Empirical Studies of ESG Scores with Corporate Credit Spreads (Insights from popularity-based pricing)

This study examines various factors or characteristics (risk and non-risk) that determine a firm’s credit risk premium, as measured by its credit default swap (CDS) spread, with a particular focus on the impact of environment, social, and governance (ESG) scores. The framework employed is a general equilibrium asset pricing model which integrates classical and behavioral finance elements, known as popularity-based asset pricing. It treats all attributes or characteristics of an asset as ”factors” to which investors assign a degree of popularity, which changes over time. Non-risk characteristics are classified as ”tastes” or ”disagreements”, Fama French (2007). Firms’ degree of adherence to ESG practices is treated as one of these factors, looking at data over a decade period (2010-2021) of US corporate credits. In the popularity-based framework, investors have divergent beliefs about expected returns, and a variety of risk and non-risk preferences, such as liquidity or ESG. The popularity of ESG awareness among investors is treated as a preference rather than an economic risk factor exposure. The main results from this analysis are that, for the entire universe of US corporate credit market, both investment-grade and high-yield (sub-investment grade), the conclusion is that ESG, as a preference, is not significant in terms of the long-term credit risk protection spread levels for the entire universe, as well as investment-grade credit, but for sub-investment grade credits, that is not the case. These results indicate that a wellestablished and mature firm with a strong ESG consciousness and policy orientation may attract ESG-conscious investors, and these investors may be willing to pay a premium for the ESG benefits due to their popularity, leading to tighter CDS spreads or in other words ESG disclosure is negatively related to the credit default swap spread, which suggests that firms with a higher ESG disclosure have lower default risk. These results are essential for all firms’ stakeholders, and bondholders, to consider the firm’s ESG disclosure in conjunction with the life cycle stage before making their investment decisions