Private Debt for Public Good

Abstract

If “he who controls the purse makes the rules,” then should corporate lenders be able to nudge borrowers to improve their societal impact? There is growing consensus that firms should mitigate environmental and social harms arising from their private business activities, yet little agreement on how best to ensure this end. A host of ad hoc market efforts have emerged, including public pledges to certain goals, voluntary disclosures to investors, and niche financial innovations designed to incentivize and evidence pro-social corporate activity. Despite these developments, market efforts always seem to fall short of effective self-monitoring necessary for so-called environmental, social, and governance (ESG) outcomes. Observers often attribute these shortcomings to market failures—agency costs or information asymmetries—and negative externalities, which firm managers and investors are thought ill-equipped to manage. Yet, the unique potential of corporate lenders to address these shortcomings has been largely overlooked by the market, and consequently the literature, until now.

This Article analyzes an original dataset of more than 125 contracts in the nascent sustainability-linked loan market to explore the potential of lender monitoring for ESG outcomes. This five-year old market has Dell promising to increase sustainable packaging, Lululemon committing to close the gender pay gap amongst its employees, and HP pledging to improve the racial diversity of its executives, in each case, in exchange for more favorable terms in novel loan agreements. In the first in-depth review of the fastest growing segment of the $5.5 trillion syndicated loan market, this Article shows how the far-reaching influence of “universal lenders” combined with the lender’s toolkit and traditional relationship with borrowers theoretically equip lenders to better overcome information symmetries and agency costs that have undermined other market-based ESG efforts. It argues, however, that enhanced informational insights and commitment mechanisms for borrowing firms cannot alone overcome the death knell that is negative externalities. But while many scholars view negative externalities as a reason to avoid such market-based ESG solutions, this Article insists on the very opposite outcome. Policy interventions that shift the burden of externalities to borrowers and/or lenders should be used to effectively harness the clear benefits of lenders as private monitors to ensure the ESG movement has real and lasting effect.

Keywords: ESG, sustainability-linked loans, ESG loans, syndicated loan, ESG-linked loans, green loans, social loans, stakeholderism