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The ECON seminars are organised by the CIES at the Institute and aim to bring top scholars in Europe to present their recent work at the frontier of environmental, resource and development economics.
A rapidly increasing amount of investments commit firms to undertake climate-friendly projects. Recent empirical evidence shows that the development of green finance, for instance through novel investment products such as certified green bonds, has a significant impact on CO2 emissions. Yet little is known about the economic mechanisms of green finance and its possible contribution to climate policy.
This paper develops the first formal analysis of green finance as a climate policy instrument. We examine public firms that undertake green and ordinary projects, and finance the former through green bonds. Green projects emit less CO2, but entail higher CO2 abatement costs, which stock investors do not directly observe. Our theory holds that green bonds allow firms not only to attract bond and stock investors concerned about the environmental impact of their investments, but also to signal to stock investors their otherwise unobservable efficiency at controlling their CO2 emissions.
Our model consistently accounts for stylized facts on the recent development of green finance. It explains, first, why firms benefit from green bonds while these bonds' yield spread is small in practice compared to ordinary bonds, and, second, why these benefits are decreasing with the use of green bonds and are lower when firms receive ESG attention. The analysis has direct implications for the effective design of climate policy: Green finance amplifies the effect of carbon taxation, which allows governments to reach their climate policy objective with lower carbon penalties. However, for firms receiving ESG attention, the long-run amplification effect only depends on investors' concern about the climate problem.
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