Who Pays for Sustainability? An Analysis of Sustainability-Linked Bonds

We examine the novel phenomenon of sustainability-linked bonds (SLBs). These bonds’ coupon is linked to the issuer achieving a predetermined sustainability performance target. We estimate the yield differential between SLBs and non-sustainable counterfactuals by matching bonds from the same issuer. Our results show that in most cases investors pay for the improvement in sustainability, while issuers benefit from a sustainability premium. Our analysis suggests that the sustainability premium is larger for bonds with a higher coupon step-up and for callable bonds. We also show that there is a ‘free lunch’ for some SLB issuers, as their financial savings are higher than the potential penalty, and they have a call option to reduce this penalty. While our findings suggest that most SLBs incentivize sustainability improvements by offering a lower cost of capital, some companies that do not benefit from a sustainability premium seem to issue SLBs to signal their commitment to sustainability targets. The ‘free lunch’ however suggests that SLBs can also be a form of greenwashing, when they are issued purely for financial optimization without a real commitment to carry out sustainability improvements