Abstract
This paper investigates the effect of environmental, social, and governance (ESG) performance on credit ratings. We argue that ESG factors should be considered in the credit analysis and the creditworthiness evaluation of borrowers because they affect borrowers’ cash flows and the likelihood of default on their debt obligations. Consequently, we develop our research by firstly reviewing the literature regarding ESG commitments within financial decision-making processes and then addressing the relation between ESG performance and the cost of debt financing. We reveal no unanimous results and no clear-cut boundaries on this matter yet. Secondly, to disentangle this relationship, which is not well defined by scholars, we empirically investigate the nexus between ESG performance and credit rating issues on a sample of 56 Italian and Spanish public firms for which ESG performance in 2015 was achieved. Our final sample includes 15 variables for 56 observations: 840 items are under analysis. Our findings suggest that ESG performance, especially concerning social and governance metrics, meaningfully affects credit ratings. We do not sort out significant results referring to environmental scores, so further research is needed to investigate this ever-growing matter and strengthen this considerable nexus.
Highlights
During the last decade, companies have increasingly enhanced corporate sustainability with a forward-thinking view by targeting social, environmental, governance, and financial objectives (Haffar, 2017; United Nations Global Compact, 2013)
We provide as follows a synthesis of previous relevant studies on this issue that help us to understand the critical relation between ESG performance and debt financing
We study how the individual dimension of each category of ESG performance influences the credit rating
Summary
Companies have increasingly enhanced corporate sustainability with a forward-thinking view by targeting social, environmental, governance, and financial objectives (Haffar, 2017; United Nations Global Compact, 2013). Banks and financial institutions exclusively rely on risk sensitivity parameters, and they are still adopting lending practices by estimating risk against the default of borrowers (Zeidan et al, 2015) This evidence leads us to claim that this estimation does not price the potential value the company may be able to set up with social initiatives among all stakeholders and the community, even if the positive impact of the ESG factor on firm value has already been confirmed (Cellier & Chollet, 2016; Fatemi et al, 2017; Gutsche, Schulz, & Gratwohl, 2017; Lins & Servaes, 2017). We acknowledge that ESG performance should positively impact on companies’ credit ratings in the sense that favorable ESG performance leads to higher-level credit ratings
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