Abstract
This study analyzes the relationship between Environmental, Social and Governance (ESG) scores and bond returns using the corporate bond data in Korea during the period of 2010 to 2015. We find that ESG scores include valuable information about the downside risk of firms. This effect is particularly salient for the firms with high information asymmetry such as small firms. Interestingly, of the three ESG criteria, only environmental scores show a significant impact on bond returns when interacted with the firm size, suggesting that high environmental scores lower the cost of debt financing for small firms. Finally, ESG is complementary to credit ratings in assessing credit quality as credit ratings cannot explain away ESG effects in predicting future bond returns. This result suggests that credit rating agencies should either integrate ESG scores into their current rating process or produce separate ESG scores which bond investors integrate with the existing credit ratings by themselves.
Highlights
Research on Environmental, Social and Governance (ESG) has developed significantly over the last few years
By analyzing and discussing the global examples involving the main players in ESG integration, other than bond issuers and investors, such as the internationally renowned credit rating agencies (CRAs) like Moody’s and S&P and largest investors in the global market like BlackRock and NGPFG, we focus on finding the underlying driver of our empirical results that helps us to generalize our findings in a broader setting
We find the existence of the relationship between ESG scores and bond pricing and make the following contributions
Summary
Research on Environmental, Social and Governance (ESG) has developed significantly over the last few years. The existing literature tends to focus on the beneficial role of ESG integration in generating excess returns [1,2,3] This literature largely overlooks how the total returns of corporate bonds vary as ESG scores vary. This is a crucial gap in literature because the total return is the most important performance measure from the perspectives of both buyers (bond investors) and sellers (bond issuers). We undertake rigorous qualitative case studies to identify the factors that drive our results Such results produce policy implications for credit rating agencies and policy makers as well as managerial implications for bond investors and issuers
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