How carbon risk affects corporate debt defaults: Evidence from Paris agreement

Abstract

There is an increasing concern in traditional energy industries (e.g., oil and coal) due to the high carbon emissions they produce. In an attempt to achieve carbon emission reduction, governments have launched various policies to restrict the use of fossil energy sources. While carbon regulation aims to encourage high‑carbon firms to accelerate their green governance transition, the carbon risk hypothesis argues that these instruments may raise compliance costs and the risk of financial default for the firms. This paper uses the exogenous shock of China's accession to the Paris Agreement as an identification strategy to test the relationship between carbon risk and corporate debt default. We find that the risk of debt default for high‑carbon firms decreases significantly after carbon regulation compared to low-carbon firms. Promoting green transformation, reducing financial leverage, and increasing legal compliance are proven to be three crucial mechanisms. Further analysis shows that this effect is heterogeneity between the different levels of government environmental governance pressure, financial market attention, industry competitive pressure, and media scrutiny. Our study provides novel evidence for promoting sustainable development in the conventional energy industries represented by oil through environmental regulation.