Where’s the Greenium?

David F. Larcker is James Irvin Miller Professor of Accounting at Stanford Graduate School of Business and Edward Watts is a Ph.D. student at Stanford Graduate School of Business. This post is based on their recent paper.

Environmental, Social, and Governance (ESG) measurement, Corporate Social Responsibility (CSR) activities, and Socially Responsible Investing (SRI) are increasingly important research topics in both academic and professional areas. A question of primary importance in this area is whether ESG investments have value to investors beyond the normal expected risk and return attributes of a security. For instance, if investors are presented with a high-ESG and low-ESG security whose risk and returns are identical, would investors pay more for the high-ESG security?

In our study, we focus on U.S. municipal issuers as it provides a novel quasi-natural experiment in which to investigate this issue. Municipal issuers have been one of the largest issuers of “Green bonds.” From 2013 to 2017, over $23 billion of self-labeled Green bonds have been issued in municipal markets, for more than 2,500 individual securities. This provides an extensive sample of securities and issuers for our empirical tests.

More importantly, our focus on municipal Green bonds allows us to take advantage of two unique institutional features of the U.S. municipal securities market to implement a methodological approach that is less prone to the standard correlated omitted variable critique of prior research. The first feature is that municipal issuers commonly price multiple tranches of securities, both Green and non-Green securities, on the same day with similar maturities. The second feature of municipal bonds is that the credit for these Green bonds is identical to the credit for their non-Green counterparts. Green bonds are identical to ordinary municipal bonds, with the key exception being that the use of proceeds is allocated for the purposes of “environmentally friendly projects.”

Unlike a number of prior studies, we provide compelling evidence that the so-called “greenium”—the premium that Green assets trade to otherwise identical non-Green securities—is exactly zero. Specifically, once we remove unusual observations, the average mean (median) yield differential between our matched pairs of Green and non-Green securities is 0.01 (0.00) basis points, while the mean (median) credit spread differential is 0.00 (0.00) basis points. The yield (credit spread) differentials are exactly zero in 88% (88%) of cases with occurrences of positive and negative equally split at 6%. Interestingly, we find that despite the lack of a pricing differential, investment banks appear to charge on average approximately 10% more for the issuance of Green bonds.

Subsequent analyses show that our findings cannot be explained by differences in institutional ownership or liquidity between Green and non-Green bonds, or by so-called “greenwashing.” (Greenwashing refers to the issuance of securities labeled as Green that lack genuine environmental benefits.) Our results indicate no meaningful association between Green and non-Green bonds and proxies for market liquidity and institutional ownership. Similarly, despite the increasingly frequent practice of issuers obtaining third-party Green certifications, such as through the Climate Bonds Initiative (CBI), we find no evidence of pricing benefits related to these certifications. Among securities that are CBI Climate Certified in our matched sample, the differential between Green and matched non-Green issues is exactly zero in 91% of cases.

Overall, our study provides some of the cleanest evidence of the effect of ESG on asset pricing to date. While we acknowledge that the inferences in this paper may not be generalizable to settings outside of the U.S. municipal bond market, there are a number of reasons to believe that this setting is one where we would be most likely to find pricing differentials between Green and non-Green securities. For instance, the inability to take short positions in the municipal market prevents cross-security arbitrage, which would preserve any Green pricing differential that might exist. In addition, because municipals are generally held by high net-worth individuals who are neither financially constrained nor competing for asset flows, they may be investors with some of the most latitude to sacrifice returns to invest in Green projects.

At a minimum, our study provides new policy relevant insights on the pricing of Green securities of municipal markets and the benefits of third-party certification. Based on prior studies that claim to document a greenium, some policy analysts are calling for more Green bond issuance to reduce the cost of government borrowing. Our results suggest just the opposite conclusion—not only is there no pricing differential, but investment banks also appear to charge slightly more to issue Green bonds on average. Combined with the fact that external certification adds additional costs of issuance for municipalities (without any apparent cost savings), our results suggest that municipalities actually increase their borrowing costs by issuing Green bonds.

The complete paper is available for download here.

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