clarify that in the original draft, we did not reference or use stewardship theory at all. The theories we applied were stakeholder theory and legitimacy theory to explain the relationship between ESG reporting and cost of capital, as well as information asymmetry theory to provide an alternative perspective. Therefore, there was no need for us to remove any references to stewardship theory, as it was not part of the theoretical framework used in this study from the beginning. We apologize if there was any confusion on this point. (On page 15 and 16) We have, however, made the other changes you suggested, such as: Condensing the explanations for the positive correlation between ESG disclosure and cost of capital into a single, more concise paragraph in Section 5.1. Interpretation of Results. Streamlining the discussion of the control variable findings in Section 5.1. Strengthening the causality language when discussing the relationship between ESG disclosure and cost of capital in Section 5.1. These revisions have helped to better justify the use of the applied theories and the findings within the discussion section. We believe the updated discussion provides a clearer and more robust theoretical foundation for the study's results. Please let us know if you have any other feedback or concerns that we can address. Comments 4: The background section does not provide any information about the non-financial sector in the UK, ESG disclosure in the UK, or the cost of capital in the UK. Despite this, the authors suddenly formulate research questions without establishing the necessary context. Response 4: Thank you for your constructive feedback. We appreciate your insight regarding the need to provide more specific information about the non-financial sector in the UK, ESG disclosure practices in the UK, and the cost of capital within the UK context (pages 3): In response to your comments, we have made substantial revisions to the background section to better establish the necessary context before formulating our research questions. Specifically, we have: 1.         Added a section on the non-financial sector in the UK: This section now includes detailed information on the composition and economic significance of the non-financial sector, highlighting its contribution to the UK economy and its diverse range of industries. 2.         Included a detailed overview of ESG disclosure in the UK: We have outlined the regulatory frameworks and guidelines that govern ESG disclosure practices in the UK, such as the Companies Act 2006 and the Task Force on Climate-related Financial Disclosures (TCFD) recommendations. This addition underscores the importance of ESG transparency and its prevalence among UK firms. 3.         Provided an explanation of the cost of capital in the UK: We have discussed the factors influencing the cost of capital in the UK, including macroeconomic conditions, market interest rates, and firm-specific risk profiles. This section also touches on the impact of recent economic trends, such as Brexit and the Bank of England's monetary policy, on the cost of capital for UK firms. 4.         Revised the formulation of research questions: With the enhanced context provided by the above sections, we have reformulated our research questions to ensure a logical progression from the background information to the specific inquiries of our study. These additions and revisions are aimed at providing a comprehensive context for our study and ensuring that the formulation of our research questions is well-grounded in the relevant UK-specific information. We believe these changes address your concerns and enhance the overall clarity and relevance of our paper. Thank you again for your valuable feedback. We hope that these revisions meet your expectations and improve the quality of our manuscript.   Comments 5: Authors stated that “The research holds substantial theoretical and practical significance in the field of 79 accounting” Why? How? Response 5: Thank you for your valuable feedback. We appreciate your comments and have made revisions to clarify the theoretical and practical significance of our research in the field of accounting. 5.2. Theoretical and Practical Insights This research offers significant academic and empirical insights in several key areas. Practical Insights for Firms: First, it suggests that firms can capitalize on increased ESG reporting and enhanced governance practices by reducing their cost of capital and enhancing their financial and sustainability performance. ESG disclosure and governance can enhance stakeholder trust, confidence, and satisfaction while lowering costs and risks associated with agency problems, political pressures, legal disputes, and risk premiums. A reduced cost of capital can enhance firm value and accessibility to financing. Therefore, firms should adopt transparent ESG disclosure standards and effective governance mechanisms to enhance their own value proposition and that of their stakeholders. Specifically, firms should consider adopting well-regarded ESG reporting standards including the Task Force on Climate-related Financial Disclosures (TCFD), the Sustainability Accounting Standards Board (SASB), or the Global Reporting Initiative (GRI), Effective governance mechanisms may include establishing independent audit committees, enhancing board diversity, and implementing robust internal control systems. For example, firms can adopt the following practices: ESG Reporting: Use the GRI or SASB frameworks to ensure comprehensive and comparable ESG reporting.   Governance: Ensure that the board of directors has a majority of independent members and that the audit committee is comprised of financially literate non-executive members. By implementing these ESG reporting and governance best practices, firms can enhance stakeholder trust, confidence, and satisfaction while lowering costs and risks associated with agency problems, political pressures, legal disputes, and risk premiums. A lower cost of capital can, in turn, increase firm value and access to finance, enhancing their own value proposition and that of their stakeholders. Implications for Regulators and Policymakers:  Second, the research demonstrates that ESG reporting and governance quality impact the cost of capital for UK non-financial firms. This implies that regulators and policymakers can promote sustainable and responsible business practices by establishing and enforcing ESG reporting standards and incentives. ESG reporting and governance can enhance the information quality, legitimacy, reputation, credibility, and reliability of ESG disclosures. Regulators and policymakers can also help firms align their strategies and actions with ESG goals and targets, facilitate the dissemination and verification of ESG information, and raise awareness and education on ESG issues. Thus, the study recommends that regulators and policymakers support ESG reporting, governance, and cost of capital in an integrated manner.  To be more actionable, regulators and policymakers might consider: Mandating ESG Reporting: Require large companies to report on their ESG performance using standardized frameworks including the GRI or SASB. Offering Incentives: Offer tax incentives for companies that meet high ESG performance thresholds. Creating Public Platforms: Establish public platforms for ESG data to enhance transparency and comparability. By aligning firms' strategies and actions with ESG goals, facilitating the dissemination and verification of ESG information, and raising awareness and education on ESG issues, regulators and policymakers Insights for Investors and Auditors:  Third, the study indicates that ESG disclosure and governance are critical factors in assessing companies’ sustainability, financial performance, and value. Investors can use ESG disclosure and governance to evaluate companies’ risk exposure and diversify their portfolios. Investing in companies with higher ESG scores and better governance practices can lower investors’ cost of capital and support sustainable development. Therefore, investors should consider ESG disclosure and governance factors when making investment decisions, as they can affect returns and risks. Investors are encouraged to: Incorporate ESG Metrics: Use ESG metrics from reliable sources like MSCI ESG Ratings or Sustainalytics in their investment analysis. Engage with Companies: Engage with companies on their ESG practices through shareholder activism and voting policies. Fourth, the study assists auditors in evaluating the reliability and value of ESG disclosure by using PCA to construct a governance score from multiple variables. This score reflects ESG disclosure credibility and impact, as higher governance quality implies lower information asymmetry, agency costs, and cost of capital. Auditors can also use PCA to compare governance scores of different firms or industries and identify ESG reporting best practices or benchmarks. This enables them to provide assurance services that increase stakeholder confidence and satisfaction in ESG disclosure. By using professional judgment and ethical standards, auditors can also advise firms on how to improve ESG disclosure and governance practices, thereby lowering their cost of capital and creating value for themselves and their stakeholders. Hence, PCA is a valuable tool for auditors to assess ESG disclosure. Auditors should focus on key governance indicators including: Board Independence: Ensure that the board of directors has a majority of independent members. Audit Committee Effectiveness: Ensure that the audit committee is comprised of financially literate non-executive members. Executive Compensation Alignment: Ensure that executive compensation is aligned with ESG goals.  Contributions to Accounting Research:  Fifth, the study contributes to accounting knowledge by providing new evidence on ESG reporting, governance, and cost of capital in the UK. The findings offer insights that guide researchers towards new research directions in these areas. For instance, researchers could investigate the causal mechanisms or processes underlying ESG reporting, governance, and cost of capital. Researchers could also examine the temporal dynamics or changes in this relationship. Furthermore, researchers could explore cross-country variations or differences in this relationship across contexts. These research directions could enhance our understanding of how ESG factors and governance practices influence financial outcomes. 5.3. Limitations and avenues for Future Research The research has limitations and biases that affect generalizability. The sample only includes non-financial UK firms, which may not generalize to other contexts. Future research could explore several additional directions to build on the results of this research: Exploring Different Types of ESG Disclosures: Future studies could investigate the impact of environmental, social, and governance metrics separately to understand if certain ESG dimensions have a stronger influence on the cost of capital and financial performance. This could provide more granular insights into how different aspects of ESG reporting are valued by investors. Sector-Specific Effects: Examining the interaction among ESG reporting and cost of capital across different industries or sectors could yield valuable insights. The impact of ESG disclosure may vary dependent upon the unique characteristics, risks, and stakeholder expectations of each sector. Longitudinal Studies: Capturing the long-term effects of ESG reporting over a longer time horizon could shed light on how the relationship evolves as companies and investors become more accustomed to sustainability disclosures. This could help differentiate short-term from long-term impacts. Comparative Studies: Expanding the research to other regulatory environments, both within the UK and internationally, could offer a broader perspective on how the cost of capital-ESG disclosure relationship is influenced by different institutional and cultural contexts. Integrated Frameworks: Developing frameworks that combine ESG metrics with traditional financial analysis could provide a more holistic understanding of how sustainability performance and governance practices impact a firm's overall value and financial decision-making. These limitations and suggestions need cautious interpretation and indicate areas for further investigation. Exploring these future research directions could enrich our knowledge on ESG reporting, governance, and capital market dynamics. They could also offer valuable insights and implications for theory, practice, and policy. We believe these revisions address your concerns and enhance the clarity and depth of our manuscript. Thank you again for your valuable feedback.   