Literature review, theoretical background and hypothesis development

Previous research indicates that higher carbon emissions increase financial risk, affecting a firm’s cost of equity (CoE), cost of debt (CoD), and weighted average cost of capital (WACC). This study hypothesises that corporate climate change actions reduce these costs by mitigating risks and reducing information asymmetry.

Data and methodology

The study analyses 2100 listed Japanese companies using econometric models. Data on carbon intensity, climate-related disclosures, and corporate commitments were sourced from the Toyo Keizai CSR database and Refinitiv Eikon database.

Results and discussion

Carbon intensity and cost of capital

Higher carbon intensity correlates with increased CoE and CoD. For example, firms with high carbon emissions experience an average increase of 0.11% in CoE and 0.02% in CoD. A one-year lag shows an even stronger impact on WACC.

TCFD Disclosure and cost of capital

Climate-related disclosures, following the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, reduce CoE and WACC but increase CoD. Specifically, TCFD disclosures lower CoE by 0.43% after one year, highlighting their importance in equity markets despite raising debt costs.

Corporate commitment to climate change and cost of capital

Corporate commitments to climate change, such as medium-term CO2 reduction plans, show no significant impact on CoE or CoD. This suggests that investors require more detailed and comparable information to assess these commitments effectively.

Moderating effect

The study finds that TCFD disclosures can moderate the adverse effects of high carbon intensity on CoE, demonstrating the value of transparent climate-related information in mitigating investment risks.

Differences between material and immaterial industries

In industries where climate change is a material issue, higher carbon intensity significantly increases CoE and CoD. TCFD disclosures significantly reduce CoE in these industries, emphasising the importance of industry-specific climate risk management.

Conclusion

Corporate climate change mitigation actions influence the cost of capital in Japanese firms. Higher carbon intensity increases CoE, CoD, and WACC. TCFD disclosures lower CoE and WACC, despite raising CoD. However, corporate commitments alone do not significantly impact capital costs.

Implications

Firms should improve carbon performance and climate-related disclosures to reduce their cost of capital. Policymakers should expand TCFD disclosure mandates to more companies, enhancing market-wide climate risk assessment. Investors should recognise the importance of detailed corporate climate commitments.

Recommendations

• Firms with high carbon intensity should adopt TCFD disclosures to mitigate negative financial impacts.
• Policymakers should support broader TCFD disclosure requirements.
• Investors need to consider both carbon performance and the quality of climate-related disclosures in their investment decisions.

Quantitative and qualitative evidence

‘The study provides evidence that each unit increase in carbon intensity results in a 0.11% increase in CoE and a 0.02% increase in CoD. TCFD disclosures, however, lower CoE by 0.43% after one year. The findings suggest that transparent climate-related information is crucial for managing investment risks and reducing the cost of capital.

Recommendations

• For firms: Improve carbon performance and enhance climate-related disclosures, particularly in industries where climate change is a material issue.
• For policymakers: Expand TCFD disclosure mandates and provide support for firms in implementing these disclosures.
• For investors: Consider detailed and comparable climate-related information when assessing investment risks.