Impact of Ethical Behavior on Syndicated Loan Rates (Digest Summary)

The authors examine the relationship between ethical corporate behavior and bank loan rates. They hypothesize that the more stringent the borrower’s business ethics, the lower the borrowing costs from banks, and that borrowers with high ethical standards obtain lower rates from lenders that also have high ethical standards. The authors provide a theoretical framework through a review of related literature on business ethics, describe the research process used to test their hypotheses, present empirical results that support their hypotheses, and provide a conclusion of their findings.

Corporate social, ethical, and environmental governance issues have drawn increased interest in recent years. The authors cite the latest McKinsey study on sustainability in which 73% of CEOs responded that incorporation of these principles into their agenda is a priority. In another McKinsey study, 65% of chief financial officers and 77% of investment professionals agreed that ethics programs create value for their shareholders.

The authors add to the growing body of literature on business ethics by examining this topic in the context of the interest rate spread charged on bank loans. They posit that one of the factors determining the spread charged involves the ethical behavior of the borrower. By studying historical lending data, the authors demonstrate that increased ethical behavior has been associated with lower borrowing costs.

They find that a one standard deviation increase in borrowers’ ethical behavior is associated with a 24.8% reduction in spread from the mean. The authors rationalize that borrowers adhering to strict ethical standards are perceived as more trustworthy and less likely to require close monitoring. This ethical signaling is more likely to be well received when lenders also place a high value on ethics. The authors determine that the reduction in spread for ethical borrowers improved to 37.6% when lenders also exhibited higher ethical scores. In addition, they find that ethical borrowers are extended longer maturities and are required to pledge less collateral. The authors also examine how their thesis applies to equity financing, but that topic is not a focus in this article.

This research will be of specific interest to those involved in the study of business ethics. But given the broad use of bank debt, the reduced cost demonstrated in this study may have broad appeal to investors and corporations involved in the borrowing process.

The authors use a dataset of 513 borrower firms in 19 different countries during the period of 2003–2007. Their sample includes 12,545 loan facilities. Information on business ethics was obtained from the Sustainalytics Global Platform database. The ethics score is scaled from 0 to 100 and composed of the weighted average of 15 different items in four areas that capture the disclosure of ethical information, the existence of a specific ethics policy, procedures on ethical issues, and the level of controversies on ethical issues. The data on loans are from the Thomson Reuters DealScan database, bank-level characteristics are collected from the Bankscope database, and borrower structure is sourced from the Osiris database.

The cost of bank financing is measured using the loan spread in basis points over LIBOR. The average loan spread was 78.6 bps over LIBOR, the average deal amount was $750 million, and the average borrower had approximately $14 billion in assets.

The authors use controls for such factors as deal size, maturity, collateral, previous lending relationship, equity risk, bond rating, company size, age, profitability, and leverage. To test robustness, they replicate their analysis on a sample of 272 US loans between 2003 and 2011 and find similar results. One concern in this subset is that the benefits appear less pronounced following the 2008 financial crisis; the only significant reduction occurred between ethical borrowers and ethical lenders.

This paper represents a good addition to the existing research on business ethics. The study is well thought out and interesting to read. I commend the real-world application of the often intangible concept of business ethics. Although there has been increased discussion on the importance of ethics, if a tangible benefit, such as reduced borrowing costs, can be demonstrated, it is more likely to result in companies’ examining the adoption of enhanced ethics policies. It would be valuable to see the broader study repeated using more-recent data. I look forward to the follow-on research proposed by the authors, particularly regarding the relationship between ethical scores and loan default rates.