Comments 6: This is repetitive “To create value for its creditors and shareholders, a firm need to earn a minimum return that covers its financing costs. This return is the cost of capital, which has two components: the cost of debt and the cost of equity. The former is the interest rate that the firm pays on its loans, while the latter is the return that investors expect for buying its shares. The weighted average cost of capital (WACC) is the cost of capital that takes into account the proportion of debt and equity in the firm’s capital structure (Corporate Finance Institute, 2020; Frank and Shen 2016).” Response 6: Thank you for your feedback on the repetitive content in the introduction. We have addressed this issue by removing the repetitive text from the introduction and keeping it only in the background section (page 3), as you suggested. Specifically, we have deleted the following paragraph from the introduction: " To create value for its creditors and shareholders, a firm needs to earn a minimum re-turn that covers its financing costs. This return is the cost of capital, which has two com-ponents: the cost of debt and the cost of equity. The former represents the interest rate borne by the firm on its borrowed funds, while the latter signifies the return anticipated by investors for acquiring its shares. The weighted average cost of capital (WACC) encapsulates the firm's overall cost of capital, incorporating the relative proportions of debt and equity within its capital structure (Corporate Finance Institute, 2020; Frank and Shen 2016). The cost of capital plays a pivotal position in corporate financial decision-making, significantly influencing optimal capital structure choices, capital budgeting decisions, financing alternatives, and overall financial performance. Companies can maximize their value and that of their stakeholders by comparing the cost of capital with expected returns and aligning their investments with their financing mix of debt and equity. Therefore, companies should understand the significant effect of the cost of capital on various aspects of decision-making (Frank and Shen, 2016). "Instead, we have retained this content in the background section under the subsection "2.1. ESG Reporting and Cost of Capital", where it provides relevant context for the study. By making this change, we have addressed your concern about the repetitive nature of this information and ensured that it is presented only once in the appropriate section of the paper.   Comment 7: Author stated that “Some studies have also explored how corporate governance moderates the interaction amongst ESG reporting and the cost of capital, namely, Ng and Rezaee (2015)” So what is the contribution of this study? Response 7:  Thank you for your feedback. The key contributions of this study are indeed outlined in the background and research questions sections. Here's a concise summary: ( •          Theoretical Framework: We utilize various lenses like stakeholder and legitimacy theories to examine the link between ESG disclosure and cost of capital. We also explore the moderating effect of corporate governance on this relationship, building upon prior work by Ng and Rezaee (2015). •          Empirical Evidence: Unlike prior studies, we focus on the UK non-financial sector and employ a robust research design to provide empirical evidence on the moderating role of corporate governance. •          Impactful Insights: The findings will benefit investors, companies, policymakers, and academia by highlighting the importance of ESG disclosure and strong governance for financial performance, risk reduction, reputation, and sustainability initiatives. By addressing the research questions on ESG disclosure, cost of capital, and the moderating effect of governance, this study aims to bridge the gap in the existing literature, particularly within the UK context. We hope this revised summary clarifies the study's contributions. Comments 8: What does the following argument mean? Need more explanation? What was lacking in the previous research that this study particularly focused on “The current literature on ESG reporting and how it influences the cost of capital is unclear and scarce, as it relies on different measures and sources of ESG information and does not account for the role of corporate governance”. Response 8: Thank you for your feedback and for pushing me to further clarify the contribution of this study. The key contributions are indeed outlined in the background and research questions sections, but here's a more explicit summary: The study examines the relationship between ESG reporting, corporate governance, and cost of capital in the UK non-financial sector. While prior research, like Ng and Rezaee (2015), has explored the moderating effect of corporate governance on this relationship, there's a gap in the literature regarding the explicit connection between these variables in the UK context. This study aims to bridge that gap by: 1.         Examining the direct impact of ESG reporting on the cost of capital for UK non-financial firms 2.         Investigating how corporate governance moderates the relationship between ESG disclosure and cost of capital in this specific context By focusing on UK non-financial firms, the study provides new empirical evidence on how corporate governance influences the financial implications of ESG reporting within this under-researched sector. Comments 9: These are the 3 gaps that authors stated that their study addressed ·       How does ESG reporting affect the cost of capital for companies in different countries and industries?  ·        How does corporate governance moderate the association amongst ESG reporting and the cost of capital? ·       What are the implications of ESG disclosure and corporate governance for financial 189 decision-making and value creation? Given these, how many countries are included in this study to address the first gap? What is the hypothesis for first one and third one? Response 9: Thank you for your feedback on the gaps addressed by our study. We understand that you are concerned about the scope of the study. To clarify, our study focuses exclusively on the UK non-financial sector and does not generalize its findings to other countries. Given this context, I propose the following changes: (page 5) •          Delete the first gap: "How does ESG reporting affect the cost of capital for companies in different countries and industries?" and replace it with "How does ESG reporting affect the cost of capital for companies in the UK?" •          Clarify the scope: Emphasize that the study's findings are specific to the UK context and may not be generalized to other countries. By making these changes, we ensure that the study's scope and findings are accurately represented, addressing your concerns about the gaps addressed. Please let me know if you have any further questions or suggestions.   Comments 10: The Legitimacy Theory is mentioned on page 5 but is not discussed in the background of the study. The authors need to elaborate more on the theoretical justification of their proposed relationships. While the topic is important and the theories appear relevant, the discussion lacks the depth necessary to provide adequate justification. Response 10: Thank you for your feedback on our manuscript. We appreciate you highlighting the need for a more detailed discussion of Legitimacy Theory in the background section. We have addressed this by elaborating on the theory and its connection to our proposed relationships. As you'll see in the revised section (page 5), we now provide a clearer explanation of Legitimacy Theory, including: •          A definition of the theory and its core principles (firms strive for legitimacy by aligning with societal expectations). •          A connection between Legitimacy Theory and the use of ESG reporting as a tool for demonstrating social responsibility and accountability. •          A justification for how improved stakeholder perception through ESG disclosure can lead to a lower cost of capital, with specific mechanisms outlined: o          Mitigating agency costs by reducing information asymmetry (Fama & Jensen, 1983; Jensen & Meckling, 1976). o          Lowering political costs associated with negative stakeholder perception and potential regulatory actions (Patten, 1992; Watts & Zimmerman, 1986). o          Reducing litigation risks by demonstrating proactive management of social and environmental impacts (Skinner, 1994; Karpoff et al., 2005). •          An acknowledgment of the importance of disclosure quality and how corporate governance practices influence it. We believe these revisions address your comment about the theoretical justification for our proposed relationships. Comments 11: The number of observations for each variable are different. Authors should discuss more about the type of data used.   Response 11:  Thank you for your insightful comments regarding the differences in observations for the variables presented in the regression analysis and the descriptive statistics. We appreciate your attention to detail, and we have made the following clarifications and adjustments in the revised manuscript to address this issue: Revised Descriptive Statistics: We have conducted a new analysis of the descriptive statistics based solely on the observations used in the regression models (n=886). This analysis accounts for the missing data for each variable and provides a more accurate representation of the sample utilized in the regression analysis. The updated descriptive statistics are now included in the manuscript. Discussion of Data Type: We have added a discussion in the methodology section that explains the nature of the data used in the analysis. Specifically, we clarify that the differences in observations arise from the exclusion of firms with incomplete data for certain variables. This ensures that the analysis is based on a consistent and reliable dataset. Impact on Analysis: We have acknowledged how the varying number of observations for different variables may impact the robustness of the analysis. The revised text discusses the importance of ensuring that the sample size for each variable is adequate to draw meaningful conclusions and how this may affect the generalizability of the findings. Addressing Potential Biases: We have also discussed potential biases that may arise from the differences in observations and how these biases were mitigated. For example, we cross-checked data from multiple sources to ensure accuracy and consistency. Clarification in Results Section: In the results section, we have made it clear that the regression analysis was conducted on the subset of firms that had complete data for all relevant variables. This is now explicitly stated to avoid confusion regarding the number of observations used in the regression models. By making these clarifications and adjustments, we aim to enhance the transparency of our methodology and the robustness of our findings. We believe these revisions will address your concerns and improve the overall quality of the manuscript. Please let us know if you have any further comments or suggestions.

