The Economics of Sustainability Linked Bonds

63 Pages Posted: 16 Mar 2022 Last revised: 14 Sep 2022

See all articles by Tony Berrada

Tony Berrada

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute

Leonie Engelhardt

University of Geneva

Rajna Gibson

University of Geneva - Geneva Finance Research Institute (GFRI); European Corporate Governance Institute (ECGI)

Philipp Krueger

University of Geneva - Geneva Finance Research Institute (GFRI); Swiss Finance Institute; European Corporate Governance Institute (ECGI); University of Geneva - Geneva School of Economics and Management

Date Written: March 15, 2022

Abstract

We develop a framework to understand the incentive structure and pricing of sustainability-linked bonds (SLBs). It provides conditions under which SLBs are incentive compatible for firms. We propose a novel mispricing measure for SLBs. Using the model and mispricing measure, we derive and test several empirical predictions. We show that overpriced SLBs experience negative returns in the secondary market after issuance. When firms issue overpriced SLBs, the stock price reaction at issuance is significantly positive, consistent with a wealth transfer from bond- to shareholders. Finally, we document a significant nonlinear relationship between the mispricing measure and firms' ESG ratings.

Keywords: ESG investing, sustainability linked bonds, security design, managerial incentives, mispricing

Suggested Citation

Berrada, Tony and Engelhardt, Leonie and Gibson, Rajna and Krueger, Philipp, The Economics of Sustainability Linked Bonds (March 15, 2022). Swiss Finance Institute Research Paper No. 22-26, European Corporate Governance Institute – Finance Working Paper No. 820/2022, Available at SSRN: https://ssrn.com/abstract=4059299 or http://dx.doi.org/10.2139/ssrn.4059299

Tony Berrada (Contact Author)

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Leonie Engelhardt

University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

Rajna Gibson

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland
+41.22.379.89.83 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Philipp Krueger

University of Geneva - Geneva Finance Research Institute (GFRI) ( email )

40 Boulevard du Pont d'Arve
Geneva 4, Geneva 1211
Switzerland

Swiss Finance Institute ( email )

Switzerland

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

University of Geneva - Geneva School of Economics and Management ( email )

Uni Mail
Bd du Pont-d'Arve 40
Geneva, 1211
Switzerland

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