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Is Capital Structure Irrelevant with ESG Investors?

Author

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  • Peter Feldhütter
  • Lasse Heje Pedersen

Abstract

This paper examines whether capital structure is irrelevant for enterprise value and investment when investors care about environmental, social, and governance issues, which we refer to as “ESG-Modigliani-Miller” (ESG-MM). Theoretically, we show that ESG-MM holds with linear pricing and additive ESG. ESG-MM means that issuing low-yielding green bonds does not lower the overall cost of capital because it makes the issuer’s other securities browner. Hence, a firm’s incentive to make a green investment does not depend on its financing choice. We provide suggestive evidence of failure of ESG-MM, implying that firms and governments can exploit inconsistent ESG attribution or segmented markets.

Suggested Citation

  • Peter Feldhütter & Lasse Heje Pedersen, 2025. "Is Capital Structure Irrelevant with ESG Investors?," The Review of Financial Studies, Society for Financial Studies, vol. 38(8), pages 2362-2385.
    • Handle: RePEc:oup:rfinst:v:38:y:2025:i:8:p:2362-2385.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhae059
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    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G4 - Financial Economics - - Behavioral Finance
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth

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