Measuring the effect of government ESG performance on sovereign borrowing cost

Abstract

This article examines whether the extra-financial performance of countries on environmental, social and governance (ESG) factors matter for sovereign bonds markets. We propose an econometric analysis of the relationship between ESG performances and government bond spreads of 23 OECD countries over the 2007-2012 period. Our results reveal that ESG ratings significantly decrease government bond spreads and this finding is robust for a wide range of model setups. We also find that the impact of ESG ratings on the cost of sovereign borrowing is more pronounced in bonds of shorter maturities. Finally, we show that extra-financial performance plays an important role in assessing risk in the financial system. In particular, the informational content of ESG ratings goes beyond the set of quantitative variables traditionally used as determinant of a country's extra-financial rating such as CO2 emissions, the share of protected areas, social expenditure and health expenditure per GDP, or the quality of institutions, and offers an additional evaluation of governments' ESG performance that matters for government bond spreads.