Do Sustainability-Linked Bonds Pay Lower Interest Rates?

Abstract

Sustainability-Linked Bonds (SLBs) are a recent phenomenon in debt financial markets that is attracting increasing attention in the literature. Nevertheless, there is still very little evidence on the potential existence of a so-called interest premium, reflecting the investors' willingness to accept lower expected returns for holding SLBs as compared to conventional bonds. This paper proposes the use of a frontier approach for analyzing the presence of the SLBs premium using Data Envelopment Analysis (DEA). In particular, we develop a two-stage procedure. In the first stage, DEA is applied to derive inefficiency measures reflecting the distance of the bond to a frontier defined by time to maturity, risk, and interest rate. Inefficiency indicates that the issuer pays a lower interest rate (discount) as compared to that of the highest yielding bonds located at the frontier. In the second stage, OLS regression with robust standard errors is used to analyze the relation between the distance to the frontier derived from the first stage and a set of bond characteristics, including a dummy variable indicating whether the bond is an SLB. The empirical application focuses on data of all bonds issued in Euros observed over the period 2015–2022. The main result shows that SLBs pay higher, though statistically insignificant, interest rates compared to conventional bonds. Hence, we do not find evidence for the SLBs interest premium and cost of capital argument, in which SLBs are issued to benefit from a cheaper source of financing.