Firms in greener countries pay less to borrow money – new study

After years of pressure from consumers, employees and activists, the business world is increasingly convinced of the importance of improving its impact on society and the natural environment. In one UN/Accenture survey as of 2013, which involved more than 1,000 senior executives from more than 100 countries, 93% of respondents said sustainability issues were important or very important to the future success of their business.

This shift is underpinned by research in the relationship between corporate social responsibility (CSR) and the financial performance of individual companies and investment portfolios. This shows a modest but statistically significant positive correlation between the two.

Why would that be? Good CSR practices can mean that a company develops better relationships with the people and organizations it works with. Building trusting relationships by addressing their needs and concerns through CSR can enhance a company’s reputation and enhance it. It also tends to give the impression of capable executives who have what it takes to stay in business and lead forward.

Yet most studies have focused on how CSR affects a company’s share price, giving less importance to its impact on debt financing. The latter is undoubtedly at least as important for companies: in 2012, according to global shareholder equity was estimated at $50 trillion (£35 trillion) by consultancy McKinsey, while total corporate debt was $86 trillion. It is also even more important for lenders than for shareholders to be invested in well-managed companies, since they are more likely to miss out on certain benefits: lenders’ earnings are capped at the level of interest they receive, while shareholders’ earnings are potentially unlimited.

Towards sustainability and beyond…

Debt and sustainability

I have just co-published a study in this field, and our starting hypothesis was that good CSR reduces the risk of a company defaulting on its debts. Since credit institutions ultimately price loans and bonds based on the risk of default, CSR should affect the cost of debt. We studied 470 loan agreements between 2005 and 2012 from borrowers in 28 countries operating in all major sectors.

In general, however, we have found that improving CSR performance does not make fundraising less costly for a company – and some types of CSR improvements, particularly those related to social issues, seem even make it more expensive. But we also looked at how debt costs were affected by what countries were doing on sustainability, and found a very interesting correlation: the efforts of governments made a significant difference to borrowing costs for companies that are based there. This touches on all major facets of sustainability, including health care, corruption, social freedoms, emissions, waste, labor rights and biodiversity.

Source: Yale EPI/Transparency International.

We found that a one-unit increase in a country’s overall sustainability measure led to an average decrease of 69 basis points in the cost of corporate debt. In other words, a loan or bond that would otherwise be priced at 3% was now priced at 2.31%.

And when we looked at the individual elements of these national sustainability efforts, we found that the environment seems to be financially more important than social justice. It led to an average decrease in the cost of debt of around 80 basis points, where the equivalent improvement in social sustainability led to a decrease of around 50 basis points.

P. Chinnapong

The intuitive explanation of why these things have an effect is that when a country takes sustainability seriously, it acts as a shield for the corporate borrower. By protecting companies from operational and reputational risks that arise from broader social and environmental challenges, lenders judge their default risks to be lower. This seems to negate the need for them to consider the company’s own CSR activities. It will be interesting to see if this affects how governments and companies approach sustainability issues in the future.

Comments are closed.