The impact of corporate social and environmental performance on credit rating prediction: North America versus Europe

Abstract

We quantify to what extent the quality of credit rating predictions improves through integrating measures of corporate social performance (CSP) in an established credit risk model. Our analysis provides comprehensive evidence of the comparative informational advantage of considering CSP in predicting credit ratings of North American and European firms. In the North American sample, both environmental and social performance have an explanatory impact. The out-of-sample prediction quality improves by more than 0.8%. By contrast, only social performance increases the explanatory power in the European sample, while environmental performance does not. Overall, we show that CSP is a relevant variable for predicting credit ratings. In general, our findings support the risk mitigation view of CSP, indicating that firms with high CSP are less risky and thus have better credit ratings. However, the quality of the relationship depends on the socio-economical and cultural environment as well, as can be seen from the differing results in North America and Europa.