Making the grass greener: the role of firms’ financial and managerial capacity in paving the way to the green transition

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By Hélia Costa, Lilas Demmou, Guido Franco, Stefan Lamp

The ambitious targets set by many OECD countries to become carbon neutral by 2050 require substantial investment. The European Commission estimates that relevant investment will need to be raised from an average of €683 billion per year to around €1,040 billion per year until 2030 (Lenaerts et al., 2021). According to the International Energy Agency, global energy investment will need to almost double to 4.5% of global GDP by 2030 and remain at this level until 2050. Furthermore, this investment will have to be shouldered mainly by the private sector, responding to market signals and policies set by governments (IEA, 2021).

Green investment efforts to date however fall well short of the zero-emission scenario (ECB, 2023). Various factors may contribute to this. Particularly, financing investment in such technologies may be more difficult to obtain compared to other, more established, technologies, due to specific characteristics like high fixed costs and risk, or information asymmetries (De Haas and Popov, 2023). Investments in newer and riskier green technologies may also be deferred due to a lack of knowledge among firms regarding this specific type of investment and how to manage it effectively (De Haas et al., 2022).

Against this backdrop, our new paper (Costa et al., 2024) delves into the factors holding back corporate green investment. The study places specific emphasis on the role of firm capacity, examining both financing constraints and weak green management practices, and their interaction with environmental policies. Our cross-country analysis focuses on the response to a survey of over 6.500 large, listed companies, which are more strictly regulated, across 33 countries between 2004 and 2020. This is complemented by a case study analysis based on disaggregated and comprehensive data available for Portuguese firms between 2010 and 2020. Our research aims to contribute valuable insights to boost green investments toward meeting the ambitious targets set for 2050.

What determines corporate green investment?

Our cross-country analysis shows that in OECD countries both financing constraints and a lack of green managerial capacity reduce firms’ probability of investing in green technologies, leading to higher emission intensity. Specifically, becoming financially constrained increases a firm’s probability to invest by 2.5 percentage points, around 8% of the average probability (Figure 1, Panel A, first column). In turn, introducing a green management practice, for example by creating a team with green functions, is associated with an increase in the probability to invest (Figure 1, Panel B, first column).

While it is known from previous research that all investment tends to respond negatively to financing constraints (Kalemli-Özcan et al., 2022), our case study shows that green investment is more elastic to financing conditions than other types of investment. Within green investment, we find that investment in integrated technologies is more sensitive to financing conditions than end-of-pipe solutions, possibly because it is performed less often and primarily to comply with regulation and its costs are less easily measured.

How does firms’ capacity interact with policy?

The impacts estimated are toned down in the presence of well-designed environmental policies. Specifically, stringent market-based environmental policies countervail the negative effects of financing barriers on green investment. This is possibly because such policies may incentivise firms to prioritise green investments which would otherwise not be undertaken due to financing constraints. In addition, the positive effect of green management practices is larger the more stringent non-market environmental policies are (Figure 1 Panel A) and the more generous public support is (Figure 1 Panel B). This indicates that green management capacity may help firms to deal with the complexity of non-market-based regulations and government support.

Figure 1: Firm capacity and environmental policy jointly affect green investment

Note: The bars represent the estimated coefficients and the green whiskers the 90% confidence intervals. Panel A: Financial constraints are firms within the highest quartile of the SAFE indicator at NACE2 rev.2 – year; Panel B: The indicator of green management practices is equal to 0-1-2 for firms adopting respectively 0, 1 or 2 green management practices (having a dedicated green team or providing green training to staff).
Source: OECD calculations based on Refinitiv ESG data matched to Orbis 2004-2020.

These results offer valuable insights for policy makers wishing to progress towards their decarbonization goal by promoting private investment. Our paper discusses a menu of policy options that may foster the green transition by upgrading firms’ capacity. These include actions to ease financing constraints both at the banking and equity market levels, and actions to improve monitoring tools such as ESG standards which help investors assess firms’ greenness and exposure to transition risks, as well as actions to improve environmental management, and complementary signals through strong and predictable climate policy.

References

Costa, H., Demmou, L., Franco, G., and S. Lamp (2024), “Making the grass greener: the role of firms’ financial and managerial capacity in paving the way to the green transition”, OECD Economics Department Working Papers, No. 1791)

De Haas, R., Martin, R., Muûls, M., and H. Schweiger (2022), “Managerial and Financial Barriers during the Green Transition”, CentER Discussion Paper Nr. 2021-008

De Haas, R. and A. Popov (2023), “Finance and Green Growth”, Economic Journal, Vol. 133/150, pp. 637-668

ECB (2023), “Closing gaps to bend the trend: embedding the flow of finance in the transition”, Speech by Frank Elderson, State of the Union conference organised by the European University Institute, May 2023

IEA (2021), “Net Zero by 2050 – A Roadmap for the Global Energy Sector”, October 2021

Kalemli-Özcan, Ş., Laeven, L., & Moreno, D. (2022), “Debt overhang, rollover risk, and corporate investment: Evidence from the European crisis”, Journal of the European Economic Association, 20(6), 2353-2395

Lenaerts, K., Tagliapietra, S.,  and G.B. Wolff (2021), “How much investment do we need to reach net zero?”, Bruegel Blog, 25 August