 

Author Response File: Author Response.docx

Reviewer 2 Report

Comments and Suggestions for Authors

Dear authors,

The topic is interesting; however, it should be improved by addressing the following issues:

Major comments:

1.       Title and Abstract:

·         The abstract should clearly state the main objective of the study right at the beginning.

·         A brief mention of the methodology used (e.g., type of data analysis, regression models, etc.) is missing. This helps readers understand how the conclusions were derived.

·         The abstract should summarize the key findings in a more structured manner, distinguishing primary and secondary findings more clearly.

·         A more explicit statement on the practical implications of the findings for different stakeholders (e.g., how investors or policymakers might use this information) would be beneficial.

 

2.       Introduction

·         The introduction should clearly articulate the primary objectives of the study at the beginning. This helps to set the stage for the reader and contextualize the rest of the introduction.

·         While the introduction mentions previous research and theories, it lacks a coherent narrative that integrates these studies into the context of the current research. A more detailed literature review section would help situate the study within the existing body of knowledge.

·         The introduction should more explicitly state the research gap that this study aims to fill and the unique contribution it makes to the field of ESG reporting and financial performance.

·         Although Stakeholder Theory and Legitimacy Theory are mentioned, the introduction does not clearly explain how these theories underpin the study. A more explicit connection between the theoretical framework and the research questions would strengthen the introduction.

·         The hypotheses should be clearly and explicitly stated in the introduction. Currently, the hypotheses are implied but not clearly delineated.

·         The introduction has some redundant information that could be streamlined. For example, the effects of firm size, liquidity, profitability, and leverage on the cost of capital are mentioned multiple times.

3.       Background Study and Formulation of Hypotheses

·         The section should better integrate the literature review with the conceptual framework. The current section lists studies without a clear narrative or connection to the hypotheses.

·         Clearly articulate the gaps in the existing literature that this study aims to address. Although some gaps are mentioned, they should be highlighted more explicitly.

·         The hypotheses need to be more clearly developed from the theoretical framework. The link between the literature review and the hypotheses should be more explicit.

·         The section lacks coherence, jumping between different topics and studies. It should flow logically from a discussion of ESG reporting, to the cost of capital, to the theoretical framework, and finally to the hypotheses.

·         The background should provide a comprehensive overview of ESG reporting, cost of capital, and corporate governance, including definitions and context where necessary.

 

4.       Methodology

·         The methodology should provide a clear rationale for choosing the sample period (2014-2018) and explain why these specific years were selected.

·         Explicitly mention the inclusion and exclusion criteria for the sample selection, detailing how non-financial companies were chosen and if any specific criteria were applied.

·         While the data sources (Bloomberg and Eikon) are mentioned, there should be a discussion on the validation of these data sources, including any potential biases and how they were addressed.

·         Table 1 lists variable definitions, but some definitions lack specificity or standard references. For instance, ESG scores are mentioned as sourced from Bloomberg but should detail the scoring methodology and criteria.

·         Provide a clear rationale for choosing the regression models and discuss why interaction terms were included in the second model. The rationale for using PCA should be better connected to the overall research aims.

