Received: 26 December 2017 Revised: 20 August 2018 Accepted: 4 September 2018

DOI: 10.1002/bse.2242

RESEARCH ARTICLE

Corporate carbon risk, voluntary disclosure, and cost of capital:

South African evidence
Tesfaye T. Lemma1 | Martin Feedman1 | Mthokozisi Mlilo2 | Jin Dong Park1

1
Department of Accounting, College of
Business and Economics, Towson University,
MD, USA
2
School of Economic and Business Sciences,
Faculty of Commerce, Law and Management,
University of the Witwatersrand,
Johannesburg, South Africa
Correspondence
Tesfaye T. Lemma, Department of Accounting,
College of Business and Economics, Towson
University, MD, USA.
Email: tlemma@towson.edu
Abstract
The study examines the interplay among corporate carbon risk, voluntary disclosure,
and cost of capital within the context of South Africa, a “rising power” in the climate
policy debate. We develop a system of simultaneous equations models and analyze
data drawn from firms traded on the Johannesburg Securities Exchange (JSE), for
the period 2010 to 2015, using the three‐stage least squares procedure. We find that
voluntary carbon disclosure is associated with lower overall (and equity) cost of cap-
ital, after controlling for corporate carbon risk. We also find that firms with higher car-
bon risk tend to provide better quality carbon disclosure and signal the possibility of
high carbon risk to avoid negative market reactions resulting from concealing carbon
information. Although the capital market does not appear to incorporate individual
firm's carbon risk exposure into the required cost of capital, we find that it generally
requires higher returns for companies operating in carbon‐intensive sectors. These
findings suggest that firms could exploit the virtues of voluntary carbon disclosure
to reduce their overall (and equity) cost of capital. Our findings also imply that regu-
lators and policymakers could point to the cost of capital reducing role of voluntary
disclosure to lure firms into voluntarily providing superior quality carbon disclosures.

KEY W ORDS

corporate carbon risk, cost of capital, South Africa, voluntary disclosure

1 | I N T RO D U CT I O N
Climate change has received heightened research and policy attention
due to its potential to cause not only disturbances to complex ecological
systems but also to inflict unprecedented damages to economies and
the health of human population (Jung, Herbohn, & Clarkson, 2018;
Labatt & White, 2007). Although there has been a push towards a low
carbon economy, the response from the corporate world varies consid-
erably, ranging from those that implement proactive approaches to mit-
igating corporate carbon risk to others that implement reactive
solutions (Hart, 1995; Liao, Luo, & Tang, 2015). An emerging strand of
research establishes that corporate carbon risk impacts firm value
through several mechanisms (Chapple, Clarkson, & Gold, 2013;
Clarkson, Li, Richardson, & Vasvari, 2008; Garber & Hammitt, 1998;
Hughes, 2000; Labatt & White, 2007; Matsumura, Prakash, & Vera‐
Muñoz, 2014; Peters & Romi, 2014). The hitherto value relevance
research decomposes firm value into expected cash flow and cost of
capital (Barth, Cahan, Chen, & Venter, 2017). Numerous studies show
that corporate capital providers incorporate the firm's carbon risk into
their capital allocation decisions (Cogan, 2006; Jung et al., 2018; Kim,
An, & Kim, 2015; Kolk, Levy, & Pinkse, 2008; Li, Eddie, & Liu, 2014; Saka
& Oshika, 2014; Subramaniam, Wahyuni, Cooper, Leung, & Wines,
2015; Weber, 2012). The present study focuses on the interrelationship
among cost of capital, corporate carbon risk, and voluntary disclosure.
Despite the increased research interest on how the capital market
rewards (or punishes) corporate carbon risk and the mediating role of
carbon disclosure, there is virtually no empirical evidence based on the
context of countries that have come to be known as the “rising pow-
ers”—China, India, Brazil, and South Africa—in the climate policy
debate. This is a significant omission because these economies are
“not only gaining weight in the international political system but also
have a growing impact on the ecosystem as they struggle to sustain

