By LARRY SWEDROE
Corporate green bonds were essentially nonexistent prior to 2013, but they have become increasingly popular in recent years. Morgan Stanley refers to this evolution as the “green bond boom” — with companies, municipalities and countries increasingly using green bonds to finance climate-friendly projects. In 2020 green bond issuance reached $270 billion.
Caroline Flammer contributes to the sustainable investing literature with her study Corporate Green Bonds, published in the November 2021 issue of the Journal of Financial Economics, in which she examined how markets respond to the issuance of corporate bonds whose proceeds finance climate-friendly projects. She explained: “To qualify as a ‘certified’ green bond, companies have to undergo third-party verification to establish that the proceeds are funding projects that generate environmental benefits, which gives rise to administrative and compliance costs.” Given their constraining nature, Flammer offered three explanations for their issuance:
- They can serve as a credible signal of commitment toward the environment.
- They could be a form of “greenwashing“.
- Investor preferences could lead to lower credit spreads.
Her data set covered the full universe (1,189 bonds from 400 unique issuers) of corporate green bonds followed by Bloomberg that were issued by public and private companies across the world over the period 2013-2018. Following is a summary of her findings:
- Corporate green bonds are more prevalent in industries where the natural environment is financially material to the companies’ operations (e.g., energy, utilities and transportation).
- Corporate green bonds are especially prevalent in China, the U.S. and Europe (the Netherlands, France and Germany being the larger issuers in dollar terms).
- The stock market responds positively — in a short time window (from -5 days to +10 days) — around the announcement of green bond issues: The cumulative abnormal return (CAR) was 0.49 percent, significantly different from zero at the 5 percent confidence level.
- CARs were larger for green bonds that were certified by independent third parties and first-time issuers of green bonds.
- Issuers improve their environmental performance post-issuance. The ASSET4 environmental rating improved 7 percentage points (an increase of 8.7 percent), and CO2 emissions fell 12.9 percent—findings that are inconsistent with greenwashing.
- Green bond issuers experience a relative increase in ownership by long-term investors and green investors post-issuance, findings that are consistent with the signalling argument — as green bonds provide a credible signal of commitment toward the environment, companies are better able to attract an investor base that is mindful of the long term and the natural environment.
- There was no statistically significant difference in yields between non-green and green bonds of the same issuer. This finding is consistent with that of David Larcker and Edward Watts, authors of the study “Where’s the Greenium,” published in the April-May issue of the Journal of Accounting and Economics, who found no significant difference in yields of municipal green and non-green bonds of the same issuer.
Flammer concluded that her “findings are consistent with a signalling argument: by issuing green bonds, companies credibly signal their commitment toward the environment.” Flammer’s finding of increased equity ownership in green bond issuers is consistent with that of Dragon Yongjun Tang and Yupu Zhang, authors of the study Do Shareholders Benefit from Green Bonds?, who found that “stock prices positively respond to green bond issuance.”
Also consistent with Flammer, they found that there was no statistically significant green premium — the improvement in stock prices was not due to a lower cost of debt; it was driven by increased institutional ownership.
There is a mounting body of evidence that the sustainable investing preferences of investors are having a favourable impact on the behaviour of companies, providing them with the incentive to improve their sustainability ratings lest they be at a competitive disadvantage in terms of their cost of capital and ability to attract and retain talent. These findings provide further support for the trend toward increasing shareholder activism related to sustainable investing objectives. In our book Your Essential Guide to Sustainable Investing (April 2022 publication), Sam Adams and I present the research findings and show the demonstrable impact of investors.
However, investors should be careful to differentiate between the finding that there is no material difference in the yields of green versus non-green bonds issued by the same company and that of the research (for example, see here and here) demonstrating that there has been a robust negative relation between sustainability ratings and issue spreads in the corporate bond primary market — although the explanatory power for spreads has decreased in recent years.
In late 2015 Moody’s and S&P announced that they would take ESG dimensions more explicitly into consideration when determining credit ratings, thereby reducing the information content of sustainability scores. Fitch (the third leading rating agency) joined Moody’s and S&P in taking ESG dimensions into account in 2017.
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LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing.
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