The effect of capital markets and climate policy on low and high-carbon energy investment: Evidence from electric utilities

Abstract

The cost of capital and climate policy are key drivers of investment in the energy transition. However, given unique regulatory characteristics, electric utilities are often excluded from studies examining the effect of financing costs on firm investment. Furthermore, while accounting data is frequently used to measure firm investment, this is unsuitable when considering the impact of climate policy, as it does not differentiate between low- and high‑carbon energy. To address this, we deploy asset-level data to examine the effect of financing costs and climate policy on firm investment. Using the S&P World Electric Power Plant database, we find that a lower cost of debt and higher debt capital raising increases low- and high‑carbon investment by listed electric utilities firms between 2012 and 2021. Using the OECD Environmental Policy Stringency Index, we find that carbon prices and taxes directly increase low-carbon investment and act as a moderator, strengthening the relationship between debt capital raising and low-carbon investment while doing the opposite for high-carbon investment. These findings demonstrate the importance of capital markets in driving firm-level transitions and highlight how policy interventions can channel capital into low-carbon energy.