(Un-)sustainable Investment

To finance the fight against climate change, sustainable investment is projected to surpass $40 trillion by 2030. In principle, sustainable investment diverts funds away from brown firms, increasing their borrowing costs to encourage them to become greener. However, recent empirical evidence does not support this channel, as the most polluting firms tend to become more brown in response to higher costs of capital. I formalise this empirical finding by developing a stylised model where brown firms must choose the optimal time to switch from old, polluting technologies to new, clean alternatives. Results indicate that raising the cost of capital for brown firms can have non-monotonic effects on the optimal switching times. For example, firms operating in capital-intensive sectors, often among the largest polluters, are more likely to respond to higher borrowing costs by delaying their switching time. In contrast, brown firms that are nearly ready to switch to cleaner methods may speed up their transition when faced with higher borrowing costs.