ESG and corporate credit spreads
ISSN: 1526-5943
Article publication date: 2 February 2022
Issue publication date: 2 March 2022
Abstract
Purpose
The authors investigate the implications of environmental, social and governance (ESG) practices of firms for the pricing of their credit default swaps (CDS). In doing so, the authors compare European and US firms and consider nonlinear and indirect effects. This complements the previous literature focusing on linear and direct effects using bond yields and credit ratings of US firms.
Design/methodology/approach
For this purpose, the authors apply fixed effects regressions on a comprehensive panel data set of US and European firms. Further, nonlinear and indirect effects are investigated utilizing quantile regressions and a path analysis.
Findings
The evidence indicates that higher ESG ratings mitigate credit risks of US and European firms from 2007 to 2019. The risk mitigation effect is U-shaped across ESG quantiles, which is consistent with opposing effects of growing stakeholder influence capacity and diminishing marginal returns on ESG investments. The authors further reveal a mediating indirect volatility channel that substantially amplifies the direct effect of ESG on credit risk. A one-standard-deviation improvement in ESG ratings is estimated to reduce CDS spreads of low, medium and high ESG firms by approximately 4%, 8% and 3%, respectively.
Originality/value
This is the first study to examine whether credit markets reflect regional differences between Europe and the US with regard to the ESG-CDS-relationship. In addition, this paper contributes to the existing literature by investigating differences in the response of CDS spreads across ESG quantiles and to study potential indirect channels connecting ESG and CDS spreads using structural credit risk variables.
Keywords
Acknowledgements
Earlier versions of this paper were presented at research conferences and seminars. We appreciate helpful comments and suggestions from Dirk Baur, Theodor Cojoianu, Ambrogio Dalò, Lammertjan Dam, Halit Gonenc, Andreas Hoepner, Julia Kapraun, Thomas Marta, Stefan Mittnick, Loriana Pelizzon, Aurélien Philippot, Auke Plantinga, Artem Prokhorov, Michael Rockinger, Stephen Schaefer, Bert Scholtens, Nassima Selmane, Andréanne Tremblay-Simard, Paul Smeets, Arjan Trinks, Gregor Weiß, Wim Westerman and the conference participants at AFFI PhD Workshop 2019, European Commission Summer School on Sustainable Finance 2019, GRASFI PhD Workshop 2019, CEQURA 2019, CREDIT 2019, DGF Poster Session 2019 and University of Groningen. This work was supported by a research grant sponsored by Inquire Europe. We also thank Marco Keidel from Markit and Dorottya Bruszt from MSCI for helpful comments on the data. The opinions, appraisals, and information expressed in this article are those of the authors and do not necessarily reflect those of HUK-COBURG Asset Management GmbH or QPLIX.
Citation
Barth, F., Hübel, B. and Scholz, H. (2022), "ESG and corporate credit spreads", Journal of Risk Finance, Vol. 23 No. 2, pp. 169-190. https://doi.org/10.1108/JRF-03-2021-0045
Publisher
:Emerald Publishing Limited
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