Investing and Governance: Through the Lens of Sustainability

Given the pivotal role of corporate sustainable debt in facilitating the transition to a more climate-resilient economy, existing research predominantly focuses on elucidating the phenomenon of greenium (Flammer [2021]; Pastor et al. [2022]; Aswani and Rajgopal [2022]) or delving into the investment preferences of stakeholders within this sector (refer to Baker et al. [2022],

Hartzmark and Sussman [2019]). Nevertheless, the efficacy of governance practices plays a critical role in determining whether investments are channeled solely towards financial gains or whether they also address and reduce a firm’s adverse environmental impacts.

In this paper, we explored this under-researched area by investigating whether sustainable investment makes firms do changes in the organizational structure such as adopting sustainable governance. Motivated by the wide literature on ‘signaling’ in economics, finance, and related disciplines3, we hypothesize that firms which care for sustainable investment would do necessary changes in the organizational structure to give signal to the market even if the signal is costly.

However, as literature on governance impact of investment, shows firms make changes in corporate governance to attract more investment and to reduce the cost of debt. Due to simultaneity issue, it is complicated to know whether firm giving this signal to the existing investors or to attract new investment. We mitigate this simultaneity issue using identification through heteroskedasticity and show that sustainable investment make firm do changes in the sustainable governance.

We utilize sustainable fixed income data from the Bloomberg Global Fixed Income database, with sustainability governance metrics extracted from the BoardEx database. Additionally, we gather data on firm fundamentals from Worldscope and Global Compustat for the controls.

Our dataset encompasses 3,944 sustainable bonds issued between 2013 and 2022. The final dataset includes 6,925 firms, resulting in 59,019 firm-year observations. Of these, 30% (or 3,053 firms) have implemented significant organizational changes to promote sustainability during the observed period.

These firms are primarily from the financial, industrial, healthcare, materials, and consumer discretionary sectors. Geographically, a significant portion of these sustainable firms are located in the United States, United Kingdom, France, Germany, Canada, and Australia. This geographical spread closely mirrors the distribution of issuers of sustainable debt, which is predominantly from the United States, France, Germany, United Kingdom, and China, suggesting a correlation between organizational sustainability changes and the issuance of sustainable debt.

For evaluating sustainable debt at the firm level, we consider two indicators: the ratio of cumulative sustainable debt to the firm’s total debt, and the natural logarithm of the annual total number of sustainable bonds issued. We define sustainable governance using a binary variable that assigns a value of 1 to firms appointing a sustainability officer or establishing a sustainability committee within the year, and 0 otherwise.

To enhance the validity of our governance metrics, we supplement our analysis with data from the Refinitiv ESG database. For empirics, we conducted event studies and use panel regression with country, year, and industry fixed effects. To mitigate endogeneity concerns (simultaneity bias), we use identification through heteroskedasticity (see, Rigobon [2003]) and generate the causal generalized method of moments (GMM) estimates.

On generating the causal Generalized Method of Moments (GMM) estimates, we find that an 1% increase in the amount of sustainable debt issuance increases the possibility of adoption of sustainable governance by 9.2%. These findings are statistically significant at the 1% level.

We confirm these results using number of sustainable bond issuances as alternate proxy for sustainable debt measure. Additionally, we also observe that superior governance tends to attract increased investment which is well documented in the prior literature. It indicates that, particularly when addressing the endogenous nature of investment and governance, investment also drives governance improvements, not just the reverse. Our methodology causally proves this.

References:

Aswani, Jitendra, and Shivaram Rajgopal. "Rethinking the value and emission implications of green bonds." Working Paper (2022).

Flammer, Caroline. "Corporate green bonds." Journal of financial economics 142, no. 2 (2021): 499-516.

Hartzmark, Samuel M., and Abigail B. Sussman. "Do investors value sustainability? A natural experiment examining ranking and fund flows." The Journal of Finance 74, no. 6 (2019): 2789-2837.

Baker, Malcolm, Daniel Bergstresser, George Serafeim, and Jeffrey Wurgler. "The pricing and ownership of US green bonds." Annual review of financial economics 14, no. 1 (2022): 415-437.

Rigobon, Roberto. "Identification through heteroskedasticity." Review of Economics and Statistics 85, no. 4 (2003): 777-792.