The influence of carbon risk on debt structure

Abstract

We add to the literature on the effect of carbon risk on the availability and cost of bank loans, by focusing on the impact of carbon risk on the proportion of bank debt relative to total debt. Using a global sample of 58 countries covering the period 2007–2020, we find that carbon risk is negatively associated with bank debt ratio, indicating that high emitter firms are less able to secure bank debt. The findings support our hypothesis that high-emitter firms reduce bank debt to avoid bank scrutiny and it is likely banks avoid lending to high-emitter firms for reputational concerns. Our results are robust to a battery of sensitivity tests and addressing endogeneity concerns using several approaches. We add to this literature by distinguishing between the demand-side vs. supply-side. Our channel tests are in line with the demand-side perspective. Indeed, we show that the negative relationship between carbon risk and bank debt is more (less) pronounced in firms with severe agency (information asymmetry) problems. We also provide support for the supply-side perspective. We show that the negative association between carbon risk and bank debt is stronger in financially developed countries and in countries with stringent environmental regulations. We offer many practical and policy implications based on our results. Our study highlights the potential role of banks in aiding climate policy implementation. Furthermore, firms can adopt carbon risk mitigating strategies to amplify their capital sources.