This study investigates the relation between corporate sustainability performance, corporations' litigation provisions and the yield spread of company issued bonds. Results show a significant negative relation between companies' ESG scores and their bond yield spreads. Most of this effect is accounted to the environmental performance of the company. Furthermore, I find support for a paradigm shift in the perception of sustainability performance. Whereas the effect on the yield spread was positive in years before the financial crisis, this relation turned negative subsequently. Besides that, country and industry facilitate a moderating role in the relationship. A strong ESG performance appears to significantly reduce bond spreads in the Mining industry and in more developed countries. Analyzing the relationship between sustainability performance and litigation provisions, I find that the ESG performance tends to reduce corporations' litigations in the years after 2012. Next to that, the social score has a significant positive relationship with litigation provisions. A mediation and moderation analysis of litigation provisions in the context of sustainability performance and yield spreads did not provide any significant findings. Finally, I conduct an event study attempting to find evidence for a possible causal relationship between sustainability performance and the yield spread.
Table of Contents
1 Introduction
2 Literature Review
2.1 Sustainability and Cost of Debt
2.2 Sustainability and Litigation Risk
3 Data and Methodology
3.1 Sustainability Performance and Corporate Bond Yield Spreads
3.2 Sustainability Performance and Litigation Provisions
3.3 Mediation Analysis of Litigation Provisions
3.4 Moderation Analysis of Litigation Provisions
3.5 Event study: Volkswagen Scandal & Paris Climate Agreement
4 Results
4.1 Descriptive Statistics
4.2 Sustainability Performance and the Corporate Bond Spread
4.2.1 Moderation Analysis: ESG, Time, Bond Spreads
4.2.2 Moderation Analysis: ESG, Industries, Bond Spreads
4.2.3 Moderation Analysis: ESG, Countries, Bond Spreads
4.3 Sustainability Performance and Litigation Provisions
4.3.1 Moderation Analysis: ESG, Time, Litigation Provisions
4.3.2 Moderation Analysis: ESG, Industries, Litigation Provisions
4.3.3 Moderation Analysis: ESG, Countries, Litigation Provisions
4.4 Mediation Analysis: Litigation Provisions
4.5 Moderation Analysis: Litigation Provision
4.6 Event study: Volkswagen Scandal & Paris Climate Agreement
5 Discussion and Limitations
5.1 ESG performance and Cost of Debt
5.2 ESG performance and Litigation Provisions
5.3 Mediation and Moderation Analyses of Litigation Provisions
5.4 Limitations
6 Conclusion
Research Objectives and Focus Areas
This thesis investigates the relationship between corporate sustainability performance (ESG), litigation provisions, and the cost of debt as reflected in corporate bond yield spreads. The primary goal is to determine if stronger sustainability performance reduces bond yield spreads and if this relationship is mediated or moderated by litigation risk, while also examining the causal implications through an event study on the Volkswagen scandal and the Paris Climate Agreement.
- Analysis of the direct relationship between ESG performance and bond yield spreads.
- Examination of the role of litigation provisions as a proxy for litigation risk.
- Investigation of potential mediation and moderation effects of litigation risk on the cost of debt.
- Evaluation of industry and country-specific differences in how capital markets value sustainability.
- Causal inference regarding sustainability and financial performance using an event study approach.
Excerpt from the Book
1 Introduction
Over the last decades, there has been significant research conducted in environmental and financial economics, exploring the relation between corporations’ sustainability performance and their cost of capital. Whereas most studies indicate a negative relationship between sustainability performance and the cost of equity (El Ghoul, Guedhami, Kwok, & Mishra, 2011; Sharfman & Fernando, 2008), the relationship between sustainability performance and the cost of debt remains unclear. Results in this field are often contradicting, with fairly limited on the direction of the relationship (Baran & Zhang, 2012; Bauer & Hann, 2010; Ge & Liu, 2015; Hoepner, Oikonomou, Scholtens, & Schröder, 2016; Menz, 2010; Oikonomou, Brooks, & Pavelin, 2014; Sharfman & Fernando, 2008). In this paper, I investigate this relationship by using a global dataset from 2003 to 2016, trying to answer the following research question: What is the effect of companies’ ESG performance on their yield spread?
