The Economics of Sustainability-Linked Bonds

Relying on theory and empirical analysis, we study the real effects and pricing of Sustainability-Linked Bonds (SLBs). After issuance, SLB issuers decarbonize approximately seven percentage points faster per year than non-issuers. Our theory helps to understand the incentive structure and pricing of SLBs. Using a novel mispricing measure, we test several empirical predictions of our model. Overpriced SLBs at issuance experience negative secondary market returns. Stock markets react more positively to large, overpriced SLB issues, suggesting a wealth transfer from bondholders to shareholders. Finally, SLB mispricing is positively associated with firms' ESG ratings. Our analysis shows that SLBs play a significant role in influencing firms' decarbonization efforts and that these instruments carry meaningful implications for financial markets.