Welfare Consequences of Sustainable Finance
49 Pages Posted: 17 Mar 2021 Last revised: 13 Sep 2021
Date Written: September 12, 2021
Asset managers face increasing pressure to only hold firms that meet net-zero carbon emissions targets. We model how these mandates incentivize firms to address the global-warming externality through investments in decarbonization capital. A firm that invests receives a lower cost of capital by an amount equal to its investments divided by its Tobin's q. The limiting case of a mandate that restricts all wealth is a capital tax that funds a higher decarbonization-to-productive capital ratio. Due to adjustment costs, this ratio rises gradually---as does the cost-of-capital wedge---until the steady state. Our model matches macro-finance moments, stock-demand elasticity, and climate-mitigation pathways. The welfare-maximizing mandate with markets approximates the planner's first-best solution.
Keywords: Sustainable Investing, ESG, Welfare, Externalities, Mitigation, Climate Change, Risk Premia, Interest Rates, Cost of Capital, Capital Accumulation, Disasters
JEL Classification: G30, G12, E20, H50
Suggested Citation: Suggested Citation