At the Sustainable Finance Frontier - Sustainability-Linked Bonds: Targets, Sustainability Profiles and Yield Spreads

Abstract: Purpose: To investigate whether the ambitiousness of sustainability performance target and/or issuer sustainability profile have an influence on Sustainability-Linked Bond (SLB) yield spreads. Methodology: The utilized econometric approach is OLS regressions on a cross-sectional data. The regressions use yield spreads as dependent variables, a self-constructed ambitiousness proxy, Average Annual Distance to Target (AADTT), and issuer ESG score as main explanatory variables. Further, we introduce gradual controls for Sustainability-Linked Bond, common bond, and issuer characteristics. Additionally, we control for sector, year, and region effects. Theoretical perspectives: The theoretical perspective for this paper consists of Efficient Market Hypothesis, Signalling theory, and the theories under Corporate Social Responsibility umbrella i.e., Stakeholder, Legitimacy, and Institutional Theory. Moreover, theoretical reasoning based on SLB’s structural features is adopted. Empirical foundation: The initial global sample consists of 220 senior fixed coupon Sustainability- Linked Bonds issued in 2018-2022. In later specifications with further controls and subsamples this sample drops to 190, 177, 150, and ultimately 120 observations. Conclusions: The study finds that more ambitious targets are associated with higher yield spreads of 2-3 bps per one percentage point increase in AADTT when the sustainability performance target is greenhouse gas emissions. Additionally, a one unit increase in ESG score is associated with a 1,031 bps decrease in yield spreads. The findings support the set hypotheses grounded on the theories above.