Sustainability Managed against Downside Risk and the Cost of Equity: Evidence in Korea
This study examines the relationship between sustainability managed against downside risk and the cost of equity in the Korean stock market during the 2000–2016 period. We employ downside co-skewness and downside beta as a measure of downside risk, to analyze the cross-sectional relationship between them and average portfolio stock returns. We have also carried out Fama–MacBeth regressions to find the required return for bearing downside risk. The results show that downside co-skewness can be used more effectively than downside beta to explain a cross-section of stock returns or cost of equity. The required premium for bearing downside risk, as measured by downside co-skewness, is approximately 19% per annum in the Korean stock market. This finding suggests that sustainable companies can raise their capital in the form of equity at 19% lower costs, and also implies that increasing sustainability can reduce the cost of capital.