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Environmental Externalities and Cost of Capital

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  • Sudheer Chava

    (Scheller College of Business, Georgia Institute of Technology, Atlanta, Georgia 30309)

Abstract

Ianalyze the impact of a firm's environmental profile on its cost of equity and debt capital. Using implied cost of capital derived from analysts' earnings estimates, I find that investors demand significantly higher expected returns on stocks excluded by environmental screens (such as hazardous chemical, substantial emissions, and climate change concerns) compared to firms without such environmental concerns. Lenders also charge a significantly higher interest rate on the bank loans issued to firms with these environmental concerns. I provide evidence that the environmental profile of a firm is not simply proxying for an omitted component of its default risk. Further, firms with these environmental concerns have lower institutional ownership and fewer banks participate in their loan syndicate than firms without such environmental concerns. These results suggest that exclusionary socially responsible investing and environmentally sensitive lending can have a material impact on the cost of equity and debt capital of affected firms. This paper was accepted by Brad Barber, finance .

Suggested Citation

  • Sudheer Chava, 2014. "Environmental Externalities and Cost of Capital," Management Science, INFORMS, vol. 60(9), pages 2223-2247, September.
    • Handle: RePEc:inm:ormnsc:v:60:y:2014:i:9:p:2223-2247
    DOI: 10.1287/mnsc.2013.1863
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    References listed on IDEAS

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