New ESG rating drivers in the cross-section of European stock returns

We assess the performance of two quantitative signals based on ESG scores across a large, multi-national cross-section of European stock returns. We test whether the cost of equity capital is more influenced by the upward momentum (measured over time) of the ESG scores of the firms issuing stocks or by their stability (identified as the volatility of the scores over time), measured around a changing mean level. We find that short-term ESG momentum over 1 month has a significant impact on the cross-section of stock returns, lowering the anticipated cost of capital and leading to positive average abnormal returns. This suggests that short-term ESG momentum may represent a novel, priced systematic risk factor. Furthermore, we find strong evidence that an ESG volatility spread strategy which buys low ESG score volatility stocks and sells high volatility ones, generates a substantial alpha and affects the ex-ante cost of capital. Both quantitative ESG signals result in portfolio sorting and long-short strategies that enhance the overall sustainability profile of the issuing firms without compromising the raw average of their ESG scores.     

Issuing bonds during the Covid-19 pandemic: Was there an ESG premium?

We rely on the ESG ratings assigned by four distinct agencies (MSCI, Refinitiv, Robeco, and Sustainalytics) to study the link between ESG scores and firms’ cost of debt financing during the Covid-19 pandemic. We document the existence of a statistically and economically significant ESG premium, i.e. better rated companies access debt at a lower cost. Despite some differences across rating agencies, this result is robust to additional controls for the issuer’s credit standing as well as several bond and issuer’s characteristics. We find that this effect is mainly driven by firms domiciled in advanced economies, whereas creditworthiness considerations prevail for firms in emerging markets. Lastly, we show that the lower cost of capital for highly rated ESG firms is explained both by investors’ preference for more sustainable assets and by risk-based considerations unrelated to firms’ creditworthiness, such as exposure to climate change risks.     

ESG,Material Credit Events,and Credit Risk

A growing body of research has extended the analysis of the materiality of ESG criteria from the perspective of equity investors to creditors. Past research and analysis have demonstrated the link between better management of ESG criteria and better management of risk overall. Despite this growing consensus and consistent evidence that ESG performance is correlated with credit risk, no empirical evidence has yet linked ESG performance to cost or expense variances or revenue shortfalls that could explain these correlations. The authors attempt to address this lack of mechanism‐based empirical evidence by citing and then building on a number of well‐publicized cases with analysis of two major ESG issues—indigenous land claims and biodiversity—as they affect the global project finance and agriculture sectors. Broadening these single‐sector results, the authors use a novel dataset providing systematic coding of material events reported in the media across a variety of empirical settings to produce the first large‐sample empirical evidence of the mechanisms linking ESG performance to credit risk.     

Does ESG matter to investors? ESG scores and the stock price response to new information

We examine how a third-party assessment of a firm's relative ESG attractiveness affects investor demand for the firm's equity in the presence of new information. Utilizing an event-study methodology, with credit-rating change events as proxies for new positive and negative information, we find evidence supporting a high ESG score as a significant factor in determining how investors respond to new positive information. Specifically, after controlling for relevant fixed effects, we find that the highest quartile of ESG scores amplifies the positive stock-price reaction to credit-rating upgrades by 130 basis points, providing evidence of confirmation bias.     

Secret Recipe of IPO survival: ESG disclosure and performance

While ESG initiation and disclosure may help newly listed companies maintain a social license to operate, mitigate information asymmetry, and attract investor attention, it may impose significant costs on initial public offering (IPO) firms and magnify agency problems. Using a sample of 1102 IPOs issued in the U.S and the ESG data from MSCI between 1999 and 2016, the paper empirically tests the competing hypotheses and examines the influence of ESG disclosure and performance on the survivability of IPOs. We document that (1) voluntary ESG disclosure reduces IPO failure risks and improves long-run performance of IPO; (2) the sooner ESG information is disclosed after the IPO, the greater the likelihood of survival and better long-run performance; and (3) IPOs with better ESG score are less likely to fail, with the impact largely attributable to the company's social and governance performance. Our findings identify new failure risks for IPOs, supply evidence of value-relevance of ESG, and provide practical guidance for managers.     