To shed light on the relation between sustainability performance, also often referred as ESG performance, and the cost of debt, I aim to look at one of the reasons that may influence the relationship between the two. The variable of interest that is included in this paper is litigation provisions, used as a proxy for litigation risk. Literature in this field often highlights potential effects that strong and weak ESG performances can have on the potential for future litigations (Hong & Kacperczyk, 2009). Therefore, I attempt to answer the following research question: How does ESG performance affect corporations’ litigation risk?
Summary of Chapters
1 Introduction: Introduces the research topic, defines the scope of investigating the link between ESG performance, litigation risk, and bond yield spreads, and presents the central research questions.
2 Literature Review: Reviews existing academic literature regarding sustainability performance in relation to the cost of debt and litigation risk, highlighting the current debate and identifying research gaps.
3 Data and Methodology: Details the global dataset used, the construction of the variables including ESG scores and litigation provisions, and the econometric models employed for testing the hypotheses.
4 Results: Presents the empirical findings, including descriptive statistics, regression results for the bond spread and litigation provisions, and the outcome of the event study.
5 Discussion and Limitations: Discusses the implications of the findings, tests the hypotheses against literature, and outlines the constraints and limitations of the research design.
6 Conclusion: Summarizes the major findings, reflects on the implications for businesses and academia, and provides a final outlook on the relationship between sustainability and financial risk.
Keywords
Sustainability Performance, ESG Score, Corporate Bond Yield Spreads, Litigation Provisions, Litigation Risk, Cost of Debt, Environmental Performance, Social Score, Governance, Financial Economics, Event Study, Volkswagen Scandal, Paris Climate Agreement, Mediation Analysis, Moderation Analysis
Frequently Asked Questions
What is the core focus of this Master Thesis?
The thesis focuses on examining whether corporate sustainability performance (ESG) influences the cost of debt, specifically through corporate bond yield spreads, and whether this link is affected by litigation risk.
Which key variables are analyzed in the study?
The main variables are the overall ESG score (and its environmental, social, governance, and economic sub-scores), litigation provisions as a proxy for litigation risk, and the yield spread over benchmark for corporate bonds.
What is the primary objective of the research?
The primary objective is to clarify the conflicting results in existing literature regarding how sustainability performance impacts the cost of debt and to determine if litigation risk acts as a mechanism (mediator or moderator) in this relationship.
Which scientific methods are applied to conduct this research?
The study employs Panel Least Squares (PLS) regressions with fixed effects for time, industry, and country. Additionally, it uses mediation tests (Sobel-test and bootstrapping) and an adjusted difference-in-difference approach for an event study.
What topics are covered in the main section of the paper?
The main body covers the theoretical framework, the methodology of data selection and regression construction, the detailed presentation of empirical results, and a critical discussion of findings in relation to existing research.
Which primary keywords characterize this work?
The work is characterized by terms such as ESG performance, litigation provisions, cost of debt, yield spreads, environmental performance, and litigation risk.
How does the Volkswagen scandal influence the analysis?
The Volkswagen scandal is used as an exogenous shock in an event study (combined with the Paris Climate Agreement) to provide evidence of a causal relationship between low environmental performance and increased bond yield spreads.
What is the role of litigation provisions in the study?
Litigation provisions are treated as a forward-looking proxy for litigation risk, used to test whether the market penalizes companies for expected future legal expenses associated with sustainability issues.
Did the study confirm the mediating role of litigation risk?
No, the mediation analyses (Sobel-test and bootstrapping) did not provide significant evidence that litigation provisions mediate the relationship between ESG performance and corporate bond yield spreads.
Why did the author include a country and industry moderation analysis?
The author included these analyses to investigate whether the impact of ESG on bond spreads varies depending on the regional institutional framework and the specific sector's risk profile, revealing significant heterogeneity in how markets reward sustainability.
- Quote paper
- Philipp A. Sostmann (Author), 2017, Sustainability Performance, Litigation Provisions and Corporate Bond Spreads, Munich, GRIN Verlag, https://www.grin.com/document/452501
