Corporate sustainability, investment, and capital structure

Michi Nishihara ()
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Michi Nishihara: Graduate School of Economics, Osaka University

No 22-05, Discussion Papers in Economics and Business from Osaka University, Graduate School of Economics

Abstract: This study develops a real options model in which a firm invests in either a sustainable project or an unsustainable project. The sustainable project requires a high investment cost and yields cash flows perpetually, whereas the unsustainable project requires a low investment cost and yields cash flows until a random maturity. The random termination of cash flows reflects the project fs environmental, social, and governance (ESG) risk. In the model, the optimal investment choice and timing are analytically derived, and the effects of key parameters on the choice are also examined. Higher ESG risk, growth rate, and volatility, and lower discount rate encourage sustainable investing mainly through their impacts on the net present value (NPV) and timing option value. The less sustainable firm chooses higher leverage to enjoy a greater benefit of debt financing. Therefore, access to debt financing and a higher corporate tax rate (tax shield) discourage sustainable investing.

Keywords: sustainability; ESG; real options; capital structure. (search for similar items in EconPapers)
JEL-codes: G13 G31 G32 (search for similar items in EconPapers)
Pages: 30pages
Date: 2022-11
New Economics Papers: this item is included in nep-cfn, nep-env and nep-ppm
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