Spillover of stock price crash risk: Do environmental,social and governance (ESG) matter?

This study measures the static and dynamic crash risk connections across ESG networks from 2015 to 2020, using the generalized vector autoregressive framework. In particular, it highlights the mixed results of the crash risk connections across ESG three pillars and the different spillover performance when firms with different ownership structures and qualification of margin-trading and short-selling. Our results reveal that stocks with higher ESG ratings display more negative net spillover effects, which is consistent with the ideas that stock groups with good ESG performance experience lower crash risk, and thus transmitting smaller crash risk to other ESG levels. Among the three ESG pillars, good social performance (S) significantly lowers the total crash risk connections. In contrast, firms with well environment performance (E) do not transmit lower crash risk. Moreover, SOEs and firms with qualification of margin-trading and short-selling have lower total crash risk connections among ESG ratings. Using propensity score matching to match companies with high ESG and low ESG quarterly, we find the results are still robust. When dividing the sample according to the outbreak of COVID-19, we find the crash risk connections across ESG networks are stronger during crisis.     

Audit 4.0-based ESG assurance: An example of using satellite images on GHG emissions

As Environment, Social, and Governance (ESG) information has become an essential resource for investors, regulators have attempted to assure its quality. While more companies offer ESG disclosure, it is usually not fully substantiated with supporting information. Assurance is needed to verify that ESG reports are free of substantive errors. However, traditional financial audit approaches are less effective in providing ESG assurance due to the difference in the nature of evidence, difficulty in measuring and verifying ESG measures, and ever-changing ESG performance. To increase the effectiveness of ESG audit approaches, this study proposes Audit 4.0-based ESG assurance, which uses Big Data and emerging technologies of Audit 4.0 to capture evidence from the physical world and provide accurate assurance on ESG reports in a timely manner. We further perform a case study as a proof of concept of the proposed approach, which explores the integration of satellite-based methane estimation as ESG audit evidence. The use of satellite images provides opportunities for regulators and companies to monitor and assure ESG reports in a continuous manner.     

Corporate social responsibility and Eurozone corporate bonds: The moderating role of country sustainability

In this paper, we empirically examine whether superior performance in corporate social responsibility (CSR) results in lower credit risk, measured by credit ratings and zero-volatility spreads (z-spreads). We are especially interested in how the environmental, social, and governance (ESG) related performance of the corresponding countries moderates this relationship. We find only weak evidence that superior corporate social performance (CSP) results in systematically reduced credit risk. However, we do find strong support for our hypothesis that a country’s ESG performance moderates the CSP–credit risk relationship. Superior CSP is regarded as risk-reducing and rewarded with better ratings and lower z-spreads only if it is recognized by the environment. In addition, we find a reduction of corporate bonds’ z-spreads by approx. 9.64 basis points if the CSP of a company mirrors the ESG performance of the country it is located in.     

Corporate hedging and the cost of debt

For a large sample of U.S. firms from 1994 to 2009, we empirically examine the impact of corporate hedging on the cost of public debt. We find strong evidence that hedging is associated with a lower cost of debt. The negative effect of hedging on the cost of debt is consistent across industries, and remains economically and statistically significant under various controls and econometric specifications. A cross-sectional analysis based on propensity score matching suggests that hedging initiation firms experience a drop in cost of debt, while suspension firms sustain a jump. We confirm our findings after employing an extensive array of models to address potential endogeneity. The influence of hedging on cost of debt is mainly through the lowering of bankruptcy risk and agency cost, and the reduction in information asymmetry. Finally, hedging mitigates the negative effect of rising borrowing costs on capital expenditure and firm value.     

