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2. LITERATURE REVIEW

This research aims to gain insight based on empirical evidence and investigate the link between influencing factor
as ESG disclosure to cost of debt in ASEAN, and as to whether its favourable impact does exist. Based on the research
background explained, the research is focused and therefore framed with the following key research questions:
1. Is the firm ESG disclosure beneficial in reducing its cost of debt?
2. Is the firm ESG disclosure beneficial in reducing its cost of debt from debt securities (bond)?
3. Is the firm ESG disclosure of beneficial in reducing its cost of debt from bank borrowing?

Sustainability is associated with the Firm’s credit risk whereby creditors analyze ESG risks, together with financial and
business risks, in their credit selection process that indicates the company’s ability to repay its debt. For instance,
corruption is considered a fundamental factor to evaluate the credit strength and correlated to payment of default.
Creditors also use other ESG information, for instance, Governance factors, to assess an issuer’s willingness to repay its
debt on time. The academic supported the motivations from the company’s management to perform ESG disclosure.
Based on the Signalling/Disclosure theory, in the communication to all stakeholders, firms with superior financial and
non-financial sustainability performance have the incentive to disclose more extensively and choose to signal their
sustainability achievement by issuing ESG reports, in addition to their mandatory financial statements (Lys, Naughton,
& Wang, 2015) and vice versa. Eliwa et al. (2019) suggested that a higher level of ESG disclosure is linked to lower
information asymmetry between borrowing firms and lending institutions, and hence lowers the cost of debt. While
Legitimacy theory suggests that social and environmental sustainability performance is desirable by all stakeholders,
including customers, creditors/financial institutions, society and the environment, although without providing any
solutions for shared value creations among diverged stakeholders (Rezaee, 2016). Myers and Majluf (1984) imply that
leverage increases with the extent of the informational asymmetry. Some advantages for the firms concerning ESG
disclosure practice based on Li, Gong, Zhang dan Koh (2018) are the increase the practice of internal management by
ESG disclosure will strengthen the relationship with shareholders and thus ESG disclosure would increase the company
value in the long term; the availability of ESG information disclosure reduces the asymmetric information between the
company with other stakeholders, as the creditor/financial institutions due to the transparency and visibility of the
firm in conducting its ESG activities, increasing their trustworthiness; and reduced agency costs. However, several prior
studies suggested contradictory results, not only the favourable impact of ESG practices and disclosures on the cost of
debt was found (Eliwa et al., 2019), but some others discovered insignificant or even a positive relationship (Erragragui,
2018; Stellner, Klein, & Zwergel, 2015; Hoepner, Oikonomou, Scholtens, & Schröder, 2016).

2.1 Hypothesis Development
2.1.1 The Association of ESG Disclosure Index on the Cost of Debt
Concerning Erragragui (2018) and similarly Eliwa et al. (2019) that studied the creditor’s perception, the lending
institutions incorporate firm’s ESG information in their credit risk assessment or lending decisions, through the cost
of debt. Additionally, Chauhan & Kumar (2018) suggested that a premium/benefit will be offered to firms revealing
more (quantity-wise) non-financial information. Therefore, this research synthesizes that ESG’s strengths indicated by
its disclosure reduce firms’ cost of debt (negative relationship), although some contradictory previous result found as
explained above. To prove the ESG favourable impact or the negative relationship, this research hypothesizes that in
the credit risk assessment, when the debtor is perceived as less risky (proxied by higher ESG disclosure), consequently,
the Creditor would be willing to lend more with a lower cost of debt, and vice versa. Therefore, the impact (relationship)
is expected to be negative. Based on the reasoning, the hypothesis H1 is developed:

H . The firm ESG disclosure index is negatively associated with the cost of debt.
1
1.1.2 The Association of ESG Disclosure Index on the Bonds YTM and the Bank Loans EIR
Furthermore, in the capital raising, to reach the optimum proportion between equity and debt is inevitable due to the
stockholders and other stakeholders interests. Prior evidence from Fama (1985), Goss and Roberts (2011) and Altman,
Gande & Saunders (2010) showed that the bank loan market is more efficient than the bond market, whereby banks
have superior access to the firm exclusive information and use this in making a lending decision. With the notion,
this research also has specific interest to find the evidence of the different characteristic between the bondholders
and the banks, i.e. the extent that they respond to ESG disclosures in the credit assessment, indicated through the

International Conference on Sustainability 51
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