Sustainability and Credit Spreads in Japan

Does the market value corporate environmental, social, and governance (ESG) performance in corporate bond credit spreads? We directly measure the relationship between corporate ESG performance and credit spread by constructing the firm-level corporate bond credit spread based on the 'bottom-up' approach. We find that ESG performance has a significantly negative effect on credit spreads, but its impact varies across ESG pillars and the credit quality of the issuing firms. Our results also indicate that with greater recognition of the importance of ESG investing, increasing ESG performance has the stronger effect of decreasing credit spreads. Furthermore, our analysis suggests differential trends across the pillars and issuing firms' credit quality. More specifically, the environmental pillar has the largest impact on the credit spreads for low-rated firms, partly reflecting the global trend toward facilitating sustainable finance. Within the E, S, and G pillars, the resource use category, human rights category, and management category respectively show the most prominent lowering effects on credit spreads.