Environmental Externalities and Cost of Capital

63 Pages Posted: 17 Sep 2010 Last revised: 18 Jun 2014

Sudheer Chava

Georgia Institute of Technology - Scheller College of Business

Date Written: June 15, 2011

Abstract

I analyze the impact of a firm's environmental profile on its cost of equity and debt capital. Using implied cost of capital derived from analysts' earnings estimates, I find that investors demand significantly higher expected returns on stocks excluded by environmental screens (such as hazardous chemical, substantial emissions and climate change concerns) compared to firms without such environmental concerns. Lenders also charge a significantly higher interest rate on the bank loans issued to firms with these environmental concerns. I provide evidence that environmental profile of a firm is not simply proxying for an omitted component of its default risk. Further, firms with these environmental concerns have lower institutional ownership and fewer banks participate in their loan syndicate than firms without such environmental concerns. These results suggest that exclusionary socially responsible investing and environmentally sensitive lending and the consequent increase in the cost of equity and debt capital has the potential to prompt firms to internalize their environmental externalities.

Keywords: Environmental Externalities, Cost of Capital, Bank Loans, Environmentally Sensitive Lending, Socially Responsible Investing

JEL Classification: D62, G21, G38, H23, H43

Suggested Citation

Chava, Sudheer, Environmental Externalities and Cost of Capital (June 15, 2011). Available at SSRN: https://ssrn.com/abstract=1677653 or http://dx.doi.org/10.2139/ssrn.1677653

Sudheer Chava (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

HOME PAGE: http://www.prism.gatech.edu/~schava6/

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