Carbon intensity and the cost of equity capital

Arjan Trinks; Gbenga Ibikunle; MacHiel Mulder; Bert Scholtens

doi:10.5547/01956574.43.2.atri

Carbon intensity and the cost of equity capital

Arjan Trinks^*, Gbenga Ibikunle, MacHiel Mulder, Bert Scholtens

^*Corresponding author for this work

Research output: Contribution to journal › Article › peer-review

Abstract

The transition from high- to lower-carbon production systems increasingly creates regulatory and market risks for high-emitting firms. We test to what extent equity market investors demand a premium to compensate for such risks and thus might raise firms' cost of equity capital (CoE). Using data for 1,897 firms spanning 50 countries over the years 2008-2016, we find a distinct and robust positive impact of carbon intensity (carbon emissions per unit of output) on CoE: On average, a standard deviation higher (sector-adjusted) carbon intensity is associated with a CoE premium of 6 (9) basis points or 1.7% (2.6%). This effect is primarily explained by systematic risk factors: high-emitting assets are significantly more sensitive to economy-wide fluctuations than low-emitting ones. The CoE impact of carbon intensity is more pronounced in high-emitting sectors, EU countries, and firms subject to carbon pricing regulation. Our results suggest that carbon emission reduction might serve as a valuable risk mitigation strategy.

Original language	English
Pages (from-to)	181-214
Number of pages	34
Journal	Energy Journal
Volume	43
Issue number	2
DOIs	https://doi.org/10.5547/01956574.43.2.atri
Publication status	Published - 1 Mar 2022

Keywords

Asset pricing
Carbon intensity
Cost of capital
Regulatory risk

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Copyright © The Author(s). This work has been made available online in accordance with publisher policies or with permission. Permission for further reuse of this content should be sought from the publisher or the rights holder. This is the author created accepted manuscript following peer review and may differ slightly from the final published version. The final published version of this work is available at https://doi.org/10.5547/01956574.43.2.a
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title = "Carbon intensity and the cost of equity capital",

abstract = "The transition from high- to lower-carbon production systems increasingly creates regulatory and market risks for high-emitting firms. We test to what extent equity market investors demand a premium to compensate for such risks and thus might raise firms' cost of equity capital (CoE). Using data for 1,897 firms spanning 50 countries over the years 2008-2016, we find a distinct and robust positive impact of carbon intensity (carbon emissions per unit of output) on CoE: On average, a standard deviation higher (sector-adjusted) carbon intensity is associated with a CoE premium of 6 (9) basis points or 1.7% (2.6%). This effect is primarily explained by systematic risk factors: high-emitting assets are significantly more sensitive to economy-wide fluctuations than low-emitting ones. The CoE impact of carbon intensity is more pronounced in high-emitting sectors, EU countries, and firms subject to carbon pricing regulation. Our results suggest that carbon emission reduction might serve as a valuable risk mitigation strategy.",

keywords = "Asset pricing, Carbon intensity, Cost of capital, Regulatory risk",

author = "Arjan Trinks and Gbenga Ibikunle and MacHiel Mulder and Bert Scholtens",

note = "Funding Information: We acknowledge the helpful comments and suggestions from Viola Angelini, Matthew Brander, Timo Busch, Ambrogio Dal{\`o}, Lammertjan Dam, Alex Edmans, Steffen Eriksen, Halit Gonenc, Marco Haan, Marcella Lucchetta, Nora Pankratz, Kenan Qiao, Rick van der Ploeg, Jaap Waverijn, Edwin Woerdman, Gijsbert Zwart, and three anonymous reviewers. We are also thankful for fruitful discussions at seminars at the University of Edinburgh Business School (April and May 2017), the University of Groningen (November 2017 and February 2018), Ca' Foscari University of Venice (January 2018), and at the following conferences: Oikos Young Scholars Finance Academy at the University of Zurich (September 2017), Asset Management with Climate Risk at Cass Business School, London (January 2018), and Global Research Alliance for Sustainable Finance and Investment (GRASFI) hosted by Columbia University, New York (September 2020). We are grateful to CEER and SOM Research Institute at the University of Groningen for their financial support. The usual disclaimer applies. ",

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N2 - The transition from high- to lower-carbon production systems increasingly creates regulatory and market risks for high-emitting firms. We test to what extent equity market investors demand a premium to compensate for such risks and thus might raise firms' cost of equity capital (CoE). Using data for 1,897 firms spanning 50 countries over the years 2008-2016, we find a distinct and robust positive impact of carbon intensity (carbon emissions per unit of output) on CoE: On average, a standard deviation higher (sector-adjusted) carbon intensity is associated with a CoE premium of 6 (9) basis points or 1.7% (2.6%). This effect is primarily explained by systematic risk factors: high-emitting assets are significantly more sensitive to economy-wide fluctuations than low-emitting ones. The CoE impact of carbon intensity is more pronounced in high-emitting sectors, EU countries, and firms subject to carbon pricing regulation. Our results suggest that carbon emission reduction might serve as a valuable risk mitigation strategy.

AB - The transition from high- to lower-carbon production systems increasingly creates regulatory and market risks for high-emitting firms. We test to what extent equity market investors demand a premium to compensate for such risks and thus might raise firms' cost of equity capital (CoE). Using data for 1,897 firms spanning 50 countries over the years 2008-2016, we find a distinct and robust positive impact of carbon intensity (carbon emissions per unit of output) on CoE: On average, a standard deviation higher (sector-adjusted) carbon intensity is associated with a CoE premium of 6 (9) basis points or 1.7% (2.6%). This effect is primarily explained by systematic risk factors: high-emitting assets are significantly more sensitive to economy-wide fluctuations than low-emitting ones. The CoE impact of carbon intensity is more pronounced in high-emitting sectors, EU countries, and firms subject to carbon pricing regulation. Our results suggest that carbon emission reduction might serve as a valuable risk mitigation strategy.

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Carbon intensity and the cost of equity capital

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