Carbon disclosure policy, external financing needs and the cost of capital: Does financial market quality matter?

Abstract

AbstractWe investigate whether the quality of financial markets matters for the relationship between net external financing, voluntary carbon disclosure and firms' cost of capital. External financing needs may create incentives for firms to engage in environmental strategies, such as disclosing their carbon emissions in response to demands from stakeholders. In countries with low financial market quality, firms may build a reputation when complying with stakeholders' demands. In these countries, firms disclosing carbon emissions and with high external financing needs may be rewarded with a lower cost of capital. Using an international sample of 24,253 firm‐year observations from 35 countries, we show that the higher firms' net external financing in the previous year, the more likely they are to disclose their carbon emissions in the current year. Moreover, the positive association between the likelihood of carbon disclosure and net external financing needs is stronger in countries with low financial market quality. We further show that disclosing firms with high external financing needs have a lower cost of capital as compared to disclosing firms with low external financing needs. This evidence also differs between countries with high versus low financial market quality.