Do Debt Investors Care about ESG Ratings?

Abstract

We study whether institutional investors in corporate debt markets respond to environmental, social, and corporate governance (ESG) - related concerns. We exploit changes in firms' ESG ratings on the cost of debt of U.S. firms using  methodology-driven changes of two major ESG rating providers in the secondary corporate loan market. We find that loan spreads of downgraded ESG-rated firms increase by 25 percent compared to non-downgraded firms after the methodology change. This increase is not driven by an increase in firms' fundamental default risk, but rather by a premium charged by debt investors above the spread for default risk. We further find that debt investors are indeed more likely to sell downgraded firms in the same period, especially when they are more ESG-conscious. Finally, we show that this has implications for the cost of debt of firms in the primary corporate loan market.

Keywords: JEL classification: E44, G20, G24 ESG ratings, Debt investors, Loan spreads, CLO

JEL Classification: E44, G20, G24