Impact of ESG on Corporate Credit Risk

Abstract

The paper exploits a panel quantile regression technique to uncover the asymmetric impact of material Environmental, Social, and governance (ESG) ratings on conditional quantiles of US corporate bond spreads. This work contributes to the literature by 1) comparing the ESG-bond spreads relationship between the heavily polluting sample (comprising of bonds belonging to heavily emitting companies) and the lightly polluting sample (comprising of bonds belonging to lightly emitting companies) 2) breaking down the effect of composite ESG ratings into effects of individual weighted pillars of ESG on bond spreads, 3) studying the impact of ESG on bond spreads across quantiles of bond spreads. The novel split-panel jackknife bias-correction approach has been employed to alleviate the bias arising from having a small T relative to N. Three main findings emerge from the analyses. First, improvements in ESG ratings lead to lower spreads due to the risk mitigation effect for brown firms. On the other hand, for green firms, ESG rating upgrades lead to higher spreads. Next, E pillar is the strongest pillar in determining the bond spreads of brown firms. All pillars E, S, and G pillars are important determinants of bond spreads for green firms. Lastly, improvements in ESG ratings are heterogeneous across quantiles.

Keywords: Panel quantile regression, split-panel jackknife bias correction, ESG, credit risk