Bus Strat Env. 2018;1–16. wileyonlinelibrary.com/journal/bse © 2018 John Wiley & Sons, Ltd and ERP Environment 1
2 LEMMA
economic growth and development” (Never, 2012). To an increasing
extent, the future of human life on our planet would be influenced
by what goes on in these countries (Schmitz, 2017). Furthermore, vir-
tually all the available empirical evidence has focused on reporting
regimes where greenhouse gas (GHG) emissions reporting is somehow
regulated. Insights grounded on empirical examination of the eco-
nomic benefits of voluntary carbon disclosure could provide informa-
tion that will help corporate executives in making important cost–
benefit trade‐offs in allocating resources to measuring and disclosing
carbon emissions related information (Matsumura et al., 2014).
South Africa provides a unique setting for four reasons. First, the
country's cheap and plentiful coal has created heavy dependency on
energy‐ and emissions‐intensive industries. Also, the country's very
slow transition to low carbon, renewable, energy sources has made
it to be a very high GHG emissions country in the world, and by far
the highest source of GHG emissions in Africa (Andreasson, 2017;
Baker, Newell, & Phillips, 2014; Hallding et al., 2011; Never, 2012;
Pegels, 2014; Schmitz, 2017). Second, despite being a very high
GHG emissions country, South Africa has had a voluntary carbon dis-
closure regime until very recently, which provides an opportunity to
investigate the interplay among our variables of interest in a voluntary
reporting setting.1 Third, the presence of entrenched stakeholders,
with clashing interests, vying for influence in shaping the country's cli-
mate policy and carbon risk management behavior of corporates
(Baker et al., 2014; Schmitz, 2017) promises to provide an exciting
research context for exploring corporate carbon risk exposures and
the related disclosure practices. Fourth, response rates to Carbon Dis-
closure Project's (CDP)2 annual survey questionnaire suggest that
South African companies tend to be more enthusiastic about voluntar-
ily disclosing their carbon emission information compared with their
peers in other countries in the “rising powers.”3 We investigate if this
“commitment to transparency” is rewarded by the capital market.
The literature on the association between voluntary carbon dis-
closure and a firm's cost of capital presents two contrasting views.
The first view contends that voluntary carbon disclosure, through its
impact on information asymmetry, estimation risk, and investor prefer-
ence, would have a decreasing effect on the firm's cost of capital
(Beyer, Cohen, Lys, & Walther, 2010; Diamond & Verrecchia, 1991;
Dutta & Nezlobin, 2017; Easley & O'Hara, 2004; Healy & Palepu,
2001; Lambert, Leuz, & Verrecchia, 2007; Merton, 1987; Verrecchia,
2001). The second view argues that voluntary disclosure of carbon
information comes with some proprietary costs and could potentially
result in revelation of information that would have negative repercus-
sions to the firm (Guidry & Patten, 2012; Peters & Romi, 2014;
Verrecchia, 1983). In our analysis, we use CDP's carbon disclosure
score as a proxy for the quality of a firm's carbon disclosure.
1 actions or lobby against carbon regulation (Leuz & Wysocki, 2016).
On the third of April 2017, the South African government gazetted the
National Greenhouse Gas Reporting Regulations which mandated certain types
of corporates to report their GHG emissions activity data into the National
Atmospheric Emissions Inventory System (NAEIS).
2
The CDP, an independent non‐for‐profit organization acting on behalf of hun-
dreds of institutional investors, holds the largest repository of carbon emission
information (Matsumura et al., 2014).
3
The response rate to the CDP annual survey of South African companies is the
second highest in the world with 83% response rate (CDP, 2013).
ET AL.
Recent literature suggests that “carbon emissions have become an
essential element in analyzing a company's risk profile” (Matsumura
et al., 2014). We note two contrasting views on the association
between corporate carbon risk and voluntarily carbon disclosure. The
first view submits that low carbon risk firms would have higher incen-
tives to voluntarily disclose their carbon risk information to differenti-
ate themselves from companies with higher carbon risk (Clarkson
et al., 2008; Dye, 1985; Verrecchia, 1983). Contrarily, the second view
contends that high carbon risk firms are more likely to voluntarily dis-
close their carbon information as they would face more pressure from
stakeholders (Hahn, Reimsbach, & Schiemann, 2015; Roberts, 1992)
and would want to convey a more positive image of the firm (Deegan,
2007; Hahn et al., 2015). We use the inverse of the ratio of Scope 1
GHG emissions to annual sales turnover, a transformed measure of
carbon emissions intensity, as a proxy for corporate carbon risk in
our main analysis.
Given the potential endogeneity among corporate carbon risk,
