We evaluate the welfare consequences of mandates to invest in sustainable corporations, defined as those that spend to mitigate a climate disaster externality. These mandates incentivize otherwise ex-ante identical unsustainable firms to become sustainable for a lower cost of capital. Despite being a dynamic stochastic general equilibrium model, a simple formula shows that the cost-of-capital wedge between sustainable and unsustainable firms is equal to a sustainable firm’s mitigation spending divided by its market valuation. A firm’s mitigation effectively lowers its productivity (a tax proportional to its market value) and is compensated by a lower cost of capital. Sustainable firms invest and accumulate capital at the same rate as unsustainable firms. Using global warming projections, a mandate of 82% of firms spending 9.6% of their output on mitigation for a 1% cost-of-capital wedge yields the first-best outcome. Welfare is nearly 20% higher while Tobin’s q is only modestly lower compared to the competitive equilibrium because mitigation, while costly, reduces aggregate risk. Mandates in practice are an order of magnitude too small.
Professor Neng Wang is Chong Khoon Lin Professor of Real Estate and Finance at Columbia Business School and a visiting professor at CKGSB. He is also a Research Associate (Senior Research Fellow) at the National Bureau of Economic Research (NBER), a Senior Research Fellow at Asian Bureau of Financial and Economics Research (ABFER), and an Academic Member of the Luohan Academy. He has widely published in leading economics, finance, and business journals. Among other awards and honors, he won a Smith-Breeden Distinguished Paper Prize awarded by the Journal of Finance, and the Bettis Distinguished Scholar Award from Carey School of Business, Arizona State University. He is an Associate Editor at the Journal of Finance and was an Editor in the Finance area at the Management Science. His research interests include corporate finance, contract theory, financial institutions, asset pricing, asset allocation, sovereign debt and international finance, risk management, entrepreneurial finance, household finance, wealth distribution, macroeconomics, private equity, hedge funds, investor protection, real estate finance, FinTech, and the Chinese economy. He has taught courses at both MBA and PhD levels including advanced corporate finance, entrepreneurial finance and private equity, fixed income securities and markets, financial institutions, risk management, real estate finance, corporate finance theory, and continuous-time finance. He received a Ph.D. in Finance from the Graduate School of Business at Stanford University in 2002.