ESG and Corporate Credit Spreads

Abstract

We investigate the implications of environmental, social and governance (ESG) practices of firms for the pricing of credit default swaps (CDS). Our evidence indicates that higher ESG ratings mitigate credit risks of U.S. 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. We 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/high ESG firms by approximately 4%/8%/3%.

Keywords: Corporate social responsibility (CSR); Enviromental, Social, Governance (ESG); Credit default swaps (CDS); Credit risk

JEL Classification: G12, G24