Backing away from ESG? The effect of sovereign rating downgrades on corporate sustainability

Periklis Boumparis, Chris Florackis, Omrane Guedhami and Sushil Sainani

Journal of Corporate Finance, 2025, vol. 94, issue C

Abstract: We examine how sovereign rating downgrades affect firms' environmental, social, and governance (ESG) policies, leveraging the sovereign “ceiling” rule as a quasi-natural experiment that generates exogenous variation in corporate credit ratings. Under this rule, firms originally rated at or above the sovereign rating (bound firms) face a higher likelihood of downgrade following a sovereign downgrade. Using a difference-in-differences (DiD) setting, we find that bound firms experience a decline in ESG performance following a sovereign downgrade. This decline occurs only after the downgrade, not before, validating the parallel trends assumption. Our analysis further indicates that this effect is not driven by financing frictions and is concentrated in countries with a shareholder-centric orientation, and among firms with low institutional ownership from countries with strong social norms. Additional evidence suggests that affected firms experience an increase in ESG-related incidents, damaging their reputation post-downgrade. Overall, our findings underscore the crucial role of sovereign risk in shaping corporate sustainability practices.

Keywords: Credit ratings; Sovereign downgrade; ESG; Corporate sustainability; Markets and institutions (search for similar items in EconPapers)
JEL-codes: G24 H63 M14 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:94:y:2025:i:c:s0929119925001245

DOI: 10.1016/j.jcorpfin.2025.102856

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