An analyst assesses a company as below average on ESG metrics. All other matters being equal, the analyst is most likely to:

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BlackTom AI · Accepted Answer

When evaluating how ESG performance affects a company’s financing costs, the baseline assumption is that below-average ESG metrics signal higher risk or lower sustainability, which lenders and investors demand compensation for. 
Option 1: assign a PE premium to the stock. This would imply paying more for earnings due to perceived quality or lower risk, which is inconsistent with below-average ESG signals that typically reduce investor confidence and would not justify a premium; instead, you’d expect a discount or higher required return. 
Option 2: increase the company's cost of capital. This aligns with the risk-aware perspective: higher ESG risk can lead to higher funding costs, as lenders may demand higher interest rates on debt and equity investors may require a higher return due to elevated perceived risk. 
Option 3: reduce the company's risk of default in the forecast model. This is contrary to the ESG signal provided. Below-average ESG metrics generally imply greater, not lesser, credit risk, so the forecast would not show a reduced risk of default. 
In summary, ESG underperformance tends to raise both cost of debt and cost of equity through a heightened risk assessment, making the most consistent choice the increase in the cost of capital.

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An analyst assesses a company as below average on ESG metrics. All other matters being equal, the analyst is most likely to:

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