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Corporate sustainability, investment, and capital structure

Author

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  • Michi Nishihara

    (Graduate School of Economics, Osaka University)

Abstract

This study develops a real options model in which a firm invests in either a sustainable project or an unsustainable project. The sustainable project requires a high investment cost and yields cash flows perpetually, whereas the unsustainable project requires a low investment cost and yields cash flows until a random maturity. The random termination of cash flows reflects the project fs environmental, social, and governance (ESG) risk. In the model, the optimal investment choice and timing are analytically derived, and the effects of key parameters on the choice are also examined. Higher ESG risk, growth rate, and volatility, and lower discount rate encourage sustainable investing mainly through their impacts on the net present value (NPV) and timing option value. The less sustainable firm chooses higher leverage to enjoy a greater benefit of debt financing. Therefore, access to debt financing and a higher corporate tax rate (tax shield) discourage sustainable investing.

Suggested Citation

  • Michi Nishihara, 2022. "Corporate sustainability, investment, and capital structure," Discussion Papers in Economics and Business 22-05, Osaka University, Graduate School of Economics.
    • Handle: RePEc:osk:wpaper:2205
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    References listed on IDEAS

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    More about this item

    Keywords

    sustainability; ESG; real options; capital structure.;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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