The effect of carbon risk on the cost of equity capital

Abstract

This study uses greenhouse gas (GHG) emissions data to investigate the effect of carbon risk on the cost of equity capital. The Korean government launched the GHG Energy Target Management Scheme in 2010 and required designated companies to report GHG data verified by third-party sources. An empirical analysis of a sample of 379 firms from the period 2007 to 2011 suggests the following: carbon intensity (proxy for carbon risk) is positively related to the cost of equity capital. Additionally, the effect of carbon intensity on the cost of equity capital is no different between companies that voluntarily disclosed sustainability reports and those that did not. Finally, the effect of carbon intensity on the cost of equity capital is lower for individual firms that belong to industrial sectors with large GHG emissions in terms of volume. This result has an important implication for the companies' CEOs, management, policymakers, and investors. Companies' efforts to improve carbon productivity are suggestively compensated by the reduction in the cost of capital, which then increases the firm's value. The results are also indicative of how the effective management of GHG lessens the negative effect of carbon risk on the cost of equity capital.