·         Clearly explain why certain control variables were chosen and how they are relevant to the study. Justify the inclusion of each control variable with references to prior literature or theoretical considerations.

·         Discuss the assumptions underlying the regression models (e.g., linearity, normality, homoscedasticity) and how they will be tested. Mention any diagnostic tests that will be conducted to ensure the validity of the models.

·         Identify potential limitations or biases in the data collection and analysis process, and describe how these will be mitigated.

 

5.       Empirical Evidence

·         The section should begin with an introduction that briefly explains what will be covered in the empirical evidence section, including the objectives and the structure.

·         The section mentions hypotheses in passing, but it lacks a clear and explicit statement of the hypotheses being tested. These should be clearly formulated and presented before diving into the analysis.

·         While the descriptive statistics are provided, there is minimal interpretation. The text should discuss what these statistics imply about the data, highlighting any interesting patterns or outliers.

·         There is a brief mention of pairwise correlations, but it lacks depth. The text should discuss the implications of these correlations for the hypotheses and the potential issues they might indicate (e.g., multicollinearity).

·         The section lists the regression models used (OLS, fixed effects, robust regression, and Tobit), but it lacks justification for why these specific models were chosen. Each model’s relevance and advantages should be briefly explained.

·         While a robustness check is mentioned, the methodology and rationale behind using the Environment Pillar Score (ENVP) as an alternative indicator are not thoroughly explained. Details on how this robustness check was performed and why it is relevant would strengthen the section.

·         The results in Table 4 and subsequent tables should be clearly discussed in the text.

·         The interpretation of the regression results is somewhat superficial. The section should delve deeper into what these results imply for the research questions and the broader literature on ESG and financial performance.

·         While the text mentions that multicollinearity is not a significant issue, it should provide more details, such as the actual VIF values, to substantiate this claim.

·         The discussion on governance as a moderator is too brief. A more detailed explanation of the interaction effects and their implications for the hypotheses would be beneficial.

 

6.       Discussion

·         The initial interpretation of results suggests that higher ESG disclosure raises the cost of capital and lowers performance, contradicting the stakeholder theory. However, it then states that ESG disclosure increases investor confidence and lowers the cost of capital, leading to confusion. These statements need to be reconciled for clarity.

·         The discussion on the short-term link between ESG disclosure and increased cost of capital could benefit from clearer explanation, particularly regarding why these effects might be short-term and how long-term benefits could eventually outweigh these costs.

·         While the study acknowledges that it only finds a correlation between ESG reporting and cost of capital, more emphasis on this limitation would strengthen the discussion. Suggesting potential methodologies for establishing causation in future research could also be valuable.

·         While alternative theories like information asymmetry are mentioned, the discussion would benefit from a broader range of theoretical perspectives. For instance, the role of signaling theory in ESG disclosure could be explored more thoroughly.

·         The section discusses how better governance practices lower the cost of capital by ensuring more reliable ESG disclosure. However, it could delve deeper into specific governance mechanisms that enhance disclosure quality and their empirical support.

·         Citing more studies that support the finding that governance negatively moderates the impact of ESG on the cost of capital would strengthen the argument.

·         The practical insights section could benefit from more detailed and actionable recommendations. For example, specifying which ESG reporting standards and governance mechanisms are most effective would be useful for practitioners.

·         While the discussion addresses multiple stakeholders, tailoring recommendations for each group (e.g., firms, regulators, investors) with specific examples would enhance its practical relevance.

·         While the control variables are discussed, the analysis would benefit from a more comprehensive examination of other potential factors influencing the cost of capital, such as macroeconomic conditions or sector-specific dynamics.

·         Clearly distinguishing between the interpretation of results, theoretical insights, practical implications, and future research within separate subsections would improve readability.

·         Some points, such as the role of governance in ESG disclosure, are repeated. Streamlining the discussion to avoid redundancy would enhance clarity.

·         Providing more specific future research directions, such as exploring the role of different types of ESG disclosures (environmental, social, governance) separately or investigating sector-specific effects, would be beneficial.

 

7.       Conclusions

·         The section mentions both a positive significant effect of ESG disclosure on the cost of capital and a negative moderating effect of governance. This should be more clearly explained to avoid confusion.

·         While the section mentions implications for various domains, it lacks specific details on what those implications are. For instance, how exactly does the study inform policy-making or financial decision-making?

·         Providing actionable recommendations for practitioners, policymakers, and researchers based on the findings would enhance the practical relevance of the conclusions.

·         The section mentions future research but lacks specific suggestions. For example, what other contexts should be studied? What specific factors or conditions should future research investigate?

·         Suggest exploring additional theories or frameworks that could be relevant to the ESG disclosure-cost of capital relationship.

·         The limitations are mentioned briefly and could benefit from a more detailed discussion. What specific aspects of the sample or methodology could limit the generalizability of the findings?

 

·         Suggest ways for future research could address these limitations. For instance, how could future studies incorporate a more diverse sample or different methodological approaches?

Author Response

 

Response to Reviewer 2 Comments:
1. Summary
Thank you for your thorough review of this manuscript. Enclosed, you will find detailed responses to your comments, along with the corresponding revisions and corrections, which are highlighted and tracked in the re-submitted files.
2. Point-by-point response to Comments and Suggestions for Authors Comments 2:

Comments and Suggestions for Authors:

Dear authors,

The topic is interesting; however, it should be improved by addressing the following issues:

Major comments:

1. Title and Abstract:

• The abstract should clearly state the main objective of the study right at the beginning.
• A brief mention of the methodology used (e.g., type of data analysis, regression models, etc.) is missing. This helps readers understand how the conclusions were derived.
• The abstract should summarize the key findings in a more structured manner, distinguishing primary and secondary findings more clearly.
• A more explicit statement on the practical implications of the findings for different stakeholders (e.g., how investors or policymakers might use this information) would be beneficial.

 

2. Introduction

• The introduction should clearly articulate the primary objectives of the study at the beginning. This helps to set the stage for the reader and contextualize the rest of the introduction.
• While the introduction mentions previous research and theories, it lacks a coherent narrative that integrates these studies into the context of the current research. A more detailed literature review section would help situate the study within the existing body of knowledge.
• The introduction should more explicitly state the research gap that this study aims to fill and the unique contribution it makes to the field of ESG reporting and financial performance.
• Although Stakeholder Theory and Legitimacy Theory are mentioned, the introduction does not clearly explain how these theories underpin the study. A more explicit connection between the theoretical framework and the research questions would strengthen the introduction.
• The hypotheses should be clearly and explicitly stated in the introduction. Currently, the hypotheses are implied but not clearly delineated.
• The introduction has some redundant information that could be streamlined. For example, the effects of firm size, liquidity, profitability, and leverage on the cost of capital are mentioned multiple times.

