CDS spreads rise sharply after ESG downgrades — most notably within the social pillar and among financially constrained firms — while upgrades show little effect. Positive ESG sentiment and transparency can mitigate these adverse credit impacts.
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Abstract
We investigate the impact of Environmental, Social, and Governance (ESG) rating changes and daily ESG news sentiment on firm credit risk. We document a significant increase in credit default swap (CDS) spreads following ESG rating downgrades, especially for the social pillar, while we find a muted reaction to ESG upgrades. A similar asymmetrical effect is documented for ESG news. We further show that the adverse effect of ESG downgrades on the CDS market is stronger for firms with lower creditworthiness, but mitigated in the presence of positive ESG sentiment, a transparent information environment, and higher rating disagreement.