Finance & Investment Organizational Governance

Companies Mitigating Climate Change Reduce Their Cost of Capital

New research shows that when companies disclose their environmental impact — and take meaningful action to mitigate it — they earn investor trust.

Published 5 months ago | About a 4 minute read

Image: Pierre Blaché

The climate crisis is now being felt worldwide through more frequent and powerful extreme-weather events. Companies, particularly those in high-emission industries, are major contributors to global carbon emissions — making them key players in the fight against climate change.

A new study shows that businesses that recognize this responsibility and take proactive measures to reduce their carbon footprint, by reducing carbon emissions and transparently sharing their environmental strategies and data, benefit from lower capital costs.

The Task Force on Climate-Related Financial Disclosures (TCFD) offers companies a framework to share climate-related financial information, allowing them to better navigate the risks and opportunities of climate change. In recent years, support for TCFD has surged, and Japan stands out as a leading proponent of such disclosures; from 2022, companies listed in Japan's prime markets have been mandated to follow TCFD guidelines. However, how TCFD disclosures improve a company's financial performance and provide tangible benefits remains underexplored.

So, researchers from Japan’s renowned Kyushu University analyzed data from approximately 2,100 Japanese listed companies over five years (2017 to 2021). Published in Corporate Social Responsibility and Environmental Management in May, the study is one of the first to use holistic TCFD and corporate data in Japan.

The research focused on the impact of corporate climate action including carbon performance, climate-related disclosures and corporate commitments. Researchers analyzed how these actions affect the cost of capital — the costs incurred by a company to finance its operations. The results show that companies with higher carbon emissions face higher costs for borrowing and raising money. However, those that follow TCFD guidelines and openly share climate-related information benefit from lower capital costs.

Importantly, the study found that simply making promises about climate action does not significantly impact financial costs — stakeholders are more attuned to companies’ action in this area, rather than just their commitments.

It's well known that high greenhouse gas (GHG) emissions increase climate-change risks — both physical risks, such as extreme-weather events; and transition risks, such as regulatory changes. These increased risks create uncertainties that drive investors and lenders to demand higher returns, resulting in both higher cost of equity (the return that investors expect for buying a company's stock) and cost of debt (the fees a company pays to borrow money from lenders such as bank).

To reduce these uncertainties and avoid unexpected losses, investors seek to make more informed decisions by understanding and assessing a company's climate-related risks. Transparency in climate change-related data thus becomes crucial.

“When companies share climate-related data, it gives investors and consumers a clearer picture of their environmental efforts — making them more likely to invest,” says Siyu Shen, a graduate student at Kyushu University's Graduate School of Economics and the paper's second author. “We found that this kind of openness is particularly important in energy sectors like electricity and oil, where climate change is a major issue.”

Notably, while the study found that following TCFD guidelines effectively reduced the cost of equity, it did not have a significant impact on the cost of debt. This might be attributed to Japan's negative interest rate policy during the study period, where the Bank of Japan kept borrowing costs low by injecting large amounts of funds into the market. With the end of this policy in March 2024, interest rates in the Japanese bond market are expected to rise. In this context, sustainability-linked loans, which provide low-interest loans for transitioning to a lower-carbon energy system, are becoming increasingly popular. In 2024 and beyond, corporate climate-change mitigation actions in Japan could have the potential to lower the cost of dept.

While more companies worldwide are engaging in climate mitigation, it’s time for them to consider additional strategies to differentiate their carbon performance.

A series of environmental economic studies, including this one, have spurred research collaborators Professor Shunsuke Managi and Associate Professor Alexander Ryota Keeley from Kyushu University’s Faculty of Engineering to establish aiESG — a startup that utilizes AI to analyze the sustainability of global supply chains. Looking ahead, the research team plans to expand their analysis globally to see how regulations and cultural differences impact the relationship between climate change, carbon performance, and capital costs in various regions. They aspire to become one of the leading teams in climate-impact research.

Although this study focuses on Japan, it provides valuable insights for investors, companies and policymakers worldwide by highlighting the connection between climate disclosures and capital costs.

“We hope our research provides the scientific evidence needed to support companies in developing new strategies, changing behaviors, and ultimately reducing emissions,” says Hidemichi Fujii, Professor at Kyushu University's Faculty of Economics and the corresponding author of the study.