3. Background Study and Formulation of Hypotheses

• The section should better integrate the literature review with the conceptual framework. The current section lists studies without a clear narrative or connection to the hypotheses.
• Clearly articulate the gaps in the existing literature that this study aims to address. Although some gaps are mentioned, they should be highlighted more explicitly.
• The hypotheses need to be more clearly developed from the theoretical framework. The link between the literature review and the hypotheses should be more explicit.
• The section lacks coherence, jumping between different topics and studies. It should flow logically from a discussion of ESG reporting, to the cost of capital, to the theoretical framework, and finally to the hypotheses.
• The background should provide a comprehensive overview of ESG reporting, cost of capital, and corporate governance, including definitions and context where necessary.

 

4. Methodology

• The methodology should provide a clear rationale for choosing the sample period (2014-2018) and explain why these specific years were selected.
• Explicitly mention the inclusion and exclusion criteria for the sample selection, detailing how non-financial companies were chosen and if any specific criteria were applied.
• While the data sources (Bloomberg and Eikon) are mentioned, there should be a discussion on the validation of these data sources, including any potential biases and how they were addressed.
• Table 1 lists variable definitions, but some definitions lack specificity or standard references. For instance, ESG scores are mentioned as sourced from Bloomberg but should detail the scoring methodology and criteria.
• Provide a clear rationale for choosing the regression models and discuss why interaction terms were included in the second model. The rationale for using PCA should be better connected to the overall research aims.
• Clearly explain why certain control variables were chosen and how they are relevant to the study. Justify the inclusion of each control variable with references to prior literature or theoretical considerations.
• Discuss the assumptions underlying the regression models (e.g., linearity, normality, homoscedasticity) and how they will be tested. Mention any diagnostic tests that will be conducted to ensure the validity of the models.
• Identify potential limitations or biases in the data collection and analysis process, and describe how these will be mitigated.

 

5. Empirical Evidence

• The section should begin with an introduction that briefly explains what will be covered in the empirical evidence section, including the objectives and the structure.
• The section mentions hypotheses in passing, but it lacks a clear and explicit statement of the hypotheses being tested. These should be clearly formulated and presented before diving into the analysis.
• While the descriptive statistics are provided, there is minimal interpretation. The text should discuss what these statistics imply about the data, highlighting any interesting patterns or outliers.
• There is a brief mention of pairwise correlations, but it lacks depth. The text should discuss the implications of these correlations for the hypotheses and the potential issues they might indicate (e.g., multicollinearity).
• The section lists the regression models used (OLS, fixed effects, robust regression, and Tobit), but it lacks justification for why these specific models were chosen. Each model’s relevance and advantages should be briefly explained.
• While a robustness check is mentioned, the methodology and rationale behind using the Environment Pillar Score (ENVP) as an alternative indicator are not thoroughly explained. Details on how this robustness check was performed and why it is relevant would strengthen the section.
• The results in Table 4 and subsequent tables should be clearly discussed in the text.
• The interpretation of the regression results is somewhat superficial. The section should delve deeper into what these results imply for the research questions and the broader literature on ESG and financial performance.
• While the text mentions that multicollinearity is not a significant issue, it should provide more details, such as the actual VIF values, to substantiate this claim.
• The discussion on governance as a moderator is too brief. A more detailed explanation of the interaction effects and their implications for the hypotheses would be beneficial.

 

6. Discussion

• The initial interpretation of results suggests that higher ESG disclosure raises the cost of capital and lowers performance, contradicting the stakeholder theory. However, it then states that ESG disclosure increases investor confidence and lowers the cost of capital, leading to confusion. These statements need to be reconciled for clarity.
• The discussion on the short-term link between ESG disclosure and increased cost of capital could benefit from clearer explanation, particularly regarding why these effects might be short-term and how long-term benefits could eventually outweigh these costs.
• While the study acknowledges that it only finds a correlation between ESG reporting and cost of capital, more emphasis on this limitation would strengthen the discussion. Suggesting potential methodologies for establishing causation in future research could also be valuable.
• While alternative theories like information asymmetry are mentioned, the discussion would benefit from a broader range of theoretical perspectives. For instance, the role of signaling theory in ESG disclosure could be explored more thoroughly.
• The section discusses how better governance practices lower the cost of capital by ensuring more reliable ESG disclosure. However, it could delve deeper into specific governance mechanisms that enhance disclosure quality and their empirical support.
• Citing more studies that support the finding that governance negatively moderates the impact of ESG on the cost of capital would strengthen the argument.
• The practical insights section could benefit from more detailed and actionable recommendations. For example, specifying which ESG reporting standards and governance mechanisms are most effective would be useful for practitioners.
• While the discussion addresses multiple stakeholders, tailoring recommendations for each group (e.g., firms, regulators, investors) with specific examples would enhance its practical relevance.
• While the control variables are discussed, the analysis would benefit from a more comprehensive examination of other potential factors influencing the cost of capital, such as macroeconomic conditions or sector-specific dynamics.
• Clearly distinguishing between the interpretation of results, theoretical insights, practical implications, and future research within separate subsections would improve readability.
• Some points, such as the role of governance in ESG disclosure, are repeated. Streamlining the discussion to avoid redundancy would enhance clarity.
• Providing more specific future research directions, such as exploring the role of different types of ESG disclosures (environmental, social, governance) separately or investigating sector-specific effects, would be beneficial.

 

7. Conclusions

• The section mentions both a positive significant effect of ESG disclosure on the cost of capital and a negative moderating effect of governance. This should be more clearly explained to avoid confusion.
• While the section mentions implications for various domains, it lacks specific details on what those implications are. For instance, how exactly does the study inform policy-making or financial decision-making?
• Providing actionable recommendations for practitioners, policymakers, and researchers based on the findings would enhance the practical relevance of the conclusions.
• The section mentions future research but lacks specific suggestions. For example, what other contexts should be studied? What specific factors or conditions should future research investigate?
• Suggest exploring additional theories or frameworks that could be relevant to the ESG disclosure-cost of capital relationship.
• The limitations are mentioned briefly and could benefit from a more detailed discussion. What specific aspects of the sample or methodology could limit the generalizability of the findings?

 

• Suggest ways for future research could address these limitations. For instance, how could future studies incorporate a more diverse sample or different methodological approaches?

 

 

Comments 1: Title and Abstract:  

The abstract should clearly state the main objective of the study right at the beginning.  

• A brief mention of the methodology used (e.g., type of data analysis, regression models, etc.) is missing. This helps readers understand how the conclusions were derived
• The abstract should summarize the key findings in a more structured manner, distinguishing primary and secondary findings more clearly
• A more explicit statement on the practical implications of the findings for different stakeholders (e.g., how investors or policymakers might use this information) would be beneficial

 

Response1: Thank you for your detailed feedback on the title and abstract of our paper. We appreciate your suggestions for improving the clarity and structure of the abstract. We have made the following revisions to address your comments: (page 1)

Title and Abstract:

Main Objective: We have rewritten the abstract to clearly state the main objective of the study at the beginning. The revised abstract now starts with a concise statement of the research question.

Methodology: We have included a brief mention of the methodology used in the study. This helps readers understand how the conclusions were derived.

