Equator Principles Adoption: Peer Pressure or Piggybacking? J.W.B. Bos, M.G. Contreras and S. Kleimeier [email protected] Maastricht University School of Business and Economics November 27, 2014 We study the adoption of the Equator Principles (EP), by banks collaborating as lead arrangers in the syndicated lending market Project financing in 1999 The emergence of the EP • The dam was expected to have a damaging effect on the environment: – – – – Large cesspools of sewage Chemical waste Threaten rare plant and animal life Deplete the stock of aquatic life • The World Bank declined to invest in the project based on “environment and social grounds” • Other private financial institutions funded the project resulting in a public uproar • Prior to 2003, only the International Finance Corporation (IFC) had clear standards on evaluation of environmental and social risks in project financing in the emerging markets (Esty, Knoop and Sesia, 2005; Scholtens and Dam, 2007) Project financing in 2003 • NGOs shifted scrutiny from the companies leading the projects to the financial institutions funding the projects • Private banks began to incorporate into their financial agreements environmental standards • Citigroup, ABN Amro, Barclays and West LB along with IFC announced they would be adopting the EP (Esty, Knoop and Sesia, 2005; Scholtens and Dam, 2007) Expected benefits of adoption Brand benefits and product differentiation Credibility boosts Increased corporate profitability Better market access (Bondy et.al., 2004) Positive signal mechanism, i.e. responsible conduct (Diller, 1999; Bondy et.al., 2004; Wright and Rwabizambuga, 2006; Deringer, 2005; Scholtens and Dam, 2007) • Pre-empt boycotts (Diller, 1999; ondy et.al., 2004; Scholtens and Dam, 2007) • Reputation mechanism • • • • • The adopters are • Headquartered in countries with strong governance and institutions (Wright and Rwabizambuga, 2006; Bondy et.al., 2004) • The largest in the market (Saunders and Allen, 2002; Saha and Darnton, 2005; Wright and Rwabizambuga, 2006; Scholtens and Dam, 2007) • Multinational banks operating transnationally (Wright and Rwabizambuga, 2006) • Most likely to be the target of public campaigns (Amalric, 2005) Data Sources: Rule of Law (World Bank Governance Indicators) Number of EP Adopters (EP Website) Market Size (LPC Dealscan) We take a different approach Data Source: LPC Dealscan Zooming into the lead arranger network Bank (i) Bank (j) Adopt vs. Not Adopt Hypotheses • Hypothesis 1 (Peer Pressure): As an Equator bank concentrates its co-arrangement with a peer bank, more peer pressure is exerted resulting in the peer bank eventually adopting the EP. • Hypothesis 2 (Social Pressure): As banks become more active in the PF market by arranging more PF loans, they become more susceptible to social pressure leading to an increased potential of adopting the EP. • Hypothesis 3 (Piggybacking): Cooperation with an Equator bank leads to piggy- backing and resistance to adopt the EP. Hypotheses • Hypothesis 1 (Peer Pressure): As an Equator bank concentrates its co-arrangement with a peer bank, more peer pressure is exerted resulting in the peer bank eventually adopting the EP. • Hypothesis 2 (Social Pressure): As banks become more active in the PF market by arranging more PF loans, they become more susceptible to social pressure leading to an increased potential of adopting the EP. • Hypothesis 3 (Piggybacking): Cooperation with an Equator bank leads to piggy- backing and resistance to adopt the EP. Hypotheses • Hypothesis 1 (Peer Pressure): As an Equator bank concentrates its co-arrangement with a peer bank, more peer pressure is exerted resulting in the peer bank eventually adopting the EP. • Hypothesis 2 (Social Pressure): As banks become more active in the PF market by arranging more PF loans, they become more susceptible to social pressure leading to an increased potential of adopting the EP. • Hypothesis 3 (Piggybacking): Cooperation with an Equator bank leads to piggybacking and resistance to adopt the EP. Economic implications Peer Pressure: • The relative risk of average peer pressure (0.01) vs. 1σ, 2σ and 3σ results in an increase in the adoption of the EP of 1.24%, 2.50% and 3.77%, respectively. # of Equator Relationships: • Bank (i) collaborates with an average of 20 Equator banks • The relative risk of having 0 vs. 1 Equator relationship results in an increased hazard of 1% for EP adoption • This relative hazard increases increases to 6%, 9%, 12% as the number of equator relationships increase to 2, 3 and 4 respectively. • However, the relative hazard plateaus once the change in the number of collaborations is greater than 4. Economic implications Peer Pressure: • The relative risk of average peer pressure (0.01) vs. 1σ, 2σ and 3σ results in an increase in the adoption of the EP of 1.24%, 2.50% and 3.77%, respectively. # of Equator Relationships: • Bank (i) collaborates with an average of 20 Equator banks • The relative risk of having 0 vs. 1 Equator relationship results in an increased hazard of 1% for EP adoption • This relative hazard increases increases to 6%, 9%, 12% as the number of equator relationships increase to 2, 3 and 4 respectively. • However, the relative hazard plateaus once the change in the number of