After years of pressure from consumers, employees and activists, the business world is increasingly convinced of the importance of improving its impact on society and the natural environment. In a UN/Accenture survey from 2013, which involved more than 1,000 top executives from over 100 countries, 93% of respondents said that sustainability issues were important or very important to the future success of their business.
This change of heart is underpinned by research into the relationship between corporate social responsibility (CSR) and the financial performance of both individual firms and investment portfolios. It shows a modest but statistically significant positive correlation between the two.
Why would this be the case? Good CSR practices can mean a firm develops better relations with the people and organisations it works with. Building trusting relationships by addressing their needs and concerns through CSR can improve the firm’s reputation and make it more valued. It also tends to give the impression of competent executives who have what it takes to stay in business and lead from the front.
Yet most studies have focused on how CSR affects a company’s share price, giving less consideration to its impact on debt finance. The latter is arguably at least as important to companies: in 2012, according to estimates by the consultancy McKinsey, global shareholder equity amounted to $50 trillion (£35 trillion) where total corporate debt was $86 trillion. It is also even more important for lenders than shareholders to be invested in well-run firms, since they have more chance of missing out on any benefits: lenders’ gains are capped at the level of the interest payments they receive, while shareholders’ upside is potentially unlimited.
Debt and sustainability
I have just co-published a study into this area, and our starting hypothesis was that good CSR reduces the risk of a business defaulting on its debts. Since lending institutions ultimately price loans and bonds based on the risk of default, CSR should affect the cost of the debt. We studied 470 loan agreements in the period 2005 to 2012 across borrowers in 28 countries operating in all the major sectors.
In general, however, we found that improved CSR performance did not make it cheaper for a company to raise money – and some kinds of improved CSR, particularly those related to social issues, even appear to make it more expensive. But we also looked at how debt costs were affected by what countries were doing in relation to sustainability, and found a very interesting correlation: governments’ efforts made a significant difference to the borrowing costs of the companies based there. This cuts across all the main facets of sustainability, including healthcare, corruption, social freedoms, emissions, waste, labour rights and biodiversity.
We found that an increase by one unit in a country’s overall sustainability metric led to an average decrease of 69 basis points in the cost of corporate debt. In other words, a loan or bond that would otherwise be priced at 3% was now priced at 2.31%.
And when we looked at the individual elements of those national sustainability efforts, we found that the environment looks to be more financially important than social justice. It led to an average drop in debt costs of around 80 basis points, where the equivalent improvement in social sustainability led to a drop of around 50 basis points.
The intuitive explanation for why these things have an effect is that where a country is taking sustainability seriously, it acts as a shield for the borrowing firm. By protecting firms from the operational and reputational hazards that come from wider social and environmental challenges, lenders judge their risks of defaulting as being lower. This appears to negate the need for them to consider the firm’s own CSR activities. It will be interesting to see if this affects how governments and corporations approach sustainability issues in future.