voluntary disclosure, and cost of capital (Hassan & Romilly, 2018),
we develop a system of simultaneous equations to examine the rela-
tionships using data drawn from the Johannesburg Securities
Exchange (JSE) for the period 2010 to 2015. We find that voluntary
carbon disclosure is associated with lower overall (and equity) cost
of capital, after controlling for the impact of the firm's exposure to car-
bon risk. Further, this association is economically meaningful, with one
standard deviation increase in carbon disclosure score leading to a
1.5% decrease in the overall cost of capital. We also find that firms
with higher carbon risk tend to provide better quality carbon disclo-
sure and signal the possibility of high carbon risk to avoid negative
market reactions resulting from concealing carbon information.
Although the capital market does not appear to incorporate an individ-
ual firm's carbon risk into the required cost of capital, we find that it
generally requires higher returns on companies operating in carbon‐
intensive sectors. The findings suggest that firms could exploit the vir-
tues of voluntary carbon disclosure to overcome the accentuating role
of corporate carbon risk on the overall (and equity) cost of capital.
That is, high carbon risk firms could utilize voluntary carbon disclosure
to obtain a more favorable overall (and equity) cost of capital leading
to a suboptimal allocation of resources and yet continue to engage
in activities that adversely impact the environment. It also suggests
that policy makers and regulators could point to the cost of capital
reducing role of carbon disclosure in luring firms into voluntarily dis-
closing carbon information.
The present study's contribution is twofold. First, it illuminates
our understanding of the interaction among corporate carbon risk, vol-
untary disclosure, and cost of capital in a voluntary reporting setting.
The findings could be used to establish the key benefits of voluntary
carbon disclosure and help us predict which firms may take avoidance
Second, it provides insights into corporate carbon risk and voluntary
corporate carbon disclosure policies within the context of one of the
“rising powers,” which would inform the climate policy debate. The
rest of the paper is organized as follows. Section 2 presents a brief
review of background literature and hypotheses development. Section
3 outlines the research design including issues of sample selection,
variable identification and definition, model specification, and
LEMMA ET AL.
econometric procedures. Section 4 presents the results and discus-
sions, and Section 5 concludes.
2 | B A CKG R O U N D L I T ER A T U R E A N D
H Y P O T H E S E S D E V EL O P M EN T
2.1 | Voluntary carbon disclosure and cost of capital
The wider literature on information asymmetry and corporate disclo-
sure contends that voluntary disclosure reduces the firm's cost of
capital (Healy & Palepu, 2001) through the following mechanisms.
First, voluntary disclosure reduces information asymmetries between
the firm and its capital providers, which in turn reduces monitoring
costs. Second, firms could use voluntary disclosure of relevant infor-
mation to increase investor demand for their securities, which in turn
increases market liquidity of their securities (Diamond & Verrecchia,
1991; Richardson, Welker, & Hutchinson, 1999; Verrecchia, 2001)
and risk‐sharing (Merton, 1987). Third, voluntary disclosures help
improve companies' information environment by enhancing analysts'
understanding of their prospects (Beyer et al., 2010) which reduces
estimation of information risk (Diamond & Verrecchia, 1991; Lambert
et al., 2007; Verrecchia, 2001). Fourth, voluntary disclosure could
affect cost of capital of a firm through its effect on the firm's real
decisions including production, investment, and capital allocation
choices (Dutta & Nezlobin, 2017; Easley & O'hara, 2004; Lambert
et al., 2007).
On the other hand, Peters and Romi (2014) submit that providing
carbon disclosures could create adverse consequences by providing
information that might encourage government agencies to investigate
firms, invoke costly litigation, providing competitors with information
about firm‐specific sustainability strategies, and inciting potentially
negative attention from environmental advocacy groups. In the same
vein, both Verrecchia (1983) and Guidry and Patten (2012) contend
that disclosure of (carbon) information comes with proprietary costs
in the form of actual costs of disclosure as well as eventual conse-
quences that accompany such decisions. Thus, the nature of influence
that voluntary carbon disclosure has on the cost of capital of a firm
remains an empirical question.
The empirical literature is seemingly dominated by studies that
present evidence consistent with the first view that the cost of capital
of a firm is likely to decrease with voluntary carbon disclosure. For
instance, Clarkson, Fang, Li, and Richardson (2013) document evi-
