How change in cost of capital motivates companies to go green?
School of Business | Bachelor's thesis
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AbstractThis literature review examines how cost of capital effects on companies' willingness to change their behavior towards green activity. There have been studies before which have examined green companies' performance compared to polluting entities. The main factor of effecting on cost of capital are green investors who demand risk premium for their investments on polluting entities. Many studies have found evidence that people will require higher expected return on firms which are polluting. I used different control variables which included restrictions: Same amount of companies, no short selling, same cash flows, same costs to reform, risk averse investors, Firms maximize share price, 5 percent reforming cost from expected cash flow, one period world, unacceptable and reformed firms have same common technology, all acceptable firms have different technology compared to unacceptable and reformed firms, and returns are normally distributed. These assumptions were for the sake of simplicity. The results of this study indicated that there has to be certain number of green investors at first until it is plausible to change production technology. This finding is based on reforming cost versus cost of capital. In equilibrium cost of capital and reforming cost is equal and there are no incentives to reform. There is strong evidence that firms are going to reform themselves when cost of capital increases above certain level and this increase is affected by the number of green investors in markets.
Thesis advisorMustonen, Mikko
cost of capital, green investors, equilibrium, production technology