Design and Incentives of Sustainability-Linked Bonds

A novel product in the sustainable debt market is a sustainability-linked bond (SLB), where the first was traded in 2018. The coupon payments of these novel bonds depend on the achievement of the issuer’s sustainability goals described by sustainability performance targets (SPTs). Most commonly, the coupon payments increase if key performance indicators (KPIs) do not reach the SPTs. We address the question of whether the choice of more ambitious targets or higher penalty payments reliably indicates a higher issuer’s commitment to sustainability. Furthermore, we discuss if the issuance of an SLB create financial incentives for the issuer to do more for sustainability, i.e., can the issuer lower its financing costs by improving its sustainability performance. Lastly, we incorporate managerial efforts explicitly and investigate whether companies genuinely aspire to enhance sustainable initiatives by issuing SLBs.