City climate disclosures and municipal bond ratings

Abstract

Do voluntary climate disclosures affect municipal bond ratings? Cities play a critical role in determining the trajectory of climate change. The major rating agencies have affirmed their use of climate information in their credit evaluations as well as indicated their preference for cities that safeguard against climate risk (Moody’s Investor Services, 2017; S&P Global Ratings, 2021). Drawing on information theory, voluntary disclosure theory, legitimacy theory, and signaling theory, this study investigated whether the level of city climate disclosures and the quality of such disclosures are associated with higher municipal bond ratings. Additionally, using both legitimacy theory and signaling theory, this study examined the differentiating effects of disclosure quality on cities with high levels of disclosure versus low levels of disclosure. For purposes of this study, disclosure quality is defined in terms of a city’s climate action, specifically mitigation and adaptation activities. Using a novel dataset of city-level information, this study found that voluntary climate disclosures are positively associated with municipal bond ratings. This finding suggests that rating agencies use climate information in their rating evaluations and respond to voluntary climate disclosures favorably. The study also found that disclosure quality is positively associated with bond ratings, which suggests that rating agencies respond more favorably to higher quality disclosures. Finally, the study found that the level of disclosure moderates the relationship between disclosure quality and bond ratings such that the positive association between disclosure quality and bond ratings is stronger for cities with higher levels of disclosure. This finding suggests that the value relevance of disclosure quality to rating agencies is stronger for cities with higher levels of climate disclosure. Overall, the study contributes to the voluntary climate disclosure and municipal bond rating literature as well as assists both city officials and municipal bond investors by revealing the impact of climate information on bond ratings. Additionally, results from this study help to determine that specific climate actions and policies affect bond rating decisions, providing valuable information to city officials, policymakers, and municipal bond market participants.