Climate-Related Disclosure Commitment of the Lenders, Credit Rationing, and Borrower Environmental Performance

The profound shifts in climate patterns and the escalating severity of natural disasters, such as wildfires and flooding, constitute an increasingly pressing threat to both human well-being and the global economy.  Recognizing the pivotal impact of industrial activities as significant contributors to climate change, an increasing number of countries are adopting mandatory environmental disclosure measures. These measures are designed to promote a more efficient allocation of capital and facilitate a smoother transition toward sustainable and green practices. For instance, numerous countries, such as the UK, Japan, New Zealand, and Switzerland, are striving to enforce mandatory corporate climate disclosure that aligns with the universally recognized framework established by the Task Force on Climate-Related Financial Disclosures (TCFD) by the year 2025.  In line with this trend, the U.S. Securities and Exchange Commission (SEC) put forth a proposal in March 2022, advocating for the mandatory disclosure of climate-related information by public companies, prepared using the TCFD framework.

The implementation of a mandatory climate disclosure rule has been shown to have positive effects on corporations’ environmental practices (Chen et al., 2017; Christensen et al. 2017). However, despite the potential efficacy of the mandatory disclosure rule, various stakeholders, including legislators, regulators, and investors, express concerns about potential costs that may outweigh the benefits. Firstly, the direct compliance costs are non-negligible, particularly for companies starting from scratch in collecting data on their environmental footprint. According to SEC estimates, the cost to businesses could significantly rise from $3.9 billion to $10.2 billion with the adoption of the mandatory disclosure rule (Eaglesham and Kiernan, 2022). Secondly, mandatory disclosure may impose indirect adverse real effects on both firms and society (e.g., Dranove et al, 2003). Recent academic research also suggests that investors possess a significant capacity to influence firms’ reporting decisions under the voluntary disclosure regime. (e.g., Jung, 2013; Pawliczek, Skinner, and Wellman, 2021). Against this backdrop, some opponents advocate for a passive approach, relying on capital markets to enhance the quality of climate-related disclosures in financial markets (e.g., Jennings, 2022). While a market-driven, voluntary reporting approach presents itself as an alternative solution for enhancing the quality of climate-related disclosure and promoting a green transition, there exists a scarcity of empirical evidence. 

In this study, we attempt to investigate this issue in the context of lenders’ membership in the TCFD. The TCFD, established by G20 leaders and the Financial Stability Board (FSB) in late 2015, aims to enhance climate-related disclosure in the financial market. As indicated by the aforementioned quote from Schumpeter (1912), lenders have traditionally played a central role among diverse investors in addressing a broad spectrum of global issues.  Specifically in the climate space, lenders actively contribute to the green transition by financing green innovations, providing environmental guidance to client firms, and participating in climate philanthropy (Light and Skinner, 2021). Notably, certain lenders demonstrated a strong commitment to enhancing climate-related disclosure in the financial market through their participation as members in the TCFD.

The TCFD is a consortium comprising 32 representatives from diverse sectors within financial markets, encompassing lenders, asset managers, insurance companies, and rating agencies. The principal goal of this group is to formulate a comparable and consistent environmental disclosure framework. In addition to crafting the framework, TCFD members have a crucial mission of advocating for the adoption of the new framework in the financial market. For example, in its 2022 inaugural report, JP Morgan Asset Management highlights the firm’s robust advocacy of the TCFD framework to their client firms.  As an additional illustration, Barclays, in a report submitted to the UK Parliament, has articulated its goal of compelling all listed companies to disclose information in accordance with the recommendations of the TCFD. This commitment is emphasized by Barclays being an original member of the TCFD.  Motivated by these considerations, our research aims to explore the following questions: Does a lender’s commitment to the improved environmental disclosure influence its client firms’ disclosure behavior? If so, does this influence ultimately result in a positive impact on the firm’s environmental performance? Lastly, what mechanisms are at play as the lender exerts pressure for disclosure?

To address these questions, we employ a sample comprising 2,293 non-financial and non-utilities Compustat firms with accessible loan information from 2012 to 2015 (pre-event period). To assess whether companies are aligning their environmental disclosure with the TCFD framework during the post-event period (between 2017 and 2020), we manually collect information from ESG reports available on the firms’ corporate websites. Out of the initial 2,293 companies, 385 firms (17%) have commenced aligning their ESG reports with the recommendations of the TCFD. Based on the data we collected, we find consistent evidence indicating that borrower firms associated with TCFD member lenders are more inclined to align their ESG disclosure with the recommendations provided by the TCFD during the post-event period. The findings suggest that the membership of lenders in the TCFD reflects the substantial commitment of lending institutions to enhancing climate disclosure.

