ECB | Working Paper Series: Climate capitalists

Non-Technical Summary

One of the most dramatic trends in financial markets over the last decade has been the rise of sustainable investing. Many prominent institutions, such as the European Central Bank, now publicly support sustainable investing. It is often argued that sustainable investing can incentivize firms to act more sustainably by decreasing the cost of capital firms have to pay for their green investments.

Despite the prominence of this idea, it is unclear whether sustainable investing influences firm behavior through a cost of capital channel. So far, it has been difficult to estimate firms’ cost of capital reliably using financial market data, leading to conflicting results and uncertainty about the impact of sustainable investing. Moreover, even if sustainable investing influences the cost of capital in financial markets, this influence may not be incorporated into firms’ perceptions of their cost of capital, eliminating potential real effects of sustainable investing through the cost of capital channel.

We directly study how firms’ perceptions of their cost of capital have responded to the rise of sustainable investing. We use data from corporate conference calls (meetings between firm managers, financial analysts, and investors). Our measures of firms’ perceived cost of capital directly capture an input into firms’ investment decisions and allow us to produce relatively precise estimates of how the cost of capital differs between green and brown firms.

Our main finding is that the perceived cost of capital has dropped substantially for green firms since the rise of sustainable investing. Up until 2016, the perceived cost of capital of green firms was close to that of brown firms. But as sustainable investing surged after 2016, the perceived cost of capital of green firms fell substantially relative to that of brown firms. On average, the perceived cost of capital of green firms is 1 percentage point lower than that of brown firms between 2016 and 2023.

We also find that some of the largest energy and utility firms have started applying a lower perceived cost of capital and discount rate to their greener divisions, such as renewable energy divisions, after 2016. Finally, firms facing a higher spread between the cost of green and brown capital in their sector have pledged to reduce emissions by more, consistent with changes in the cost of capital affecting real outcomes. Together, the results are consistent with the view that sustainable investing is associated with reductions in the perceived cost of green capital and with capital reallocation toward green investments.

Read the working paper here.

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