Drivers of Firm Investment in Low and High-Carbon Energy: Capital Markets and Climate Policy

Abstract: The cost of capital is a key driver of the low-carbon transition, as changes in firm-level financing costs can support or hinder low-carbon energy investment (LCI) and high-carbon energy investment (HCI). Using asset-level data from the S&P World Electric Power Plant database, we track firm-level LCI and HCI for publicly listed electric utilities firms from 2012-2021. Using a fixed-effects Poisson model, we find that a reduction in the firm-level cost of debt directly increases firm-level LCI and HCI, and indirectly increases investment by enabling debt capital raising. We then control for climate policy using the OECD Environmental Policy Stringency Index. We find that market-based policies, such as carbon prices and taxes, directly increase domestic LCI and act as a moderator, strengthening the relationship between debt capital raising and LCI, while doing the opposite for HCI. With regard to pricing policies, such as feed-in tariffs, we find inconclusive results. In summary, these findings demonstrate the importance of capital markets in firm-level transitions and show that governments can channel capital away from HCI and into LCI through policy interventions.