collaborations is greater than 4. Economic implications Peer Pressure: • The relative risk of average peer pressure (0.01) vs. 1σ, 2σ and 3σ results in an increase in the adoption of the EP of 1.24%, 2.50% and 3.77%, respectively. # of Equator Relationships: • Bank (i) collaborates with an average of 20 Equator banks • The relative risk of having 0 vs. 1 Equator relationship results in an increased hazard of 1% for EP adoption • This relative hazard increases increases to 6%, 9%, 12% as the number of equator relationships increase to 2, 3 and 4 respectively. • However, the relative hazard plateaus once the change in the number of collaborations is greater than 4. Economic implications Peer Pressure: • The relative risk of average peer pressure (0.01) vs. 1σ, 2σ and 3σ results in an increase in the adoption of the EP of 1.24%, 2.50% and 3.77%, respectively. # of Equator Relationships: • Bank (i) collaborates with an average of 20 Equator banks • The relative risk of having 0 vs. 1 Equator relationship results in an increased hazard of 1% for EP adoption • This relative hazard increases increases to 6%, 9%, 12% as the number of equator relationships increase to 2, 3 and 4 respectively. • However, the relative hazard plateaus once the change in the number of collaborations is greater than 4. Economic implications Peer Pressure: • The relative risk of average peer pressure (0.01) vs. 1σ, 2σ and 3σ results in an increase in the adoption of the EP of 1.24%, 2.50% and 3.77%, respectively. # of Equator Relationships: • Bank (i) collaborates with an average of 20 Equator banks • The relative risk of having 0 vs. 1 Equator relationship results in an increased hazard of 1% for EP adoption • This relative hazard increases increases to 6%, 9%, 12% as the number of equator relationships increase to 2, 3 and 4 respectively. • However, the relative hazard plateaus once the change in the number of collaborations is greater than 4. Piggybacking: Figure 1 Survivor function, S(t) = P{T > t} represents the survivor function of bank (i) whose covariate values are equal to the average for two types of banks, those who collaborate with Equator banks (Equator Bank (j)=1) and those who do not (Equator Bank (j)=0). The piggybacking effect shows that collaboration with Equator banks has a higher survival probability, i.e. lower risk of EP adoption. The probability differential ranges between 2 and 8% and slowly converges towards the end of our observation period. Robustness (1) Robustness (1) Robustness (1) Robustness (1) Robustness (1) Robustness (1) Robustness (1) Robustness (2) • Split sample by arranging levels in arrangement of project finance deals – – – – Quantile 1 Quantile 2 Quantile 3 Quantile 4 • Results remain robust to – Peer pressure – Piggybacking • For banks (i) in Quantiles 1 and 2, Social Pressure has a hazard less than 1 • For banks (i) in Quantiles 3 and 4, Social Pressure has a hazard greater than 1 Conclusion (1) • We proposed a view on the adoption of the EP that extends beyond institutional approaches • Our peer pressure, social pressure and piggybacking hypotheses hold even after controlling for country ESG and involvement in dodgy deals • Piggybacking banks do not adopt the EP partly explaining the slow down in the adoption of the EP • However, peer pressure serves as a moderator to piggybacking • In addition, banks are subject to public pressures that lead them into adopting the EP Conclusion (2) • Overall, banks may collaborate with Equator banks with the purpose of benefiting from reputation gains, but their piggybacking behavior is moderated once collaboration becomes concentrated with an Equator bank • This occurs because the potential loss associated with not adopting the EP may be higher than adopting the EP. Conclusion (3) • From a policy perspective, if project financing activities by banks are to be “regulated” through voluntary guidelines, a wider adoption of the EP by banks should be encouraged: – Reduce piggybacking – Understand which collaboration settings enable the diffusion of the adoption of codes of conduct (Contreras, M.G., 2014) • Develop country ESG as a(n) (almost) perfect substitute to the EP References • Bondy, K., D. Matten, and J. Moon. The adoption of voluntary codes of conduct in mncs: A three-country comparative study. Business and Society Review, 109: 449-477, 2004. • Contreras, M.G.. The institutionalization of codes of conduct in a world of free riders. Working Paper, 2014. • Diller, J.. A social conscience in the global marketplace? labour dimensions of codes of conduct, social labelling and investor initiatives. International Labor Review, 138: 99-129, 1999. • Scholtens, B. and L. Dam. Banking on the equator. are banks that adopted the equator principles different from non-adopters? World Development, 35:1307-1328, 2007. • Saunders, A. and L. Allen. Credit Risk Measurement. John Wiley & Sons, 2002. • Wright, C. and A. Rwabizambuga. Institutional pressures, corporate reputation and voluntary codes of conduct: An examination of the equator principles. Working Paper, 2006. Equator Principles Adoption: Peer Pressure or Piggybacking? J.W.B. Bos, M.G. Contreras and S. Kleimeier [email protected] www.mgcontreras.com
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