Key Findings: We have structured the abstract to summarize the key findings in a more organized manner, distinguishing primary and secondary findings more clearly.

Practical Implications: We have added a more explicit statement on the practical implications of the findings for different stakeholders, such as investors, companies, regulators, auditors, and policymakers.

The revised abstract is as follows:

Abstract:

This research examines the effect of ESG disclosure on the cost of capital for non-financial firms in the UK, indexed on the FTSE All Share Index, during the period from 2014 to 2018. Using multivariate analysis with ordinary least squares (OLS), fixed effects, robust regression, and Tobit models, the research assesses the effect of ESG reporting, governance, and cost of capital, including robustness checks with an alternative ESG indicator, the Environment Pillar Score. Contrary to expectations, ESG reporting is positively associated with the cost of capital. However, corporate governance moderates this relationship, weakening the positive correlation and reversing it to a negative as-sociation for firms with strong governance practices, consistent with the hypotheses. The research also finds that firm size, liquidity, profitability, and leverage positively affect the cost of capital, while board size, independent board composition, audit committee independence, and auditor type do not significantly influence it. Notably, non-executive directors on the audit committee have a significant negative effect on the cost of capital.

These findings are valuable for investors, companies, regulators, auditors, policymakers, and the academic and research community. Specifically, for investors, the study provides insights into how ESG disclosures can influence investment risks and returns, highlighting the importance of robust corporate governance. Companies can leverage these insights to enhance their governance practices and optimize their capital costs. Regulators and policymakers can use the findings to develop guidelines that encourage transparent ESG reporting and strong governance frameworks, thereby improving market stability and investor confidence. Auditors can utilize the results to better un-derstand the effect of non-financial reporting on financial metrics, aiding in more accurate audits and assessments. These findings inform investors, companies, regulators, auditors, and academia, fos-tering a more sustainable and transparent financial environment.

We believe these revisions have improved the clarity and relevance of the abstract, making it more accessible and informative to a wider audience. Please let us know if you have any further comments or suggestions.

Comments 2: Introduction   

• The introduction should clearly articulate the primary objectives of the study at the beginning. This helps to set the stage for the reader and contextualize the rest of the introduction
• While the introduction mentions previous research and theories, it lacks a coherent narrative that integrates these studies into the context of the current research. A more detailed literature review section would help situate the study within the existing body of knowledge
• The introduction should more explicitly state the research gap that this study aims to fill and the unique contribution it makes to the field of ESG reporting and financial performance.
• Although Stakeholder Theory and Legitimacy Theory are mentioned, the introduction does not clearly explain how these theories underpin the study. A more explicit connection between the theoretical framework and the research questions would strengthen the introduction
• The hypotheses should be clearly and explicitly stated in the introduction. Currently, the hypotheses are implied but not clearly delineated.
• The introduction has some redundant information that could be streamlined. For example, the effects of firm size, liquidity, profitability, and leverage on the cost of capital are mentioned multiple times.

Response 2: Thank you for your valuable feedback on the introduction section. We appreciate your suggestions for improving the clarity, coherence, and relevance of the introduction. We have carefully considered your comments and made the following revisions to address your concerns:

1. Articulation of Primary Objectives: We have rewritten the introduction to clearly state the primary objectives of the study at the beginning. The revised introduction now opens with a concise statement of the research questions and hypotheses, providing a clear roadmap for the reader.
2. Narrative Integration of Literature: We have enhanced the introduction with a more detailed literature review section. This section now provides a more coherent narrative that situates the current study within the existing body of knowledge on ESG reporting and financial performance. We have incorporated relevant previous studies to build a stronger foundation for our research.
3. Articulation of Research Gap: We have more explicitly stated the research gap that this study aims to fill and the unique contribution it makes to the field of ESG reporting and cost of capital. The revised introduction clearly identifies the void in the existing literature regarding the explicit connection between ESG reporting and cost of capital, as well as the moderating impact of corporate governance in the UK context.
4. Theoretical Framework Connection: We have strengthened the connection between the theoretical framework (stakeholder theory and legitimacy theory) and the research questions. The revised introduction now provides a clearer explanation of how these theories underpin the study and guide the formulation of the hypotheses.
5. Explicit Statement of Hypotheses: We have clearly and explicitly stated the hypotheses in the introduction. The hypotheses are now clearly delineated, rather than being implied.
6. Streamlining of Redundant Information: We have streamlined the introduction by removing redundant information. For example, the effects of firm size, liquidity, profitability, and leverage on the cost of capital are now mentioned only once in the appropriate context.

We believe these revisions have significantly improved the clarity, coherence, and relevance of the introduction, providing a stronger foundation for the rest of the paper. Please let us know if you have any further comments or suggestions.

Comments 3: Background Study and Formulation of Hypotheses:

• The section should better integrate the literature review with the conceptual framework. The current section lists studies without a clear narrative or connection to the hypotheses.
• Clearly articulate the gaps in the existing literature that this study aims to address. Although some gaps are mentioned, they should be highlighted more explicitly.
• The hypotheses need to be more clearly developed from the theoretical framework. The link between the literature review and the hypotheses should be more explicit.
• The section lacks coherence, jumping between different topics and studies. It should flow logically from a discussion of ESG reporting, to the cost of capital, to the theoretical framework, and finally to the hypotheses.
• The background should provide a comprehensive overview of ESG reporting, cost of capital, and corporate governance, including definitions and context where necessary.

Response 3: Thank you for your valuable feedback on our manuscript. We have made significant revisions to the Background Study and Formulation of Hypotheses section to better address your comments:

1. We have rearranged the section to flow more logically from a discussion of ESG reporting, to the cost of capital, to the theoretical framework, and finally to the hypotheses.
2. The gaps in the existing literature have been highlighted more prominently in the introduction and at the beginning of this section.
3. We have explicitly stated how stakeholder theory supports H1 and how legitimacy theory supports H2, making the link between theory and hypotheses clearer.
4. Definitions of key concepts like ESG reporting, cost of capital, and corporate governance has been added, along with more context on their importance and relevance to the study.

We believe these revisions have significantly improved the coherence and clarity of this section. The literature review is now better integrated with the conceptual framework, and the hypotheses are more clearly developed from the theoretical underpinnings.

 

Comments 4: Methodology

• The methodology should provide a clear rationale for choosing the sample period (2014-2018) and explain why these specific years were selected.
• Explicitly mention the inclusion and exclusion criteria for the sample selection, detailing how non-financial companies were chosen and if any specific criteria were applied.
• While the data sources (Bloomberg and Eikon) are mentioned, there should be a discussion on the validation of these data sources, including any potential biases and how they were addressed.
• Table 1 lists variable definitions, but some definitions lack specificity or standard references. For instance, ESG scores are mentioned as sourced from Bloomberg but should detail the scoring methodology and criteria.
• Provide a clear rationale for choosing the regression models and discuss why interaction terms were included in the second model. The rationale for using PCA should be better connected to the overall research aims.
• Clearly explain why certain control variables were chosen and how they are relevant to the study. Justify the inclusion of each control variable with references to prior literature or theoretical considerations.
• Discuss the assumptions underlying the regression models (e.g., linearity, normality, homoscedasticity) and how they will be tested. Mention any diagnostic tests that will be conducted to ensure the validity of the models.
• Identify potential limitations or biases in the data collection and analysis process, and describe how these will be mitigated.

