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Environmental Performance Influences Cost of Debt
By Christie Renner

In recent years, both academic research and real world experience have shown that environmental management is an important indicator of business success. Responsible investment strategies pay close attention to the connections between environmental performance and financial performance, but research has often focused on equities. New research evaluates how environmental management influences corporate bond markets.

Can poor environmental performance lower a company’s credit rating and increase its cost of debt?

Rob Bauer and Daniel Hann of Maastricht University and the European Center for Corporate Engagement addressed this question in their recently released paper, Corporate Environmental Management and Credit Risk. Their strong research methodology earned them the 2010 Moskowitz Prize for outstanding quantitative academic research in the field of socially responsible investing, awarded at the 21st annual SRI in the Rockies Conference in November.

Using research data from KLD (now part of MSCI ESG Research), Bauer and Hann evaluated the practices of 582 firms between 1995 and 2006. They found that environmental performance and cost of credit (the amount of interest a company pays on its corporate bonds) are linked, and that the link is growing stronger. Firms with environmental concerns often pay a premium on their cost of debt financing and are assigned lower credit ratings. “The results are consistent with the view that the regulatory implications of climate change have sensitized lenders to the downside risk of poor environmental practices,” the report concludes.

The authors also found better environmental performance associated with a lower cost of debt. However, negative environmental performance weighed more heavily than positive performance. Bauer told the University’s Research Magazine, “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 penalized through higher capital costs.”

You can listen online to the presentation Daniel Hann made at the SRI in the Rockies Conference. To review studies published by past Moskowitz Prize winners, visit the Center for Responsible Business at the University of California Berkeley Haas School of Business.

Posted: January 22, 2011