Environmental,social, and governance premium in Chinese stock markets

Financial markets have increasingly adopted the concept of ESG (environmental, social, and governance); this paper studies the evolving effect of corporate ESG performance on the stock returns in China's stock markets. Utilizing the Paris Agreement and China's President Xi's pledge to achieve carbon neutrality by 2060 as ESG shocks, we find that firms with lower ESG scores provide higher stock returns after the announcement of the Paris Agreement. Furthermore, the effect of ESG performance heightens after Xi's pledge. Using sorted portfolios and Fama–French factor models, we find that investors are rewarded for bearing ESG-related risks. Our estimated monthly ESG risk premium is between 0.52% and 0.61%, while state-owned firms with larger market capitalizations and better financial and operational performance tend to have better ESG performance.     

ESG disclosure and technological innovation capabilities of the Chinese listed companies

The main objective of this study is to explore how ESG disclosure effectively promotes technological innovation capabilities (TIC) and also in different industries (green vs. high-tech). Further, examine the role of financing constraint (FC) in the relationship between the ESG disclosure and TIC. We employed the panel regression model, Causal step approach, Bootstrap mediation effect test, 2SLS, and GMM model. We used Bloomberg’s ESG disclosure score of China’s A-share listed companies from 2011 to 2019 (1); we found that the ESG disclosure has a significant relationship with corporate innovation indicators (OTI, STI, NSTI) and play a significant role in promoting TIC at different levels of corporate innovation (2) ESG disclosure of non-green (high-tech) industry is more effectively promote TIC than green (non-high tech) industry (3) ESG disclosure can promote corporate innovation by reducing the level of corporate financing constraints, and FC has a partial intermediary role between ESG and TIC.     

Corporate governance performance ratings with machine learning

We use machine learning with a cross-sectional research design to predict governance controversies and to develop a measure of the governance component of the environmental, social, governance (ESG) metrics. Based on comprehensive governance data from 2,517 companies over a period of 10 years and investigating nine machine-learning algorithms, we find that governance controversies can be predicted with high predictive performance. Our proposed governance rating methodology has two unique advantages compared with traditional ESG ratings: it rates companies' compliance with governance responsibilities and it has predictive validity. Our study demonstrates a solution to what is likely the greatest challenge for the finance industry today: how to assess a company's sustainability with validity and accuracy. Prior to this study, the ESG rating industry and the literature have not provided evidence that widely adopted governance ratings are valid. This study describes the only methodology for developing governance performance ratings based on companies' compliance with governance responsibilities and for which there is evidence of predictive validity.     

ESG scores and target price accuracy: Evidence from sell-side recommendations in BRICS

ESG profiling of a firm reflects its exposure to various environmental, social, and governance factors, which influence the business dynamics and impact the valuation metrics. In this paper, we evaluate the relationship between ESG scores and the target price precision of sell-side analysts. We employ four different constructs of forecast accuracy on a comprehensive sample of firms with analyst coverage in the BRICS between 2011 and 2021. The results demonstrate that the ESG score positively impacts the target price accuracy, and firms with higher ESG scores have lower forecast errors. The findings remained robust even after segregating the sample based on buy, hold, and sell recommendations. Finally, we report that within ESG, environmental and governance factors largely explain the forecast accuracy while the social aspects were insignificant. The results also suggest that the precision of sell-side analysts is persistent across periods. These findings have important implications for investors.     

ESG in credit ratings and the impact on financial markets

This study examines environment, social, governance (ESG) consideration in rating reports published by credit rating agencies. 3,719 Moody's credit rating reports between 2004 and 2015 are examined and the ESG consideration is analyzed using a latent dirichlet allocation (LDA) approach. We further analyze the stock returns and credit default swap (CDS) spread changes to check whether ESG consideration has an effect on the capital market reactions. We find a small but present consideration of ESG in rating decisions. Within ESG, corporate governance plays the most important role. Moreover, the results reveal that ESG consideration is a significant determinant in the stock return and CDS spread around the rating announcement. We find that all ESG criteria are important for equity and debt investors.     

