ESG incidents and corporate green bond market reaction

• Green bonds outperform conventional bonds following ESG incidents involving the same issuer. • Cost-effectiveness, linked to bond liquidity, drives investors’ response to the incidents. • Green bond liquidity is higher for CBI-aligned green bonds and for EU issuers. • In these latter cases, post-incident performance differences are insignificant. This paper examines how the secondary market for corporate green bonds reacts to the announcement of Environmental, Social and Governance (ESG) incidents. We compare the cumulative abnormal returns (CARs) of green bonds with those of similar conventional bonds issued by the same firm, using a large international sample covering the period 2013–2022. Our results indicate that the performance of both green and conventional bonds declines after an ESG incident, but the decline is more pronounced for conventional bonds. We attribute this finding to the cost-effectiveness motive driving investors’ response to the ESG incident, as we find that a) there is no green premium (at issuance) in our sample, and b) green bonds are, on average, less liquid than conventional bonds, making the latter easier to sell due to lower transaction costs. Consistent with this argument, we observe opposite findings − namely, no significant performance differences and conventional bonds outperforming green bonds after the ESG incident − only in cases where green bonds exhibit higher liquidity, such as those issued by European firms or those compliant with the Climate Bond Initiative (CBI) standards.