Green Policies, Greener Wallets: How Cap‐and‐Trade Regulation Affects Cost of Capital

ABSTRACT As one of the most efficient regulations on climate abatement, the cap‐and‐trade mechanism has been broadly adopted to mitigate greenhouse gas emissions. Although there are common concerns about the nexus between environmental regulations and financial markets, this paper investigates how cap‐and‐trade policy affects companies' cost of equity (COE) and cost of debt (COD) and explores the underlying mechanisms. By merging nationwide data from China's listed companies and exploiting the staggered introduction of cap‐and‐trade pilots as a quasi‐natural experiment, we apply a propensity score matching and difference‐in‐differences framework. We find robust evidence that cap‐and‐trade policy significantly decreases companies' COE by 0.341% and COD by 0.492%, respectively. The reduction in capital costs makes cap‐and‐trade an attractive policy that can ease financing burdens, promote sustainable investment, and facilitate green transformation toward carbon neutrality. Mechanism analyses suggest that cap‐and‐trade regulation affects cost of capital through environmental information disclosure and current ratio. This study enriches the literature on comprehensive outcomes of cap‐and‐trade regulation in emerging economies and offers implications for regulators, managers, and stakeholders navigating the transition toward a net‐zero future.