Abstract

In this paper the relationship between carbon risk and corporate capital structure is examined. Recent literature highlights that heavy carbon-emitting firms need to adjust their level of indebtedness to reach their optimal financial leverage. Specifically, the amount of debt raised by high carbon-emitting businesses is lower than that of their low carbon-emitting counterparts. This can be explained by using the trade-off theory, according to which heavy carbon-emitting firms undergo both increasing financial distress costs and decreasing tax benefits of debt, causing them to employ a lower level of financial leverage relative to light carbon-emitting firms.

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