We next leverage the introduction of the TCFD to examine the environmental real effect of lending institutions’ commitment to disclosure using a difference-in-differences (DiD) framework. Our analysis reveals that companies identified as treated firms (i.e., those whose relationship banks are TCFD members) encounter, on average, fewer enforcement actions from the US Environmental Protection Agency (EPA) following the TCFD launch (i.e., the treatment), compared to control firms (i.e., those whose relationship banks are not affiliated with the TCFD). The observed treatment effect is economically significant, with treated firms experiencing a reduction of approximately 0.14 EPA enforcement actions per year post-TCFD establishment, constituting a 58% decline relative to the sample mean.

The findings remain consistent when we employ alternative metrics to gauge environmental performance. Using data sourced from the Toxics Release Inventory (TRI) program from the EPA website, we observe that treated firms, on average, exhibit a 33% reduction in total toxic releases per year compared to control firms post-TCFD establishment. Additionally, using data from the Kinder, Lydenberg, and Domini Research & Analytics database (KLD), we find that treated firms demonstrate higher environmental scores than control firms after the TCFD launch.

Our dynamic DiD regressions yield results indicating that the treatment effects on EPA enforcement actions, toxic chemical releases, and environmental scores emerge only after the establishment of the TCFD and persist in subsequent years, suggesting that the parallel-trends assumption is satisfied. The findings consistently support the causal interpretation of the influence of lenders’ commitment to transparent climate-related disclosures on the environmental performance of borrower firms.

Additionally, we divide our full sample into two groups: TCFD-aligning borrower firms (those integrating the TCFD framework into their environmental disclosure during the post-event period) and non-TCFD-aligning borrower firms (those not aligning their ESG report to the TCFD framework). Our analysis reveals that lenders’ commitment to climate-related disclosure influences the environmental performance of borrower firms mainly within the TCFD-aligning subgroup. These findings suggest that the commitment of lenders to transparent climate-related disclosures translates into an enhanced environmental performance of borrower firms through the market-discipline effect of informative environmental disclosure. This observation aligns with the premise of market-driven voluntary disclosure.

Next, we examine the mechanisms through which the lenders committed to TCFD framework can influence the firms’ disclosure decisions. We conjecture that the lenders who are committed to transparent climate-related disclosures can influence the borrowers’ climate-related disclosure behavior via two channels: 1) charging higher loan spread and reducing the number and amount of new loans issued to non-TCFD-aligning borrower firms (the credit-rationing channel) and 2) increasing the strength of lender monitoring on non-TCFD-aligning borrower firms (the monitoring channel). By examining syndicated loans extended to the sample firms, we observe that, following the TCFD launch, non-TCFD-aligning borrowers on average face an approximately 17 percent higher (or 12.5 bp higher) loan spread when the lead arranger of loans is a TCFD member compared to loans arranged by a non-TCFD member. In contrast, we do not find any significant difference between loans arranged by TCFD members and those arranged by non-TCFD members for the TCFD-aligning borrowers following the establishment of the TCFD.

Furthermore, although we observe a significantly smaller loan amount for non-TCFD aligning borrower firms when the loans are lead-arranged by TCFD members compared to those arranged by non-TCFD members following the TCFD establishment, we do not find any significant difference in other non-price loan terms, such as loan maturity, and the use of covenants and collateral. Shorter loan maturity are conventionally associated with heightened monitoring incentives of lenders (Barclay and Smith, 1995; Gustafson, Ivanov, Meisenzahl, 2021; Park, 2000; Rajan and Winton, 1995), and covenants and collaterals are linked to ex-post monitoring of lenders (e.g., Rajan and Winton, 1995; Roberts and Sufi, 2009; Nini, Smith, and Sufi, 2012; and Ozelge and Saunders, 2012). These findings suggest that the commitment of lenders to climate-related disclosure influences borrowers’ climate-related disclosure behavior mainly through credit rationing rather than active monitoring.

In order to provide further evidence on credit rationing, we construct a firm-bank pair panel dataset and investigate aggregate syndicated loan flows for each firm-bank pair around the TCFD establishment, separately for TCFD-aligning borrowers and non-TCFD-aligning borrowers. To isolate the loan-supply-side effect, we account for time-varying, firm-specific loan demand, and the endogenous borrower-lender matching by incorporating firm-period fixed effects and firm-bank fixed effects, respectively. Consistent with credit rationing, our findings indicate that after the TCFD establishment, the total number of new loans and the total dollar amount of new loans experience a significant decline only for borrower firms of TCFD member lenders who are not aligning with the TCFD framework. Further, our additional analysis of aggregate bank loan portfolios reinforces this argument, revealing that TCFD-member banks significantly decrease their loan allocations to non-TCFD-aligning borrower firms following the TCFD establishment.

Finally, we observe that client firms of TCFD members within the non-TCFD-aligning borrower subgroup face significantly more stringent financial constraints compared to control firms. In contrast, we do not observe a similar effect in the TCFD-aligning borrower subgroup. These findings suggest that the credit rationing imposed by TCFD-member lenders has a substantial financial impact on non-TCFD-aligning borrower firms.

The complete paper is available for download here.