Response 4: Methodology

Thank you for your valuable feedback on the methodology section. We appreciate your suggestions for improving the clarity, justification, and rigor of our methodological approach. We have carefully considered your comments and made the following revisions to address your concerns:

1. Sample Period Rationale: We have provided a clear rationale for choosing the sample period from 2014 to 2018. The revised methodology section now explains that this period was selected to capture the recent trends in ESG reporting and its impact on the cost of capital in the UK non-financial sector, while ensuring data availability and consistency.
2. Sample Selection Criteria: We have explicitly mentioned the inclusion and exclusion criteria for the sample selection. The revised section details how non-financial companies were chosen based on the exclusion of firms in the financial sector due to their distinct regulatory and financial structures. Companies with incomplete data for the period were also excluded to ensure consistency and reliability.
3. Data Source Validation: We have added a discussion on the validation of the Bloomberg and Eikon data sources. The revised section explains how we cross-checked the data from these sources with other publicly available information, such as company reports and regulatory filings, to ensure the accuracy and consistency of the data used in the analysis. Any potential biases in the data sources are also acknowledged and addressed.
4. Variable Definitions: Table 1 has been updated to provide more specific definitions and standard references for the variables, particularly the ESG scores. The scoring methodology and criteria used by Bloomberg are now clearly explained.
5. Regression Model Rationale: We have provided a clearer rationale for choosing the regression models and the inclusion of interaction terms in the second model. The revised section explains how the interaction term allows us to explore the moderating effect of governance on the relationship between ESG disclosure and the cost of capital. The rationale for using PCA is now better connected to the overall research aims, highlighting its ability to consolidate governance variables and address concerns related to multicollinearity and measurement error.
6. Control Variable Justification: We have clearly explained the choice of control variables and their relevance to the study. The revised section justifies the inclusion of each control variable with references to prior literature or theoretical considerations, such as their established relevance in determining the cost of capital and factors influencing the relationship between ESG disclosure and financial performance.
7. Model Assumptions and Diagnostics: We have discussed the assumptions underlying the regression models (e.g., linearity, normality, homoscedasticity) and how they will be tested. The revised section mentions the diagnostic tests that will be conducted to ensure the validity of the models, such as tests for multicollinearity, heteroscedasticity, and autocorrelation.
8. Limitations and Biases: We have identified potential limitations or biases in the data collection and analysis process, and described how these will be mitigated. The revised methodology section acknowledges the limitations of the data sources and the potential for omitted variable bias in the regression models, while outlining strategies to address these issues.

Comments 5 Empirical Evidence:  

• The section should begin with an introduction that briefly explains what will be covered in the empirical evidence section, including the objectives and the structure.
• The section mentions hypotheses in passing, but it lacks a clear and explicit statement of the hypotheses being tested. These should be clearly formulated and presented before diving into the analysis.
• While the descriptive statistics are provided, there is minimal interpretation. The text should discuss what these statistics imply about the data, highlighting any interesting patterns or outliers
• There is a brief mention of pairwise correlations, but it lacks depth. The text should discuss the implications of these correlations for the hypotheses and the potential issues they might indicate (e.g., multicollinearity).
• The section lists the regression models used (OLS, fixed effects, robust regression, and Tobit), but it lacks justification for why these specific models were chosen. Each model’s relevance and advantages should be briefly explained.
• While a robustness check is mentioned, the methodology and rationale behind using the Environment Pillar Score (ENVP) as an alternative indicator are not thoroughly explained. Details on how this robustness check was performed and why it is relevant would strengthen the section.
• The results in Table 4 and subsequent tables should be clearly discussed in the text.
• The interpretation of the regression results is somewhat superficial. The section should delve deeper into what these results imply for the research questions and the broader literature on ESG and financial performance.
• While the text mentions that multicollinearity is not a significant issue, it should provide more details, such as the actual VIF values, to substantiate this claim.
• The discussion on governance as a moderator is too brief. A more detailed explanation of the interaction effects and their implications for the hypotheses would be beneficial.

Response 5: Empirical Evidence

Thank you for your detailed feedback on the Empirical Evidence section. We appreciate your suggestions for improving the clarity, structure, and depth of the analysis and interpretation. We have carefully considered your comments and made the following revisions to address your concerns:

1. Introduction and Objectives: We have added an introductory paragraph to the Empirical Evidence section that clearly outlines the objectives of this section and the structure of the analysis. This provides the reader with a roadmap of what to expect in the subsequent subsections.
2. Hypothesis Formulation: We have explicitly stated the two hypotheses being tested in this study at the beginning of the Empirical Evidence section. This ensures that the reader is aware of the specific predictions being examined through the analysis.
3. Descriptive Statistics Interpretation: We have expanded the discussion of the descriptive statistics to provide more interpretation of the data. The revised section now highlights key patterns, such as the relatively high mean WACC, the moderate levels of ESG disclosure, and the diverse range of firm characteristics within the sample.
4. Pairwise Correlations Analysis: The pairwise correlations section has been enhanced to provide a more in-depth discussion of the implications for the hypotheses and the potential multicollinearity issues. We have explicitly addressed how the positive correlation between ESG Score and WACC contradicts the first hypothesis and the need for further regression analysis to understand the relationship.
5. Regression Model Justification: We have added more details on the rationale for choosing the specific regression models (OLS, fixed effects, robust regression, and Tobit). The revised section explains how these models address the panel structure of the data, the non-negative nature of the dependent variable, and the need to account for potential biases.
6. Robustness Check Explanation: The methodology and rationale behind the robustness check using the Environmental Pillar Score (ENVP) have been expanded. The revised section provides a clear explanation of why this alternative ESG indicator was chosen and how it contributes to the overall analysis.
7. Regression Results Discussion: The discussion of the regression results in Tables 4 and 5 has been enhanced to provide a more in-depth interpretation of the findings. We have explicitly linked the results to the hypotheses and the broader literature on ESG and financial performance.
8. Multicollinearity Assessment: We have included the actual VIF values in the text to substantiate the claim that multicollinearity is not a significant issue in the data.
9. Governance Moderation Analysis: The discussion on the moderating role of governance has been expanded to provide a more detailed explanation of the interaction effects and their implications for the second hypothesis.

We believe these revisions have significantly improved the clarity, structure, and depth of the Empirical Evidence section, addressing your specific concerns. Please let us know if you have any further comments or suggestions.

