Sustainability and Credit Spreads in Japan

Does the market value the environmental, social, and governance (ESG) performance of firms in
corporate bond credit spreads? In this study, we construct the firm-level corporate bond credit spread
based on the ‘bottom-up’ approach and examine the relationship between corporate ESG performance
and credit spreads. Our results indicate that the ESG performance significantly decreases the credit
spreads and the effects of ESG performance increase with the recognition of the importance of ESG
investing regardless of the pillar. Furthermore, our analysis suggests differential trends across the issuing
firms’ credit quality. Specifically, the ESG performance has a much higher impact on the credit spreads
for lowly-rated firms, implying that the information on higher ESG scores could be a stronger signal for
higher sustainability for those firms that are considered to have higher default risk from the financial
information. Within the E, S, and G pillars, the resource use category, human rights category, and
management category respectively show the most prominent annual lowering effects.