This thesis, graded with summa cum laude, examines the effect of Corporate Social Responsibility (CSR) expressed through Environmental, Social, and Governance (ESG) scores on firms’ cost of debt on two distinct layers with a particular interest on the economic mechanism through which sustainability performance unfolds. Three distinct economic channels for the effect of corporate sustainability on the cost of debt capital are established, namely governance strengths, information asymmetry, and credit risk. The work provides evidence that the latter is primarily responsible for lower debt premia to sustainable borrowers. First, on firm-level, it is shown that superior ESG performance can offset cost of debt by 0.45% for a one standard deviation improvement on ESG performance.
In current times of global climate stress with environmental anomalies happening at a daily rate, business actions are understood to play the pivotal role in fighting the most pressing concern in contemporary human history – the transition towards a sustainable economic model. In fact, in order to reach the ambitious sustainability target set by the European Union to reach carbon neutrality by 2050, additional sustainable investments of EUR175 to EUR290 billion are in demand annually. As such, the scaling up of private sector investments entered as key element into the EU Sustainable Finance Action Plan launched by the European Commission in 2018. And although the first climate change bankruptcy with PG&E Corp. failing to meet potential liabilities of around USD30 billion resulting from wildfires already occurred, the need for sustainable adaptation of business practices is erroneously evaluated against hypothetical scenarios or a debatable model of the long-term effects of change.
Table of Contents
1 Introduction
2 Theoretical Foundation and Hypothesis Development
2.1 Corporate Social Responsibility
2.2 The Role of ESG in Corporate Finance
2.2.1 ESG and Firm Performance
2.2.2 ESG and Cost of Capital
2.3 Credit Risk in the ESG – Cost of Debt Relation
3 Data and Methodology
3.1 Data for the ESG-CoD Relationship
3.1.1 Firm-Level Argument
3.1.2 Loan-Level Argument
3.2 Variable Construction for the ESG-CoD Relationship
3.2.1 Firm-Level Argument
3.2.2 Loan-Level Argument
3.3 Methodology for the ESG-CoD Relationship
3.3.1 Firm-Level Empirical Model
3.3.2 Loan-Level Empirical Model
3.4 Empirical Model for the Credit Risk Impact
4 Results
4.1 Analysis on the ESG-CoD Relationship
4.2 Analysis on the Credit Risk Channel
4.3 Robustness Checks
4.3.1 Alternative Model Specifications
4.3.2 Addressing Endogeneity Concerns
5 Conclusion
Research Objectives & Key Themes
This thesis investigates the impact of corporate Environmental, Social, and Governance (ESG) performance on the cost of debt for European firms, specifically exploring whether credit risk serves as the primary economic channel for this relationship.
- Analysis of the relationship between ESG performance and firm-level cost of debt.
- Evaluation of sustainability-linked loans as a mechanism for incentivizing sustainable performance.
- Examination of credit risk as an economic channel in the ESG-cost of debt link.
- Utilization of propensity score matching to evaluate pricing differences in private debt markets.
- Validation of results using post-financial-crisis data from 2013 to 2020.
Excerpt from the Book
1 Introduction
In current times of global climate stress with environmental anomalies happening at a daily rate, business actions are understood to play the pivotal role in fighting the most pressing concern in contemporary human history – the transition towards a sustainable economic model. In fact, in order to reach the ambitious sustainability target set by the European Union to reach carbon neutrality by 2050, additional sustainable investments of EUR175 to EUR290 billion are in demand annually. As such, the scaling up of private sector investments entered as key element into the EU Sustainable Finance Action Plan launched by the European Commission in 2018. And although the first climate change bankruptcy with PG&E Corp. failing to meet potential liabilities of around USD30 billion resulting from wildfires already occurred, the need for sustainable adaptation of business practices is erroneously evaluated against hypothetical scenarios or a debatable model of the long-term effects of change (Mui, 2019).
Still, market constraints and the prevalence of short-termism hinder tangible action-taking in the near-term. More alarming however, since weak economic incentives and uncertain relations between sustainable performance and business value persist, governmental and business efforts in the transition towards a new economic model remain misaligned (Schoenmaker & Schramade, 2019a). By establishing this long-missing practical incentive for connecting sustainable performance and firm value, sustainable lending has become a recent phenomenon of interest in the corporate world – a phenomenon implying that corporate social responsibility has in fact the potential to offer tangible economic value by improving creditworthiness, decreasing the risk of default, and thus reducing borrowing costs for sustainable firms. Hence, the apparent contradiction between hesitant corporate action-taking and lenders’ willingness to economically incentivize sustainable performance gives rise to the following research question: R: What is the impact of corporate ESG Performance on Cost of Debt through Credit Risk?
Chapter Summaries
1 Introduction: Provides the research motivation regarding the transition to a sustainable economic model and defines the research question concerning the impact of ESG on the cost of debt.
2 Theoretical Foundation and Hypothesis Development: Reviews academic literature on CSR and ESG, discusses the role of ESG in corporate finance, and formulates testable hypotheses regarding credit risk.
3 Data and Methodology: Details the sample construction, variable definition, and the empirical models used for both firm-level and loan-level analyses, including propensity score matching.
4 Results: Presents the empirical findings of the study, assesses the credit risk channel, and conducts various robustness checks.
5 Conclusion: Summarizes the key findings, discusses limitations, and provides suggestions for future research within the field of sustainable finance.
Keywords
Corporate Finance, Sustainable Finance, Corporate Social Responsibility, ESG, Cost of Capital, Cost of Debt, Credit Risk, Sustainability-Linked Loans, European Firms, Firm Performance, Credit Ratings, Debt Markets, Private Lending, ESG Controversies, Risk-Mitigation.
Frequently Asked Questions
What is the primary focus of this thesis?
The thesis examines how a firm's ESG (Environmental, Social, and Governance) performance influences its cost of debt, specifically within the context of European companies.
What are the central themes discussed?
The work covers corporate social responsibility, the cost of capital, credit risk mechanisms, and the emergence of sustainability-linked loan facilities.
What is the core research question?
The study aims to determine: What is the impact of corporate ESG Performance on Cost of Debt through Credit Risk?
Which scientific methodology is employed?
The research uses a panel regression approach for firm-level data and propensity score matching to compare regular and sustainability-linked loans in private debt markets.
What does the main body of the work cover?
The main body covers the theoretical background, the construction of data samples, empirical modeling techniques, analysis of results, and various robustness tests to ensure validity.
How is this work characterized by its keywords?
It is characterized by its focus on sustainable finance, credit risk management, and the empirical link between ESG metrics and financing costs.
What role does the credit risk channel play in the findings?
The study finds that credit risk is a significant channel, as lenders increasingly account for sustainability performance when assessing the default risk of corporate borrowers.
How do sustainability-linked loans impact firms?
The analysis reveals that firms with higher ESG performance are more likely to raise sustainability-linked debt, often achieving significant initial interest spread discounts compared to regular loans.
- Arbeit zitieren
- Florian Porzel (Autor:in), 2020, The Impact of ESG Performance on Cost of Debt via Credit Risk. A Case for Sustainability-Linked Loans in Europe, München, GRIN Verlag, https://www.grin.com/document/988243
