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The Effect of Environmental, Social, and Governance (ESG) Performance and Disclosure on Cost of Debt: The Mediating Effect of Corporate Reputation

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Abstract

Prior studies on the relationship between ESG information and cost of debt have found mixed results. They conclude that this relationship may be affected by some characteristics or attributes of the company. In this study, we examine whether corporate reputation mediates the relationship between ESG information and cost of debt. In other words, this study explores how ESG information influences corporate reputation, and how, in turn, corporate reputation affects the cost of debt financing. Data for corporate reputation were obtained from the Fortune “World’s Most Admired Companies” List, whereas data on ESG information were extracted from two sources: ESG performance were obtained from Sustainalytics database and ESG disclosure were obtained from Bloomberg database. Data on cost of debt and other control variables were also collected from Bloomberg database. Using structural equation models, we report a positive effect of both ESG performance and disclosure on corporate reputation. We also find that a good corporate reputation reduces the cost of debt financing and mediates the relationship between ESG performance/disclosure and cost of debt. We therefore conclude that firms that manage and disclose information on ESG issues have a better reputation, which in turn reduces their debt financing costs.

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Notes

  1. In this paper, we use ESG as a generic term subsuming all different sustainability terminologies, such as “corporate social responsibility (CSR)”, “corporate responsibility”, “corporate citizenship”, “sustainability”, etc.

  2. According to the Financial Times Lexicon, “the cost of debt is the effective rate that a firm pays on its current loans, bonds and various other forms of debt. The measure provides an idea as to the overall rate being paid by the firm to use debt financing”. A higher cost of debt implies that the firm has poor credit and higher risk, whereas a lower cost of debt means that the firm has good credit and less risk (Maaloul 2018).

  3. http://www.unglobalcompact.org.uk/issues/financial-markets/ (accessed the 22nd November 2020).

  4. http://lexicon.ft.com/Term?term=ESG (accessed the 22nd November 2020).

  5. Corporate reputation is considered as a key mediator in the relationship between a firm’s CSR and financial performance.

  6. In an unpublished study, Anginer et al. (2019) have also examined the relationship between corporate reputation and cost of debt. Their results show that reputation plays an important role in determining corporate cost of debt in the US.

  7. In this study, we expect that corporate reputation acts as mediator variable and not as moderator variable in the relationship between ESG performance/disclosure and cost of debt. In another words, we expect that ESG performance/disclosure have an indirect effect on cost of debt through reputation (mediator variable) (see Fig. 1). In a mediating relationship, as in our model, the independent variable (ESG performance or disclosure) is an antecedent of the mediator variable (reputation) and the latter is an antecedent of the dependant variable (cost of debt). The mediator variable (reputation) therefore has the status of dependent or independent variable depending on the angle from which it is observed. A moderator variable, on the other hand, systematically remains an independent variable regardless of the angle of analysis, which is not the case in this study since our results confirm our first hypothesis according to which both ESG performance and disclosure have a positive and significant effect on corporate reputation (see “Results” section).

  8. Sustainalytics’ ESG rating research methodology: Company ESG research (2017): https://wrds-www.wharton.upenn.edu/documents/303/Sustainalytics_ESG_Ratings_Methodology_Quick_Overview_2017.pdf (accessed the 22nd September 2021).

  9. Bloomberg Professional Services: https://www.bloomberg.com/professional/solution/bloomberg-terminal/ (accessed the 22nd September 2021).

  10. The Fortune World’s Most Admired Companies List was publicly available “free of charge” until 2016, the last year of our sample. From 2017, this list is included in paid databases.

  11. In robustness tests, we calculated the industry-adjusted cost of debt and re-estimated all our equations, replacing the cost of debt by the industry-adjusted cost of debt. The industry-adjusted cost of debt is the difference between the cost of debt of a firm in a given year and the median cost of debt of its industry in that year. The results are quite similar to those based on cost of debt (untabulated results).

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Acknowledgements

CPA-Canada Accounting and Governance Research Centre at the University of Ottawa.

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Authors and Affiliations

  1. School of Business Administration, TELUQ University of Quebec, 5800 Saint-Denis St. (Office B1105), Montreal, QC, H2S 3L5, Canada

    Anis Maaloul & Sari Mansour

  2. TELFER School of Management, University of Ottawa, Ottawa, Canada

    Daniel Zéghal & Walid Ben Amar

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Appendices

Appendix 1: Fortune’s World’s Most Admired Companies

 

Attributes of corporate reputation

1

Ability to attract and retain talented people

2

Quality of management

3

Social responsibility to the community and the environment

4

Innovativeness

5

Quality of products or services

6

Wise use of corporate assets

7

Financial soundness

8

Long-term investment value

9

Effectiveness in doing business globally

Appendix 2: Variable definitions

Cost of debt it

The cost of debt for firm i in year t is measured as following:

Cost of debt = [[(Short term debt / Total debt) × (Pre-tax cost of short term debt × Debt adjustment factor)] + [(Long term debt / Total debt) × (Pre-tax cost of long term debt × Debt adjustment factor)]] × [1 − Effective tax rate]

ESG information:

 

ESG performance it

The Sustainalytics ESG performance score for firm i in year t ranges from 0 (poor) to 100 (good)

ESG disclosure it

The Bloomberg ESG disclosure score for firm i in year t ranges from 0.1 (minimum) to 100 (maximum)

Reputation it

The corporate reputation score for firm i in year t ranges from 0 (poor) to 10 (excellent)

Size it

Size measured by logarithm of total assets of firm i at the end of year t

Performance it

Performance measured as net income scaled by total assets of firm i at the end of year t

Leverage it

Leverage measured as total debt scaled by total equity of firm i at the end of year t

Growth sales it

Growth sales measured by the percentage increase or decrease of sales revenue of firm i by comparing current year t with same period prior year t

Volatility it

Volatility measured by the standard deviation of the monthly stock returns of firm i in year t

Sector

Sector fixed effect. The GICS sectors are consumer discretionary, consumer staples, energy, financials, health care, industrials, IT, materials, real estate, telecommunications services, and utilities

Year

Year fixed effect. The years are 2013, 2014, 2015, and 2016

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Maaloul, A., Zéghal, D., Ben Amar, W. et al. The Effect of Environmental, Social, and Governance (ESG) Performance and Disclosure on Cost of Debt: The Mediating Effect of Corporate Reputation. Corp Reputation Rev 26, 1–18 (2023). https://doi.org/10.1057/s41299-021-00130-8

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