Counterproductive Sustainable Investing: The Impact Elasticity of Brown and Green Firms

Abstract

We develop a new measure of impact elasticity, defined as a firm's change in environmental impact due to a change in its cost of capital. We show empirically that a reduction in financing costs for firms that are already green leads to small improvements in impact at best. In contrast, increasing financing costs for brown firms leads to large negative changes in firm impact. Thus, sustainable investing that directs capital away from brown firms and toward green firms may be counterproductive, in that it makes brown firms more brown without making green firms more green. We further show that brown firms face very weak financial incentives to become more green. Due to a mistaken focus on percentage reductions in emissions, the sustainable investing movement primarily rewards green firms for economically trivial reductions in their already low levels of emissions.

Keywords: sustainable investing, ESG, cost of capital, impact elasticity, proportional thinking

JEL Classification: G11, G32, G02