The Effects of Corporate and Country Sustainability Characteristics on The Cost of Debt: An International Investigation

• Date: 01 January 2016
• DOI: http://doi.org/10.1111/jbfa.12183
• Published date: 01 January 2016

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 43(1) & (2), 158–190, January/February 2016, 0306-686X

doi: 10.1111/jbfa.12183

The Effects of Corporate and Country

Sustainability Characteristics on The Cost

of Debt: An International Investigation

ANDREAS HOEPNER,IOANNIS OIKONOMOU,BERT SCHOLTENS

AND MICHAEL SCHR¨

ODER∗

Abstract: We investigate the relationship between corporate and country sustainability on

the cost of bank loans. We look into 470 loan agreements signed between 2005 and 2012

with borrowers based in 28 different countries across the world and operating in all major

industries. Our principal findings reveal that country sustainability, relating to both social

and environmental frameworks, has a statistically and economically impactful effect on direct

financing of economic activity. An increase of one unit in a country’s sustainability score is

associated with an average decrease in the cost of debt by 64 basis points. Our international

analysis shows that the environmental dimension of a country’s institutional framework is

approximately twice as impactful as the social dimension, when it comes to determining the

cost of corporate loans. On the other hand, we find no conclusive evidence that firm-level

sustainability influences the interest rates charged to borrowing firms by banks. Our main

findings survive a battery of robustness tests and additional analyses concerning subsamples,

alternative sustainability metrics and the effects of financial crisis.

Keywords: corporate social responsibility, CSR, CSP, sustainability, banking, financial contracts,

culture, loans, international

1. INTRODUCTION

Corporate social responsibility1(CSR) has firmly established itself as a crucial notion

for modern business and society on an international level. Consumers, environmen-

talists, employees, activists and concerned citizens have been pushing corporations

∗The first and second authors are both with the ICMA Centre, Henley Business School, University of

Reading, UK. Bert Scholtens is with the Department of Economics, Econometrics and Finance, University

of Groningen, The Netherlands, and the School of Management, University of St Andrews, UK. Michael

Schr¨

oder is with the Frankfurt School of Finance & Management, Frankfurt, Germany and ZEW,Mannheim,

Germany.The authors are ver y grateful to Frank Br¨

uckbauer for his research assistance and Oekom research

AG for provision of data. This project was funded via a SEEK grant provided by the Centre for European

Economic Research. All remaining errors are the sole responsibility of the authors. (Paper received October

2014, revised version accepted January 2016)

Address for correspondence: Ioannis Oikonomou, ICMA Centre, Henley Business School, University of

Reading, PO Box 242, Whiteknights, Reading, RG6 6BA, UK.

e-mail: i.oikonomou@icmacentre.ac.uk

1 Concisely described by the European Commission as a concept whereby “companies are taking responsi-

bility for their impact on society” (see European Commission, 2011).

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CORPORATE AND COUNTRY SUSTAINABILITY AND THE COST OF DEBT 159

for many years to go beyond their purely economic goals and attempt to improve

their impact on society and the natural environment in broader ways. The latest

Nielsen Global Survey on Corporate Social Responsibility2was conducted in 2013

with 29,000 respondents from 58 countries and demonstrates that at least 50% of

global consumers are willing to pay a premium for goods and services coming from

socially responsible firms. The trend is for this percentage to keep rising as it has

from the previous related survey conducted by Nielsen in 2011. Thus, societal pressure

moves from the area of implicit reputational gains to explicit financial incentives

for responsible producers and, vice versa, the lack of socially responsible practices

(or even worse, the engagement in social/environmental controversies) constitutes

a competitive disadvantage. This is also recognized by the European Commission’s

renewed strategy for CSR (2011–2014), according to which CSR “can bring benefits

in terms of risk management, cost savings, access to capital, customer relationships,

human resource management, and innovation capacity.”3

The traditional view of CSR used to be that it constituted a misallocation and

misappropriation of valuable resources in order for managers to promote their own

ethical agenda (Friedman, 1970) or that, at best, it has an insignificant effect on a

firm’s financial performance, as there are too many confounding factors to observe

a statistically strong direct impact (Ullmann, 1985). However this perception does

not seem to be held as strongly in today’s business world. According to the UN

Global Compact–Accenture CEO Study on Sustainability,4conducted in 2013 with the

participation of more than 1,000 top executives from 27 industries and 103 countries,

93% of respondents saw sustainability issues as an important or very important factor

for the future success of their business.

It is, therefore, unsurprising that considerable research efforts have been made

to identify the details of the association between CSR and financial performance of

individual firms, as well as portfolios of assets. The conceptual breadth and method-

ological diversity characterizing this extensive literature over a span of 40 years has led

to contradictory evidence being brought forward by hundreds of empirical studies.

