Ethical behaviour and Corporate Financing: evidences from legality rating

Given the growing attention of ethical principles in business practices, a key question in the related literature is how the adoption of ethic behaviour affects the company’s corporate financing. Answering to this question permits to further understand how ethics can mitigate the information asymmetry between borrowers and debt lenders, favouring the access to external financing. In a risk mitigation view, business ethics seek to moderate the lenders’ perception of credit risk, leading to a decrease in the interest rates and facilitating access to finance. Prior literature modelled the relationship between debt lender and borrower as principal-agent relationship (Kim et al., 2014). The lenders (principal) are characterised by bounded rationality and could not assess completely the borrower (agent) behaviour. The agents can behave in an opportunistic way not in the interest of debt lender, and as a result, they are required to pay higher costs of interests to compensate the lender’s high-risk exposure (Deegan, 2014; Eisenhardt, 1988, 1989). By following ethical principles, firms’ business practices share the value of honesty and integrity, and thus business ethic becomes a signal of trustworthiness which potentially reduces the agency problems in the relationship between borrower and debt lender. The ethical agent behaves honestly, avoiding opportunistic behaviours and increasing the trust from the debt lender (Treviño et al., 2006; Weaver et al., 1999), which may price this behaviour into a lower interest rate, favouring the access to external financing. Extant literature mainly focuses on the relationship between corporate financing and corporate social responsibility (CSR), which embraces the ethical dimension together with the social and environmental ones (Margolis & Walsh, 2003; Orlitzky et al., 2003). To increase the understanding of the effects of companies’ ethic behaviours on corporate financing, we argue it is important theoretically and empirically to widen our gaze beyond overreaching measures of firms’ CSR, to consider an institutionalised indicator of firms’ ethical behaviour. The institutional environment, in which companies operate, has a crucial role in fuelling the positive relationship between companies’ ethic behaviour and access to external financing. A high level of institutionalised ethic behaviour may activate the mechanisms at the base of the risk mitigation view, rewarding companies ethic’ behaviours. However, to the best of our knowledge prior literature is almost silent about the effects of 16 institutionalised ethic behaviour on corporate financing (Kim et al., 2014). As such, we aim to fill this literature gap investigating the effects of legality rating on the company’s access to debt financing. The legality rating represents an institutionalised indicator of firms’ ethical behaviour, introduced by the Italian legislative system. It certifies that firms fulfil certain requirements of legality and sustainability. By introducing the legality rating, the Italian legislator has institutionalised ethic values, recognizing and rewarding firms’ ethical behaviour. Banks are required to reward firms with legality rating, favouring them in the access to debt financing. Additionally, other stakeholder groups, such as employers, suppliers, governments and community may reward companies with legality rating, favouring them in the access to different financing sources, from bank loans (Kim et al., 2014; La Rosa et al., 2018) to trade credit (Xu et al., 2019; Zhang et al., 2014). Limited literature empirically investigates the legality rating and it is almost silent in relation to its effects on corporate financing (Caputo and Pizzi 2019). As far as we are aware, our study is the first study which deepens the investigation of the effects of legality rating on access to external financing, Our empirical investigation aims to study the effects of the legality rating on cost of debt and leverage level. We expect that legality rating increases the trust from the debt lender, leading to a decrease in the cost of debt and to an increase of the leverage level. To reach our aim, we use propensity score matching in an attempt to control for differences in the cost of debt and in the leverage level between all the Italian firms, which hold legality rating and all the Italian firms, which do not. We conduct the analysis by using a dataset of Italian firms, created by combining the financial data downloaded from AIDA database, with information about legality rating extracted from the official database of the Guarantor Authority for Competition and Market (AGCM) (AGCM, 2018).