Why Do Firms Issue Green Bonds?

Julien Xavier Daubanes, Shema Frédéric Mitali and Jean-Charles Rochet,

January 2022

Green bonds allow firms to commit to climate-friendly projects. Equity investors react positively to their announcement. Based on prior empirical studies, we suggest that green bond commitments help managers signal the profitability of their green projects and that they do so because they are sensitive to their firm’s stock price. We present a signaling model in which firms undertake green projects not only because of carbon penalties but, additionally, because of managerial incentives, predicting that the role of the former is augmented by the latter. We test this prediction by exploiting both cross-industry differences in the stock-price sensitivity of managers’ pay and in stock share turnover, and cross-country variations in effective carbon prices. Our results not only support the role that our theory ascribes to managerial incentives, but also show that this role mainly depends on carbon pricing. Green bonds are not substitutes to carbon pricing. On the contrary, the latter is essential to the effectiveness of the former.

Keywords: Green bonds; Green finance; Climate policy; Carbon pricing; Managerial incentives; Short-termism.

JEL classification: D53; H23; G14; Q54.