Climate Policy Risk and Corporate Financial Decisions: Evidence from the NOx Budget Trading Program

Author:

Dang Viet Anh1ORCID,Gao Ning1ORCID,Yu Tiancheng2ORCID

Affiliation:

1. Alliance Manchester Business School, University of Manchester, Manchester, Greater Manchester, M15 6PB, United Kingdom of Great Britain and Northern Ireland;

2. University of Exeter Business School, University of Exeter, Exeter, EX4 4PU, United Kingdom of Great Britain and Northern Ireland

Abstract

We find that manufacturing firms adopt more conservative capital structures in response to the Nitrogen Oxides (NOx) Budget Trading Program (NBP) of 2004, a regional cap-and-trade program aimed at mitigating the NOx emissions of power plants in 11 midwestern and southeastern states in the United States. Our further analysis demonstrates that, because the NBP induces an electricity price shock, it affects manufacturers’ financial decisions by raising their operating leverage and distress risk. We also find that firms respond to the NBP’s adoption heterogeneously: they adjust their financial leverage more dramatically when facing greater electricity intensity, financial distress threats, or competitive pressure. In addition, firms adapt not only capital structure, but also other financial policies in response to the regulation. Overall, our study shows that climate policy risk constitutes an essential consideration in firm financial decisions. It also highlights potential unintended consequences of policy responses to climate change for the corporate sector. This paper was accepted by George Serafeim, Special Issue of Management Science: Business and Climate Change. Funding: The authors gratefully acknowledge generous financial support from the Alliance Manchester Business School Strategic Research Investment Fund. Supplemental Material: The data files and online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4617 .

Publisher

Institute for Operations Research and the Management Sciences (INFORMS)

Subject

Management Science and Operations Research,Strategy and Management

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