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

Abstract

We develop a new measure of impact elasticity: the change in a firm’s environmental impact due to a change in its cost of capital. We find that reducing green firms’ financing costs leads to minimal impact changes, while increasing brown firms’ financing costs causes significant negative impact changes. Thus, sustainable investing strategies that shift capital from brown to green firms contain a counterproductive channel that makes brown firms more brown without making green firms more green. A mistaken focus on \textit{percentage} reductions in emissions rewards already-green firms for trivial reductions in emissions and gives brown firms weak incentives to improve.

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

JEL Classification: G11, G32, G02