Dynamic Carbon Emission Reduction, Investment, and Risk Management

Abstract

We develop a dynamic Q-theoretic framework that investigates the interaction among investment, financing, carbon emission reduction, and risk management for financially constrained firms. The model generates the following predictions: (1) financing constraints hinder carbon emission reduction and investment; (2) carbon emission reduction enhances firm value and investment, postpones payout, increases external equity financing, and strengthens incentives for hedging relative to the scenario without carbon emission reduction; (3) access to credit lines increases incentives for carbon emission reduction; and (4) the impact of hedging on carbon emission reduction is contingent on firms’ cash reserves.

Keywords: Carbon emission reduction, Dynamic investment, Payout policy, Risk management

JEL Classification: E22, G30, G35