Economics Webinar - ESG Integration under Asymmetric Information

We present a model of ESG integration where borrowers can deviate from ESG promises ex-post. Borrowers are incentivized to pursue ESG projects only when lenders charge a high borrowing rate, which decreases the borrowers’ private benefit from reneging on their ESG claims. In the presence of adverse selection on borrowers’ genuine preferences for ESG, there is an equilibrium in which borrowers conduct ESG integration when ESG-friendly lenders bid first. Specifically, when ESG-friendly lenders take out non-ESG borrowers from the lending market, non-ESG lenders perceive the holdout borrowers to be ESG-friendly and demand a higher borrowing rate, which facilitates ESG integration.