How do higher carbon emissions increase financing costs?
Higher carbon emissions raise financing costs through several channels. First, they increase perceived risk: investors and lenders see high-emitting firms as more vulnerable to regulatory changes, carbon taxes, and climate-related disruptions. One study of 1,897 firms across 50 countries found that a one-standard-deviation increase in carbon intensity (emissions per unit of output) raises the cost of equity by 6 to 9 basis points (1.7% to 2.6% of the average cost) [3]. This premium is driven by systematic risk—high-emitting assets are more sensitive to economy-wide shocks.
Second, higher emissions increase default risk and reduce competitiveness. A study of Chinese A-share companies from 2010 to 2022 showed that climate risk weakens debt financing capacity by raising default risk and lowering resilience, especially for non-state-owned firms and those with weak internal controls [2]. Similarly, an Australian study of 1,016 company-year observations found that higher emissions increase idiosyncratic risk, raising costs in both debt and equity markets [4].
Third, extreme weather events—exacerbated by climate change—directly increase debt costs. A study of Chinese listed firms found that extreme weather raises debt financing costs by increasing default risk and worsening business operations, with a stronger effect on high-carbon-footprint companies [6].
Can reducing emissions ever backfire and increase financing costs?
Yes, but only in specific circumstances. One study of S&P 500 companies from 2015 to 2022 found a U-shaped relationship between carbon intensity and the cost of debt: initially, lower emissions reduce debt costs, but once emissions fall below a certain threshold, further reductions can paradoxically increase debt costs [1]. The likely reason is that deep decarbonization requires expensive investments in advanced technologies, which creditors view as risky in the short term. However, this effect was not observed for equity costs, where lower emissions consistently lowered costs [1].
Another study of bond markets found that higher carbon emissions raise spreads in secondary markets (where bonds are traded) but not in primary markets (where bonds are first issued), suggesting that uncertainty about climate concerns affects pricing differently [5]. This gap means that, on average, carbon emissions may not directly affect the cost of capital in bond markets, reducing firms' financial incentives to decarbonize [5]. However, this finding is an outlier; the majority of studies here find a clear positive link between emissions and financing costs.
How can firms lower financing costs by reducing emissions?
The evidence shows that reducing emissions can lower financing costs, especially when firms communicate their efforts effectively. A study of European firms on the Stoxx Europe 600 Index found that environmentally virtuous companies enjoy a lower after-tax weighted average cost of capital (WACC), with the effect prominent in both high- and low-emitting industries [9]. Similarly, a study of Chinese power generation companies found that carbon emission reduction investments lower the cost of equity by improving competitiveness and building a reputation for sustainability [7].
Disclosure is also critical. A study of US firms responding to the Carbon Disclosure Project (CDP) found that firms providing complete carbon emission disclosures experience lower information asymmetry (measured by bid-ask spreads) than those that decline to disclose [8]. First-time disclosure led to a significant reduction in spreads, especially for firms that provided full information [8]. This suggests that transparency about emissions can directly lower the cost of capital by reducing uncertainty for investors.
About These Sources
This answer is built on 9 peer-reviewed studies — published from 2021 to 2026, 5 from 2024 or later, 5 in Q1 journals, collectively cited 165 times — selected as the most relevant from 9 studies that passed quality screening, drawn from 59 papers retrieved from a database of over 500 million.
Sources used in this answer
The effects of corporate carbon performance on financing cost-evidence from S&P 500
Finds a U-shaped relationship between carbon intensity and cost of debt for S&P 500 firms (2015–2022): high emissions raise debt costs, but very low emissions can also raise costs due to required investments. Equity costs consistently rise with emissions.
The Impact of Climate Change Risk on Corporate Debt Financing Capacity: A Moderating Perspective Based on Carbon Emissions
Shows that climate risk weakens debt financing capacity for Chinese A-share firms (2010–2022), lowering leverage and raising costs, with effects stronger for non-state-owned firms and those with weak internal controls.
Carbon Intensity and the Cost of Equity Capital
Across 1,897 firms in 50 countries (2008–2016), a standard deviation higher carbon intensity raises the cost of equity by 6–9 basis points (1.7%–2.6%), driven by systematic risk and more pronounced in high-emitting sectors and EU countries.
Do corporate carbon emissions affect risk and capital costs?
For Australian-listed companies (2007–2020, 1,016 observations), higher carbon emissions increase idiosyncratic risk and raise capital costs in both debt and equity markets.
Do carbon emissions affect the cost of capital? Primary versus secondary corporate bond markets
Finds that higher carbon emissions raise bond spreads in secondary markets but not in primary markets, suggesting that, on average, emissions do not affect the cost of capital in bond markets.
The impact of extreme weather on corporate debt financing costs: evidence from China
Extreme weather events increase corporate debt financing costs for Chinese A-share firms (2010–2022), with a stronger effect on high-carbon-footprint companies, non-state firms, and those with poor governance.
The impact of carbon emission reduction inputs of power generation enterprises on the cost of equity capital
For Chinese power generation firms (2013–2020), carbon emission reduction investments lower the cost of equity by improving competitiveness and building reputation, especially when management holds shares.
Voluntary disclosure and information asymmetry: do investors in US capital markets care about carbon emission?
US firms that provide complete carbon emission disclosures (via CDP) have lower information asymmetry (bid-ask spreads) than non-disclosers; first-time disclosure reduces spreads, especially for full disclosure.
Does it pay to be environmentally responsible? Investigating the effect on the weighted average cost of capital
European firms on the Stoxx Europe 600 Index (2014–2018) with strong environmental performance enjoy a lower after-tax weighted average cost of capital, in both high- and low-emitting industries.