Corporate social responsibility (CSR) has become a major issue for company management, with much debate over whether it adds or destroys value.

Many researchers have examined the value-adding potential of CSR from a share price performance perspective, but less so from a debt perspective, and where debt has been considered it is typically from a bond holder perspective. This study considers whether CSR practices impact the cost of bank debt. Since banks typically gain access to company information that is not normally available to outsiders, they may be in a better position to evaluate the value of a firm’s CSR programme than other outside parties such as bond credit rating agencies.

The research focuses on loans to US companies over the period 1991-2006, and finds that companies exposed to more CSR-related risks (typically meaning concerns related to environmental, social, or corporate governance issues) pay more for their loans than companies with few or no CSR risks. However, companies with CSR strengths, i.e. proactive CSR programmes, are treated differently if they are in a strong financial position (i.e. high quality borrowers), than if they are weaker. Low quality borrowers appear to be penalised for investing in discretionary CSR programmes, while high quality borrowers are not. The authors suggest that this demonstrates lenders discriminating between genuine attempts to align firm goals with societal needs, and CSR programmes that are merely for show and destroy value.

Goss, A. and Roberts, G.S. (2011) The impact of corporate social responsibility on the cost of bank loans Journal of Banking & Finance, Vol 35:7, p1794–1810

Analysis

The authors hypothesise that firms with more CSR risks will face higher costs of borrowing since the risks represent a potential impact on future cash flow that may prevent the borrower from repaying the debt, and that this would be exacerbated in the absence of collateral.

In common with other studies looking at the impact of intangible factors on the cost of bank loans, the primary measure used by the authors is the all-in spread, i.e. the interest rate including additional fees. The data comes from a standard industry source, Dealscan.

To evaluate CSR practices, the authors use KLD Research and Analytics data, an established provider of CSR research and CSR-based company rankings, to source information on a range of different factors that typically form part of a CSR programme. These include a range of environmental, social and governance issues such as community relations, corporate governance, employee diversity, employee relations, environmental impact, human rights, and any productspecific issues. Both strengths and risks in these areas are identified for all companies, in addition to any exposure to six sectors that are perceived by investors to have substantial inherent CSR concerns: alcohol, gambling, firearms, military, tobacco and nuclear power.

Results

The results suggest a significant correlation between CSR risks and loan costs, with loan costs increasing as CSR risks increase. Within the sample, companies with above average CSR risks paid nearly 10 basis points more for their loans than companies with below average CSR risks did. However, companies with CSR strengths did not benefit from a corresponding reduction in loan costs. Companies with high risks and high strengths pay approximately the same premium as companies with high risks and low strengths. Over the whole sample, the impact of CSR strengths is not significant. Furthermore, if collateral is provided for the loan then the impact of CSR risks on the interest rate is reduced. The authors also found that the impact on loan cost varies between individual CSR factors. For example, of the six sectors with CSR concerns, only tobacco companies appear to pay higher loan spreads than average.

The results are robust, controlling for company and loan characteristics such as size (larger firms are generally viewed as less risky by banks), loan security, company balance sheet strength and profitability, loan maturity, type, purpose, and whether it is a single lender or a syndicated loan. Different time periods, regional differences between companies, and improved monitoring by banks over time are also shown to not diminish the relationship. However, regardless of CSR strengths, the authors found that companies with lower risks tend to take larger loans, corroborating other research that suggests firms with better CSR performance have easier access to financing, and that longer maturities appear to be correlated with lower loan costs.

Conclusions

Goss and Roberts’ theory to explain their findings is that banks view CSR programmes as a risk management exercise, i.e. companies that act irresponsibly may be subject to future cash costs to correct the impact of their current activities. Such companies may therefore be less able to repay their debt in the future, with the risk of future costs increasing as the length of the loan term increases. Since the evidence suggests that longer maturities are actually leading to lower loan costs, the authors believe that higher risk companies may be effectively frozen out of the long term debt market.

Their theory would also imply that proactive CSR investments should lower risk and lead to lower loan costs, but only up to the point where the cost of the investment equals the reduction in loan cost. Hence companies that have major CSR risks are penalised for spending on CSR programmes that will not offset the higher cost of debt resulting from these risks.

Although the relationship between CSR risks and bank loan costs is statistically significant, the economic impact is relatively modest, suggesting that CSR is a secondary determinant of loan spreads rather than a major consideration. However, banks are also able to impose restrictive covenants and there is some evidence that banks also respond to CSR risks with less attractive contract terms. The authors highlight the impact of loan covenants as a potential area for future work.

Finally, the variation in impact of different CSR factors suggests that all parties with an interest in evaluating the impact of a company’s CSR performance should consider individual factors, not only aggregate scores that attempt to create a single CSR performance reference point with which to compare companies.

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RI Quarterly Vol.1: ESG issues in bank loan pricing and decision making