Creditors at the Gate: Effects of Selective Environmental Disclosure on the Cost of Debt

Research Question/Issue

What is the impact of selective environmental disclosure, also known as greenwashing, on firms' credit risk profiles? Can the superior information and monitoring abilities of private lenders serve as environmental governance mechanisms to promote the adoption of ESG best practices by firms?

Research Findings/Insights

Through detailed examination of private debt contracts and environmental disclosure practices, we reveal that private lenders impose financial penalties on firms with poor environmental records, manifesting as higher spreads and loan-related fees. Additionally, our analysis demonstrates that greenwashing, or misleading environmental transparency, results in increased debt financing costs for firms. Moreover, lenders may adopt lenient nonprice terms to mitigate the impact of higher loan costs on firms engaged in selective environmental disclosure. This intricate contract design allows lenders to extract appropriate returns without hindering firms' access to external financing.

Theoretical/Academic Implications

Our findings underscore the significance of private creditors in enhancing environmental disclosure standards within the corporate sphere. Additionally, our evidence emphasizes the importance of integrating firms' environmental impact into theoretical and empirical credit risk models.

Practitioner/Policy Implications

The intricate contract structures of bank loans can effectively address the informational risks associated with selective disclosure, without impeding firms' access to external financing. Hence, this financing mechanism holds the potential to enhance the ESG performance of firms.