Is Capital Structure Irrelevant with ESG Investors?

22 Pages Posted: 3 Oct 2022

See all articles by Peter Feldhütter

Peter Feldhütter

Copenhagen Business School

Lasse Heje Pedersen

AQR Capital Management, LLC; Copenhagen Business School - Department of Finance; New York University (NYU); Centre for Economic Policy Research (CEPR)

Date Written: September 23, 2022

Abstract

This paper examines whether capital structure is irrelevant for enterprise value and investment when investors care about environmental, social, and governance issues, which we denote “ESG-Modigliani-Miller” (ESG-MM). Theoretically, we show that ESG-MM holds if ESG is additive and markets are perfect. ESG-MM means that issuing low-yielding green bonds does not lower the overall cost of capital because it makes the issuer's other securities browner. Hence, a firm's incentive to make a green investment does not depend on its financing choice. Empirically, we provide evidence of failure of ESG-MM, implying that firms and governments can exploit non-additive ESG or segmented markets.

Keywords: Externalities, ESG, CSR, capital structure, carbon emission, asset pricing

JEL Classification: E22, G12, G32, G4, H23, Q56

Suggested Citation

Feldhütter, Peter and Pedersen, Lasse Heje, Is Capital Structure Irrelevant with ESG Investors? (September 23, 2022). Available at SSRN: https://ssrn.com/abstract=4227547 or http://dx.doi.org/10.2139/ssrn.4227547

Peter Feldhütter

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Lasse Heje Pedersen (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

New York University (NYU) ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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