ESG scores and cost of debt

Abstract

As sustainable investing becomes central to capital allocation in many markets, the Environmental, Social and Governance (ESG) metrics and scores have become of critical importance. This study aims to analyze the relation between the cost of debt and ESG scores. We provide evidence that the cost of debt for borrowing firms is associated with their ESG score/rating. Firms that have low ESG scores are considered to be riskier, in the sense that they are exposed to liabilities related to Environmental, Social and Corporate factors that ultimately increase their probability of default. In case of a bankruptcy unsecured bondholders' claims may be subordinate to those liabilities. Using a framework for evaluating ESG performance developed by Refinitiv, this study investigates whether firms within S&P 500 over the period 2010–2019 that exhibit strong ESG scores benefit from lower bond spreads and better bond ratings relative to firms with weaker ESG scores. After controlling for other risk characteristics our analysis points that better ESG rating is associated with lower cost of unsecured debt in the primary bond market. Our findings are consistent over the aggregate metric and all E,S, and G pillars. Furthermore, they support the ongoing calls for improved transparency, which would allow for the reporting of quantifiable ESG information in firms' disclosures.