The Nexus Between Energy Efficiency and Cost of Debt: Evidence from the Indian High and Low Energy Efficient Firms

Globally, businesses are implementing energy-efficient strategies that align with market sustainability to enhance their performance. While the environmental and operational benefits of energy efficiency are well understood, its financial implications, particularly in debt financing, remain less clear. To achieve the objective, we examine the relationship between energy efficiency and the cost of debt in the context of emerging economies, with a focus on India, and explore the nature of this relationship. We utilize an unbalanced panel dataset comprising 4,856 Indian firms listed on the Bombay Stock Exchange between 2011 and 2022. We estimate firm-year fixed effects, a Tobit regression, and a two-stage least squares (2SLS) Tobit model to address potential endogeneity concerns. The findings reveal intriguing results, as improved energy efficiency reduces the costs associated with debt. We find a convex (U-shaped, curvilinear) relationship between firms' energy efficiency and the cost of debt. Firms initially benefit from energy efficiency through lower debt costs, reflecting reduced risk perceptions by lenders. However, beyond a threshold level, the marginal financial gains diminish, and the costs of debt rise, suggesting diminishing returns to energy efficiency. Our robustness tests include alternative debt cost proxies to confirm these findings. Our findings contribute to the literature by identifying non-linear financing effects of energy efficiency, where R&D acts as a critical channel through which efficiency translates into financial outcomes. The research findings may also enable firms to establish an energy policy that balances their energy efficiency, debt costs, and sustainability.