Sovereign bond yield spreads and sustainability: An empirical analysis of OECD countries

•We study how sustainability affects sovereign bond spreads.•We find that countries with good sustainability performance tend to have less default risk and lower bond spreads.•In particular, governance and social factors appear to have an impact, but environmental factors do not. We study whether and how a country's environmental, social, and governance (ESG) performance relates to its sovereign borrowing costs in international capital markets. We hypothesize that good ESG performance plays an economic role: It signals a country's commitment to sustainability and long-term orientation and is a buffer against negative shocks, leading to lower sovereign bond yield spreads. Using a sample of 20 OECD countries over the period 1996–2012, we show that countries with good ESG performance are associated with lower default risk and lower sovereign bond yield spreads. Moreover, we show that the social and governance dimensions have a significant negative association with sovereign bond yield spreads, whereas the environmental dimension does not.