The Price of Carbon Risk: Evidence from the Kyoto Protocol Ratification

This paper examines the impact of carbon risk on firms' financing costs. We exploit the Kyoto Protocol ratification (hereafter KPR) committed by the Australian government in December 2007 as an exogenous increase in carbon risk. We find that, in the post-KPR period, firms with high carbon emissions (carbon emitters) experience a substantial increase in the costs of debt and equity relative to those firms with a lower carbon footprint. We further identify higher cash flow risk and lower investor recognition as the two channels through which carbon risk affects the financing costs. Moreover, after the KPR, carbon emitters are less likely to be financed by major banks and more likely to borrow from new lenders. When conducting seasoned equity offerings, carbon emitters are more willing to use underwriting services rather than rights offerings. Our findings suggest that capital providers incorporate firms' exposure to carbon risk into their decisions and charge them a corresponding risk premium.