ESG and Corporate Credit Spreads
59 Pages Posted: 13 Jun 2018 Last revised: 11 May 2020
Date Written: April 30, 2020
We analyze the implications of environmental, social and governance (ESG) practices of firms for the pricing of credit default swaps (CDS). Building on Merton (1974) and literature on ESG and firm risk, we provide a simple theoretical framework for the relationship between ESG and credit risk. Our empirical results indicate a significant risk mitigation effect of ESG on credit risk for U.S. and European firms from 2007 to 2019. A one-standard-deviation (~25%) improvement in ESG is estimated to reduce CDS spreads by 4 basis points. We also analyze this effect across regions, industries, business cycle stages and ESG quantiles. Additionally, we conduct a path analysis and uncover indirect ESG effects on credit risks. These findings indicate that investors may improve performance and credit risk management when considering ESG.
Keywords: Corporate social responsibility (CSR); Enviromental, Social, Governance (ESG); Credit default swaps (CDS); Credit risk
JEL Classification: G12, M14
Suggested Citation: Suggested Citation