Nevertheless, both qualitative reviews (Margolis and Walsh, 2003) and statistical meta-

analyses (Orlitzky et al., 2003; Margolis et al., 2009) hint at a modest but statistically

significant correlation between the two concepts.5The underlying arguments in favor

of this positive link between CSR and firm performance can be broadly categorized

into two groups. The first one draws from instrumental stakeholder theory (Freeman,

1984; Jones, 1995) and posits that the efficient implementation of CSR policies and

practices can lead to effective stakeholder management on the part of the firm.

Establishing mutually beneficial long-term relationships with key constituents can

bring about the generation of multiple comparative advantages for the firm, both in

terms of improved profitability (Clarkson, 1995; Hillman and Keim, 2001) and better

risk management (Godfrey, 2005). In other words, building trusting relationships with

primary stakeholders by addressing their legitimate needs and concerns (ideally on

2 See Nielsen Holdings NV (2013).

3 European Commission (2013).

4 Hayward et al. (2013).

5 However, when focusing either on fund performance (Kreander et al., 2005) or index performance

(Schr¨

oder, 2007), there are usually no significant differences to be found between the performance of

conventional and socially responsible investing (SRI) funds. And this is despite SRI funds being true to their

name and investing in more sustainable firms compared to their conventional peers (Kempf and Osthoff,

2008).

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160 HOEPNER, OIKONOMOU, SCHOLTENS AND SCHR ¨

ODER

a proactive basis), through CSR, creates reputational wealth and relational capital

for the firm and can ultimately lead to an improved corporate valuation or to the

preservation of value during turbulent times.

A second line of reasoning commonly used to support a positive association between

CSR and firm performance is often referred to as “the good management hypothesis”

(Alexander and Buchholz, 1978; Waddock and Graves, 1997). This hypothesis suggests

that high levels of sustainable business practices can be viewed as signaling supremely

competent and trustworthy corporate managers. The effective application of CSR is a

very complex task that requires the consideration of the relative importance of claims

made by a plethora of different stakeholder groups (often contradicting each other)

and the estimation of both explicit and implicit costs and benefits accruing from the

related practices to the firm. Consequently, executives who choose to use CSR for

strategic purposes can be viewed as being highly skilled.

Interestingly, although the aforementioned arguments can be used to motivate

research on the financial impacts of CSR on either the equity or debt valuation of

the firm, the majority of relevant studies focus on identifying the influence of CSR on

the cost of equity capital (Kempf and Osthoff, 2007; Galema et al., 2008; Hong and

Kacperczyk, 2009; El Ghoul et al., 2011). It has only been in the last few years that

some attention has been paid to the possibility of a linkage between CSR and cost

of debt. The sheer size of the corporate debt market and its importance on a global

scale merits such investigations. According to McKinsey, as of 2012, global equity is

estimated to aggregate to US$ 50 trillion, whereas total corporate debt amounts to

US$ 86 trillion.6An additional reason to motivate such research comes from the view

that distinguishing good management via a firm’s CSR levels is even more important

in the debt markets due to the agency conflicts arising between shareholders and

debt-holders (Ashbaugh-Skaife et al., 2006). Merton’s (1973) seminal work has demon-

strated that the pay-offs accruing from a corporate bond (the extension to corporate

loans is straightforward) are asymmetric and resemble that of a put position. This is

because the potential benefits for the borrower are capped at the level of accruing

interest payments, whereas the potential losses can be as much as the entirety of the

borrowed capital. In contrast, for shareholders, the gains are potentially unlimited.

This distinction makes the imperative to identify competent and responsible firm

managers in order to reduce agency and monitoring costs more important for debt-

holders than for equity-holders.

It should also be noted that from the US$ 86 trillion of outstanding, global

corporate debt, US$ 75 trillion (or approximately 87%) relates to securitized or non-

securitized bank loans, and US$ 11 trillion is connected to outstanding corporate

bonds. Bradley and Roberts (2004) also report that private debt, including bank loans,

tends to be at least two to three times the amount of public debt. Apart from their

differences in order of magnitude, the role of banking institutions as “quasi insiders”

(Goss and Roberts, 2011) provides a basis to assert that the loan market is more

efficient than the bond market and, as such, the financial effects of CSR will be more

prominently exhibited there. Banks have access to unique information related to a

firm’s operational and financial standing, a specialized skill set to appropriately assess

this information in order to make a lending decision, and the privilege of being able

to set the terms regarding the monitoring of the borrower during the duration of the

6 See Lund et al. (2013) for more details.

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