Moskowitz Prize for SBE researchers

Poor environmental management penalised by investors

Companies that have a good handle on their environmental management pay millions of euros less when financing themselves with debt than companies with questionable environmental practices. This is the outcome of a study by PhD candidate Daniel Hann and his promoter Professor Dr. Rob Bauer from the Maastricht University School of Business and Economics. Their research is one of the first to demonstrate the effect of environmental management on the costs of corporate bonds. For this, it has been awarded the American Moskowitz Prize for Socially Responsible Investing from the renowned Haas School of Business in Berkeley.

Over the last ten years, sustainability has become an increasingly important factor in financial markets. More than ever before, institutional investors are starting to take into account information about corporate sustainability in their investment processes. In most cases, this happens in the context of equity investments; only rarely do these same investors consider sustainability when selecting corporate bonds, despite the fact that this market is considerably larger. “We’re the first to comprehensively study whether there’s a connection between the interest that companies pay on these loans and their environmental performance”, says Bauer. “And that’s in the United States, too – the biggest market that there is for corporate bonds.”

Corporate bonds

For the non-economists among us: a corporate bond is issued when a corporation like Philips, for example, indicates that it wants to borrow money on the capital market. A syndicate of banks helps the corporation to place the loan with a group of institutional investors, such as pension funds. At that point, the interest rate, which Philips would have to pay annually on the borrowed amount for as long as the loan exists, is also fixed. A base rate can be derived from loans to the state; as the state is the most reliable client, the lowest interest rate can be calculated for it. Companies, on the other hand, usually pay higher interest: the greater the risk that they will not be able to fulfil their payment obligations, the higher the interest. In determining this extra interest, there is one crucial question: by lending Philips money, what risk do you run as an investor? Bauer: “This usually revolves around the company’s credit worthiness. But our study now shows that environmental management also plays a role in determining that extra interest percentage. It’s only logical that since the oil disaster in the Gulf of Mexico, BP has been having all sorts of trouble borrowing money. But our research shows that even without such a disaster, investors take these sorts of scenarios into account and factor them into the interest percentage. And the extent to which this is a genuine risk largely depends on what sort of shape a corporation’s environmental management is in.”

In practice

What this means in practice is that companies that hold their environmental management to a higher standard pay significantly less interest on their bonds than companies that pay no heed to environmental management. For corporations, this can amount to several million euros’ worth of lower costs per loan. “Just as there are rating agencies that screen companies on their credit value, such as Moody’s, S&P and Fitch, you also have rating agencies that assess companies in terms of sustainability, including the quality of their environmental management”, says Hann. “Investors use this type of information to estimate the environmental risk of companies, given that environmental incidents can result in costly legal, reputational, and regulatory consequences for the borrower. And that again has value implications for their investments. What we do is to use these ratings to quantify the environmental performance of companies, and then relate their environmental profiles to the interest that they pay on new corporate bonds.”

Weighing risks

Interestingly, the research shows that a lower score on environmental management has a proportionally greater effect on the interest of the corporate bond than a higher score. This sensitivity to environmental risks has particularly increased over the last decade, which is in line with the growing attention that is paid to climate change issues. Hann: “Lenders are primarily concerned about the downside risk of their investments. Any efforts to proactively cater for environmental management have a proportionally less positive influence on the cost of debt. So non-surprisingly we found that environmental concerns risks are more important to bond investors than environmental engagement.”

“You see this more often on financial markets”, adds Bauer. “Negative information is given more weight. A good environmental management system for an oil producer is seen as self-evident, a necessary condition. But if a corporation isn’t on top of this, it’s immediately penalised through higher capital costs.”

International market

The study also shows that the degree to which the quality of environmental management plays a role in financial markets has only increased in the last ten years. And the researchers expect that this development will continue in the coming years. Bauer: “It might sound logical, but some players on this market – investors and corporations – are not yet altogether convinced.” Although this study focused on 582 US corporations between 1995 and 2006, the researchers suggest that the results can also be applied to large Dutch corporations. “The bond market is international, so I can’t think why we wouldn’t observe a similar effect for companies like Philips and Unilever”, says Hann. “What’s more, most Dutch investors have considerable holdings in the foreign corporate bonds that we studied.”

The publication, according to Bauer and Hann, is just the first drop in a sea of literature set to appear on the impact that sustainability issues have on the pricing of corporate bonds. Bauer: “I think that’s also why we won the Moskowitz Prize. We broadened the scope of sustainable investments to the bond market, which is extremely relevant given the size of that market, both for corporations and investors. Credit is continually being handed out and renewed. Daniel is one of the first people to really dive into bond data in this context. And what an interesting result.”

The publication ‘Corporate environmental management and credit risk’ can be downloaded here.


Rob Bauer is a Professor of Institutional Investors at the Maastricht University School of Business and Economics and director of the European Centre for Corporate Engagement (ECCE). Daniel Hann is expected to obtain his PhD from Maastricht University in spring 2011. Contact:

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