Do personal taxes affect capital structure? Evidence from the 2003 tax cut

Because the personal tax treatments of interest and dividend income likely affect the relative cost of debt and equity financing, a sharp change in tax treatment could affect firms' optimal leverage. This paper examines the effect of the 2003 equity income tax cut on firms' debt usage. Because this tax cut affected only individual investors, we can use a difference-in-differences method to identify the effect of personal tax on firms' leverage. Previous research has found that the 2003 tax cut encouraged dividend payouts and reduced the cost of equity, but it provides no link to equilibrium leverage ratios. We estimate that the tax cut causes the affected firms' leverage to decrease by about 5 percentage points. Furthermore, we show that the effects of the tax cut are stronger for firms with lower marginal corporate tax rates and for firms that are not financially constrained, consistent with our theoretical predictions. Overall, we find strong evidence that personal tax is an important determinant of firms' optimal leverage.     

Executive Compensation Tied to ESG Performance: International Evidence

Using a wide sample of international publicly traded firms, this paper studies the rapidly increasing practice of incorporating Environmental, Social, and Governance (ESG) metrics in executive compensation contracts. Our evidence suggests that this compensation practice varies at the country, industry, and firm levels in ways that are consistent with efficient incentive contracting. We also observe that reliance on ESG metrics in executive compensation arrangements is associated with engagement, voting, and trading by institutional investors, which suggests that firms could be adopting this practice to align their management's objectives with the preferences of certain shareholder groups. Finally, we find that the adoption of ESG Pay is accompanied by improvements in key ESG outcomes, but not by improvements in financial performance.     

Understanding resource deployment efficiency for ESG and financial performance: A DEA approach

COVID-19 has stimulated additional research interest on economic sustainability and ESG in both academia and industry. This study adopts a DEA approach to examine the efficiency of achieving ESG targets and their relationships with financial performance. Using MSCI ESG data from 2015 to 2019 on 1108 Chinese firms, we examine the ESG proportional and pillar mix efficiencies. The dominant strategies for our sampled firms are to improve overall ESG performance by enhancing the E and S pillars through sacrificing G’s performance. The second result shows a positive relationship between proportional efficiency and financial performance while a mixed relationship between pillar mix efficiency and financial performance. However, for the technology sector, there exists some trade-offs between ESG performance and financial performance. Specifically, relative to non-technology firms, improving proportional and pillar mix efficiencies for technology firms could result in some sacrifice in stock valuation.     

Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants

Using a regression discontinuity design, we provide evidence that there are sharp and substantial employment cuts following loan covenant violations, when creditors gain rights to accelerate, restructure, or terminate a loan. The cuts are larger at firms with higher financing frictions and with weaker employee bargaining power, and during industry and macroeconomic downturns, when employees have fewer job opportunities. Union elections that create new labor bargaining units lead to higher loan spreads, consistent with creditors requiring compensation when employees gain bargaining power. Overall, binding financial contracts have a large impact on employees and are an amplification mechanism of economic downturns.     

Environmental,social and governance (ESG) activity and firm performance: a review and consolidation

Interest in why firms conduct environmental, social and governance (ESG) activity is longstanding and increasing. Our understanding, however, remains fragmented with alternative accounts that seek to explain the relationship between ESG performance (ESGP) and corporate financial performance (CFP). This paper reviews alternative accounts for the relationship and finds that the weight of empirical evidence shows a positive, statistically significant but economically modest ESGP–CFP link, consistent with theoretical expectations. This economically modest relationship suggests ESG activity is unlikely to be primarily motivated by narrow measures of CFP. Further scholarship viewing ESG as part of overall firm activity would be constructive.     

The impact of bank regulation on the cost of credit: Evidence from a discontinuity in capital requirements

We study the effect on credit relationships of the Small and Medium Enterprises Supporting Factor (SME-SF), a regulatory risk weight reduction on small loans to SMEs. Employing a regression discontinuity design and matched bank-firm data from Italy, we find that a 1 percent drop in capital requirements causes an average 13 basis points reduction in the cost of credit. Moreover, with a novel measure of bank regulatory capital scarcity, we show that the drop is larger for banks facing tighter constraints. Furthermore, the drop is larger for firms with low switching costs, while the sharp assignment rule may have led to the rationing of marginal borrowers. Such findings indicate that the entire distribution of firms and banks’ characteristics plays a crucial role in determining the impact of regulatory capital changes.