Carbon emissions trading system and the cost of equity for high-carbon firms

Purpose - Although an increasing body of research has examined the role of emission trading systems (ETS) at the macroeconomic level and their various effects at the firm level (Liuet al., 2022; Zhanget al., 2023; Niet al., 2022; Huanget al., 2024; Renet al., 2024), there remains a lack of systematic empirical analysis on the specific impact of pilot implementations in different regions on the cost of equity for high-carbon firms, particularly when accounting for varying levels of regional economic development and firm characteristics. Therefore, this study employs a difference-in-differences (DiD) approach to systematically analyze the impact of ETS pilots on the cost of equity for high-carbon firms. Design/methodology/approach - From late 2013, several regions initiated carbon ETS pilots. ETS’s phased and orderly implementation provides an excellent quasi-natural experiment for formulating a DID model. The pilot regions span China’s eastern, central and western areas, covering various stages of socio-economic development, effectively representing China. To examine the impact of ETS on the cost of equity for high-carbon firms, we use a staggered DiD approach. Findings - We find that the implementation of ETS significantly increases high-carbon firms’ cost of equity. Investors request more compensation for the increased stock return volatility, reduced operating cash flows and heightened distress risks following ETS. The effect is more pronounced for firms with severe financing constraints, while it is alleviated in state-owned enterprises and firms with higher institutional ownership. Additionally, the effect of ETS is stronger in areas with better governance capacity and economic conditions. Originality/value - First, this paper complements to some extent the literature on the microeconomic consequences of carbon trading systems. Second, this paper has some policy implications by discussing the heterogeneity of ETS effects at firm and regional levels. We find that ETS had a greater impact on non-state-owned enterprises, suggesting that the government should support the transformation of non-state-owned enterprises by providing targeted assistance for complying with carbon-trading regulations and promoting green economic growth. Additionally, we find that ETS is more effective in economically developed areas with good governance capacity, which means that the government should tailor local carbon trading policies to each region’s governance and economic conditions and avoid a one-size-fits-all approach.