To address climate change, an increasing number of firms have declared net zero commitments. In this article, we theoretically and empirically demonstrate that firm’s net zero commitment presents a double-edged sword on cost of equity. By modelling a firm’s optimal transition pathway, we theoretically elucidate the relationship between transition ambition, transition readiness, and enterprise value. By estimating the carbon risk premium for 1,100 listed firms that had declared net zero commitments globally by 2022, we empirically uncover that such commitments can either increase or decrease a firm’s carbon risk premium, depending on the firm’s transition readiness. Specifically, among firms with the same greenhouse gas emissions intensity, those with lower transition readiness can experience a higher cost of equity from declaring net zero commitments. These results align with our theoretical analysis and cannot be explained solely by investors’ green preferences or the discounted transition credibility of high-emitting firms. Additionally, we show that institutional investors effectively channel carbon risk into the equity market by divesting from high-emitting firms that have declared net zero commitments. Our findings have important implications: firms that fail to align their transition readiness with their net zero commitments may paradoxically expose themselves to greater transition risk and, consequently, a higher cost of equity. To alleviate the accumulation of carbon risk premium in the equity market, policymakers should support the transition readiness of firms in their jurisdictions. This involves fostering transition capacity, raising transition urgency, and extending investors’ decision horizons.