 

Comments 6: Discussion

• The initial interpretation of results suggests that higher ESG disclosure raises the cost of capital and lowers performance, contradicting the stakeholder theory. However, it then states that ESG disclosure increases investor confidence and lowers the cost of capital, leading to confusion. These statements need to be reconciled for clarity
• The discussion on the short-term link between ESG disclosure and increased cost of capital could benefit from clearer explanation, particularly regarding why these effects might be short-term and how long-term benefits could eventually outweigh these costs.
• While the study acknowledges that it only finds a correlation between ESG reporting and cost of capital, more emphasis on this limitation would strengthen the discussion. Suggesting potential methodologies for establishing causation in future research could also be valuable
• While alternative theories like information asymmetry are mentioned, the discussion would benefit from a broader range of theoretical perspectives. For instance, the role of signaling theory in ESG disclosure could be explored more thoroughly.
• The section discusses how better governance practices lower the cost of capital by ensuring more reliable ESG disclosure. However, it could delve deeper into specific governance mechanisms that enhance disclosure quality and their empirical support.
• Citing more studies that support the finding that governance negatively moderates the impact of ESG on the cost of capital would strengthen the argument
• The practical insights section could benefit from more detailed and actionable recommendations. For example, specifying which ESG reporting standards and governance mechanisms are most effective would be useful for practitioners.
• While the discussion addresses multiple stakeholders, tailoring recommendations for each group (e.g., firms, regulators, investors) with specific examples would enhance its practical relevance.
• While the control variables are discussed, the analysis would benefit from a more comprehensive examination of other potential factors influencing the cost of capital, such as macroeconomic conditions or sector-specific dynamics.
• Clearly distinguishing between the interpretation of results, theoretical insights, practical implications, and future research within separate subsections would improve readability.
• Some points, such as the role of governance in ESG disclosure, are repeated. Streamlining the discussion to avoid redundancy would enhance clarity.
• Providing more specific future research directions, such as exploring the role of different types of ESG disclosures (environmental, social, governance) separately or investigating sector-specific effects, would be beneficial.

 

Response 6:  Discussion

Thank you for the detailed feedback on the Discussion section. We appreciate your suggestions for improving the clarity, depth, and coherence of the interpretation and implications of our findings. We have carefully considered your comments and made the following revisions to address your concerns:

1. Reconciling Contradictory Statements: We have revised the initial interpretation of results to provide a more coherent and nuanced explanation of the positive relationship between ESG disclosure and the cost of capital. The discussion now acknowledges the short-term nature of this relationship and the potential for long-term benefits to outweigh the initial costs. We have also incorporated alternative theoretical perspectives, such as information asymmetry theory and signaling theory, to better explain the complex dynamics underlying this finding.
2. Emphasis on Correlation vs. Causation: We have added more emphasis on the limitation that the study only establishes a correlation between ESG reporting and the cost of capital, and we have suggested potential methodologies for establishing causation in future research.
3. Broader Theoretical Perspectives: The discussion has been expanded to explore a wider range of theoretical frameworks, including signaling theory, to provide a more comprehensive understanding of the relationship between ESG disclosure and the cost of capital.
4. Governance Mechanisms and Empirical Support: The discussion on the moderating role of governance has been enhanced to provide more details on the specific governance mechanisms that can enhance the credibility and reliability of ESG disclosure, with additional references to supporting empirical studies.
5. Practical Recommendations: The practical insights section has been expanded to provide more detailed and actionable recommendations for different stakeholder groups, such as specifying the most effective ESG reporting standards and governance practices.
6. Examination of Other Factors: The discussion has been expanded to include a more comprehensive examination of other potential factors influencing the cost of capital, such as macroeconomic conditions and sector-specific dynamics.
7. Structural Organization: The discussion has been reorganized into distinct subsections to clearly distinguish the interpretation of results, theoretical insights, practical implications, and future research directions, improving the overall readability and flow of the section.
8. Reduction of Redundancy: We have streamlined the discussion to avoid repetition and enhance the clarity of the presentation.
9. Future Research Directions: The section on future research directions has been expanded to provide more specific and actionable suggestions, such as exploring the role of different types of ESG disclosures and investigating sector-specific effects.

We believe these revisions have significantly improved the clarity, depth, and coherence of the Discussion section, addressing your specific concerns. Please let us know if you have any further comments or suggestions.

Comment 7:    Conclusions

• The section mentions both a positive significant effect of ESG disclosure on the cost of capital and a negative moderating effect of governance. This should be more clearly explained to avoid confusion.
• While the section mentions implications for various domains, it lacks specific details on what those implications are. For instance, how exactly does the study inform policy-making or financial decision-making?
• Providing actionable recommendations for practitioners, policymakers, and researchers based on the findings would enhance the practical relevance of the conclusions.
• The section mentions future research but lacks specific suggestions. For example, what other contexts should be studied? What specific factors or conditions should future research investigate?
• Suggest exploring additional theories or frameworks that could be relevant to the ESG disclosure-cost of capital relationship.
• The limitations are mentioned briefly and could benefit from a more detailed discussion. What specific aspects of the sample or methodology could limit the generalizability of the findings?
• Suggest ways for future research could address these limitations. For instance, how could future studies incorporate a more diverse sample or different methodological approaches?

Response 7:  Conclusions

Thank you for the valuable feedback on the Conclusions section. We appreciate your suggestions for improving the clarity, depth, and practical relevance of the key findings and their implications. We have carefully considered your comments and made the following revisions to address your concerns:

1. Clarity on Contradictory Findings: We have revised the Conclusions section to more clearly explain the seemingly contradictory findings regarding the positive effect of ESG disclosure on the cost of capital and the negative moderating effect of governance. The discussion now provides a more nuanced interpretation of these results, acknowledging the potential short-term nature of the positive relationship and the long-term benefits that may outweigh the initial costs.
2. Detailed Implications for Stakeholders: The Conclusions section has been expanded to provide more specific and actionable implications for the various stakeholder groups, including investors, companies, regulators/policymakers, and auditors. These insights offer concrete recommendations on how each group can leverage the study's findings to inform their decision-making and practices.
3. Suggestions for Future Research: The section on future research directions has been enhanced to include more specific and detailed suggestions. These include exploring different contexts (e.g., other countries, industries), investigating longer-term effects, and incorporating additional theoretical frameworks (e.g., agency theory, resource dependence theory) to further enrich the understanding of the ESG disclosure-cost of capital relationship.
4. Expanded Discussion of Limitations: The limitations of the study have been discussed in more detail, highlighting the potential constraints posed by the focus on non-financial UK firms, the short sample period, and the variations in ESG reporting quality. The revised section also suggests ways in which future research could address these limitations, such as incorporating a more diverse sample and employing different methodological approaches.

We believe these revisions have significantly improved the clarity, depth, and practical relevance of the Conclusions section, addressing your specific concerns. Please let us know if you have any further comments or suggestions.

Author Response File: Author Response.docx

Round 2

Reviewer 2 Report

Comments and Suggestions for Authors

The paper can be published in the present form.