Climate Policy Risk and Corporate Capital Structure: Evidence from the NOx Budget Trading Program

We find that manufacturing firms adopt more conservative capital structures in response to the NOx Budget Trading Program (NBP) of 2004, a regional cap-and-trade program aimed at mitigating NOx emissions in 11 midwestern and southeastern states in the U.S. Firms respond more dramatically when facing more severe financial-distress threats or competitive pressure. Further analysis demonstrates that, because the NBP induces an energy price shock, it affects firms’ financial leverage by increasing their operating leverage. These findings suggest that emission mitigation policies impact corporate capital structure through the trade-off framework. Overall, our study shows that the policy risk associated with climate change regulations constitutes an essential consideration in firm financial decisions.