Does the Cost of Borrowing Increase for Firms that are Socially and Environmentally Irresponsible?

SynopsisThe research problemThis study aims to determine the financial repercussions for firms that engage in irresponsible environmental, social, and governance (IESG) practices. Specifically, it examines whether these practices influence the cost of debt through increased borrowing costs imposed by lending institutions.MotivationAmid growing scrutiny over corporate behavior and its broader impacts, understanding how irresponsible practices affect corporate finance is crucial for stakeholders, including investors, policymakers, and regulators. This research is driven by the need to explore beyond the often-studied beneficial impacts of positive ESG practices, focusing on the consequences of their negative counterparts.HypothesesThe current study makes three hypotheses as follows: Ceteris paribus, first, there is a positive association between firms’ IESG practices and their cost of debt; second, the anticipated positive impact of IESG practices on the cost of debt is more pronounced in countries with low levels of corruption; and finally, the anticipated positive impact of IESG practices on the cost of debt is more pronounced among firms in sinful industries.SampleThe analysis covers a broad international sample of 50,281 firm-year observations from nonfinancial listed firms across 44 countries, covering the years 2002–2022. This comprehensive dataset allows for generalized insights across various geographic and industrial contexts.Adopted methodologyMultivariate analysis is employed, based on pooled regression with standard errors clustered at the firm level to account for intrafirm correlations and potential heteroskedasticity. A two-stage instrumental variable approach is also employed to address potential endogeneity issues, providing a robust framework for examining the causal impact of IESG practices on the cost of debt.AnalysesThe analyses focus on evaluating the direct impact of IESG practices on borrowing costs, alongside assessing the moderating effects of the corruption perception index (CPI) and differentiating between industry types (sinful versus nonsinful). Sensitivity tests are conducted to ensure the robustness of the findings against various model specifications and potential biases.Findings and ImplicationsThe findings indicate a universally significant positive relationship between IESG practices and the cost of debt, confirming that firms engaged in irresponsible practices face higher borrowing costs. This effect is particularly pronounced in countries with lower levels of corruption, emphasizing the critical role of national governance in influencing corporate behavior. Moreover, the analysis reveals no significant differences between sinful and nonsinful industries, suggesting uniform financial penalties for irresponsible practices across sectors. These results are robust across a range of sensitivity analyses, affirming the reliability of the conclusions. The study offers valuable insights for lending institutions, firms, and credit rating agencies about the financial implications of irresponsible corporate practices. It highlights the importance for policymakers and regulators to enforce comprehensive ESG guidelines that encourage substantive disclosures and responsible behaviors as well as eliminating greenwashing and ESG decoupling.