Column | Rex Wang Are investors willing to prioritize societal impact over financial gain?

So far, the above question has remained unanswered. While some experimental and survey-based studies suggest that social values play a more significant role in impact-conscious investing than financial motives, many investors also cite higher returns as a key motivator for embracing ESG principles.

Addressing this question using real-world data is complex, as it requires identifying a scenario where two assets with identical expected returns and risks can be compared, with the only difference being their ESG profiles. Together with Dr. Shuo Xia of the Halle Institute for Economic Research and the University of Leipzig, we undertook this challenge. In our research, we compare green bonds with conventional bonds issued by the same U.S. municipalities, such that we can separate any non-financial incentives from the financial benefits associated with sustainable investing.

This setting offers two advantages. Firstly, green bonds are identical to conventional bonds from the same issuer, except for the fact that the proceeds are explicitly used for environmentally friendly and sustainable projects. This means that the financial returns and risks are equivalent for green and conventional bonds from the same municipality. Secondly, green bonds are often issued on a smaller scale, allowing green investors (if present) to influence prices by purchasing the majority of offerings. If green bonds are issued or traded at a higher price than normal bonds from the same issuer, this additional premium, which we refer to as "greenium," indicates that investors are willing to accept a lower return for investments that better align with their social values.

In our research, we are developing a novel approach to assess the additional price (greenium) of green bonds. This method is based on the principle of no-arbitrage pricing, meaning we aim to ensure there is no opportunity for profit without risk. For each green bond, we essentially create an imaginary regular bond with the same financial returns and risks. The greenium is then the price difference between the green bond and this imaginary regular bond.

Using a sample of 3,699 U.S. municipal green bonds issued between June 2013 and December 2020, we found that the average price of green bonds is approximately 3% higher. Additionally, we discovered that the price of green bonds is influenced by their popularity for investors seeking environmentally friendly investments. When there is less reason for ESG investors to be concerned about greenwashing, for example because there are external certifications or better credit ratings, we observe that the price of these green bonds is higher. The price increase is also larger when local investors are more aware of climate change and have more confidence in the issuing institutions' efforts to protect the environment. This confidence is often influenced by local environmental regulations and their enforcement.

In summary, our research suggests that green bonds are issued and traded at a higher price. This indicates that a significant portion of investors is willing to pay extra for environmental and societal benefits, in addition to their financial considerations.