Leveraging climate change: Estimating the effect of capital structure on shareholder value using the Paris Agreement

We explore how capital structure decisions influence shareholder value around the adoption of the Paris climate agreement. We find that companies with greater leverage encounter significantly more adverse stock market reactions. Specifically, a rise in leverage by one standard deviation decreases the three-day cumulative abnormal return by 11 %. Firms with higher leverage are viewed as more financially constrained and possess less capacity to cope with climate-related concerns in alignment with the Paris Agreement. Interest payments take away resources that could otherwise be deployed to tackle climate-related challenges. Higher leverage also raises the probability of financial distress, causing companies to be more cautious and thus less likely to invest in climate-related issues. The adverse effect of leverage on shareholder value is significantly worsened for firms more exposed to the physical risks of climate change. However, the negative effect of leverage is found to be significantly mitigated by firms that exhibit stronger profitability and greater liquidity.