Is Capital Structure Irrelevant with ESG Investors?

This paper examines whether capital structure is irrelevant for enterprise value and investment when investors care about environmental, social, and governance issues, which we denote “ESG-Modigliani-Miller” (ESG-MM). Theoretically, we show that ESG-MM holds if ESG is additive and markets are perfect. ESG-MM means that issuing low-yielding green bonds does not lower the overall cost of capital because it makes the issuer’s other securities browner. Hence, a firm’s incentive to make a green investment does not depend on its financing choice. Empirically, we provide evidence of failure of ESG-MM, implying that firms and governments can exploit non-additive ESG or segmented markets.