Environmental, Social, and Governance (ESG) Factors and Municipal Bond Yields

We investigate the association between a wide range of environmental and social outcomes and the credit risk of municipal finance fixed income securities. Building on recent work documenting the pricing of climate risk, future opioid health care costs and race-based investor preferences at the municipal-level and a more holistic view of Environmental, Social and Governance (ESG) risks and opportunities for sovereign and corporate bonds, we explore whether the US municipal bond market prices a broad spectrum of Environmental and Social as well as more traditional Governance (e.g., fiscal policy) factors. We develop a novel dataset designed to underpin such analysis and use that dataset to demonstrate that better ESG outcomes and the equity thereof across racial identity groups, are associated with reductions in credit yields for US municipal finance instruments. Of particular substantive importance are a set of factors related to racial justice outcomes at the county-level. These results suggest that even socially agnostic investors should investigate the environmental and social performance of a municipality as part of their credit due diligence. Improvements in ESG performance should be rewarded with lower credit yields. If we allow for some investors to also exhibit pro-social behavior in the desire to invest in municipalities that are higher performers on ESG factors, we have an additional potential impetus for environmental and social factors to move markets in a manner that improves social welfare and reduces (racial) injustice