Are environmental, social and government factors incorporated in the credit ratings?

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Abstract

Sustainability aspects are assuming a key role both in investment decisions and in credit assessment processes. The aim of this research is to investigate the relationship between environmental, social and governance (ESG) variables and credit rating. We conduct an analysis on a sample of 1191 US-listed companies in 2021. We collect S&P credit ratings on Thomson Refinitiv and we regress ESG variables, and the sub-categories of each pillar E/S/G, against credit rating, along with common firm-specific factors affecting credit risk. The result highlights a direct relationship between ESG performance and credit ratings, confirming previous literature (Apergis et al., 2022; Devalle et al., 2017). Companies with good ESG scores achieve better credit ratings of up to three points. Particularly, good social performance is significantly associated with better credit ratings. However, the empirical analysis shows that the current integration of ESG parameters into credit rating assignment processes is only at an early stage because it is still difficult to quantify the impact of these factors by separating them from economic and financial indicators. This study updates previous research with a larger sample and paves the way for improving and strengthening ESG research on environmental, social and governance performance issues. Managers should promote an effective ESG policy and, in particular, social practices to improve a firm’s creditworthiness, while regulators should unify the ESG evaluation criteria for credit rating agencies.

Keywords: ESG Performance, Capital Structure, Rating, Cost of Debt

Authors’ individual contribution: Conceptualization — A.G. and V.C.; Methodology — A.G. and V.C.; Investigation — L.P.; Writing — A.G. and V.C.; Supervision — O.R.

Declaration of conflicting interests: The Authors declare that there is no conflict of interest.

JEL Classification: G11, G12, G32, G34, M14, Q56

Received: 21.07.2023
Accepted: 18.09.2023
Published online: 20.09.2023

How to cite this paper: Cioli, V., Giannozzi, A., Pescatori, L., & Roggi, O. (2023). Are environmental, social and government factors incorporated in the credit ratings? Risk Governance and Control: Financial Markets & Institutions, 13(3), 22–32. https://doi.org/10.22495/rgcv13i3p2