Making the grass greener: The role of firm’s financial and managerial capacity in paving the way for the green transition

Despite the ambitious carbon reduction targets set by policy makers worldwide, current investments fall well short of the net-zero emissions scenario. This paper analyses the factors holding back corporate green investment, with a particular focus on the role of firm capacity – specifically financing constraints and weak green management practices – and its interaction with environmental policy. Combining a variety of econometric techniques, including panel data models, difference-in-differences settings and instrumental variable approaches, our cross-country analysis on large listed companies shows that: i) both financing constraints and a lack of green managerial capacity reduce firms’ probability of investing in green technologies, leading to higher emission intensity; ii) well-designed environmental policies can mitigate these impacts. A case study using more granular data on Portuguese firms further shows that: iii) green investment is more elastic to financing conditions than other types of investment; iv) investment in integrated technologies is more sensitive to financing conditions and to managerial capacity compared to end-of-pipe solutions. Lastly, the paper discusses a wide range of policy options that may be considered to foster the green transition through upgrading firms’ capacity.