Climate change exposure and cost of equity

Abstract

In this study, we investigate the association between climate change exposure and the cost of equity financing. Using a novel dataset of US firm-level exposure to climate change risks, we find that higher exposure to climate risks co-exists with higher financing costs for the period 2010 through 2021. While the effect of physical and regulatory risks is rather muted, the main mechanism shaping financing costs stems from climate transition risk driven by uncertainty about new business opportunities. Our results are not compromised by endogeneity concerns as shown by alternative methods such as entropy balancing, instrumental variable regression, dynamic panel estimation and a difference-in-differences setting. We also document that the link between climate change exposure and the cost of equity financing is more prominent for firms facing higher attention to climate topics, a stronger realization of climate change and more problematic financing constraints.