dence that strongly corroborates the conjecture that environmental
disclosures enhance firm value. In a similar vein, in a study that
focused on S&P 500 firms, He, Tang, and Wang (2013) demonstrate
that cost of equity capital is negatively associated with carbon disclo-
sure and the association is weaker for companies with good carbon
performance. Both Freedman and Patten (2004) and Plumlee, Brown,
Hayes, and Marshall (2015) reach similar conclusions. On the other
hand, empirical investigations by Murray, Sinclaire, Power, and Gray
(2006) document that there is no association between environmental
disclosures and firm performance. Consistent with the dominant
empirical evidence, we propose our first hypothesis (in alternative
form) as follows:
3
Hypothesis 1. : Voluntary carbon disclosure is nega-
tively associated with cost of capital.
2.2 | Voluntary carbon disclosure and corporate
carbon risk
Corporate carbon risk refers to “threats and opportunities that are
associated with a firm's management of carbon emissions” (Jung
et al., 2018; Subramaniam et al., 2015). It poses regulatory, physical,
and business risks (Labatt & White, 2007) each of which are likely to
impact firms to varying degrees “depending on the actions that firms
undertake to confront or even pre‐empt the risks and challenges
posed by climate change” caused by carbon emissions (Jung et al.,
2018). Voluntary disclosure theory suggests that companies with
lower carbon risk have the incentive to voluntarily disclose their car-
bon risk information as they would want to differentiate themselves
from companies which have higher carbon risk (Clarkson et al., 2008;
Dye, 1985; Verrecchia, 1983). Likewise, signaling theory contends that
companies with low carbon risk are more likely to voluntarily disclose
carbon information as they cannot be easily imitated by companies
with high carbon risk, and thus, have more incentives to voluntarily
engage in carbon disclosure (Clarkson et al., 2008; Li, Richardson, &
Thornton, 1997). Thus, both voluntary disclosure and signaling theo-
ries imply an inverse association between voluntary carbon disclosure
and corporate carbon risk (Clarkson et al., 2008).
Sociopolitical theories of which stakeholder theory and legitimacy
theory are the most prominent explain disclosure based on companies'
response to perceived outside pressure (Hahn et al., 2015). These the-
ories contend that a firm could use disclosure of information about its
carbon risk to convey a positive image about itself and to satisfy the
demands for transparency. That is, these theories submit that firms
with high carbon risk with threatened legitimacy would voluntarily
engage in disclosure of carbon‐related information to deflect or nullify
suspicion or doubt about their environmental activities (Adams, 2004;
Gray, Kouhy, & Lavers, 1995; Hughes, Anderson, & Golden, 2001).
Stakeholder theory contends that firms are accountable to all their
stakeholders, not just their investors. Because these stakeholders have
multiple demands, and the demands may in fact conflict, the firm
needs to provide information to meet these demands (Roberts, 1992).
On the other hand, legitimacy theory is concerned with whether a firm
conforms to society's expectations of the firm (Chen & Roberts, 2010;
Deegan, 2007). By disclosing carbon risk information, the firm can be
seen as fulfilling its social contract (Hahn et al., 2015). Both stake-
holder and legitimacy theories suggest a positive association between
voluntary carbon disclosure and corporate carbon risk (Clarkson et al.,
2008; Patten, 2002).
Again, available empirical literature on the association between
voluntary corporate disclosure and corporate environmental risk pre-
sents mixed results. Consistent with voluntary disclosure and signaling
theories, Luo and Tang (2014) demonstrate that carbon disclosure and
corporate carbon risk are negatively associated. Both Al‐Tuwaijri,
Christensen, and Hughes (2004) and Clarkson et al. (2008) find evi-
dence that supports voluntary disclosure and signaling theories. On
the other hand, corroborating sociopolitical theories, several studies
show that firms that were poorer environmental performers made
4 LEMMA
more extensive environmental disclosures (Bewely & Li, 2000;
Campbell, 2003; Cho, Freedman, & Patten, 2012; Cho & Patten,
2007; Clarkson, Li, Richardson, & Vasvari, 2011; Hassan & Romilly,
2018; Hughes et al., 2001). Likewise, He et al. (2013) provide evidence
corroborating a positive association between carbon disclosure
and corporate carbon risk. Still, some studies found no statistically
significant association between the two variables (see, for instance,
Wiseman, 1982; Freedman & Wasley, 1990). In line with the dominant
empirical evidence, we propose our second hypothesis (in alternative
form) regarding the association between voluntary carbon disclosure
and corporate carbon risk as follows:
Hypothesis 2. : Voluntary carbon disclosure is positively
associated with corporate carbon risk.
2.3 | Corporate carbon risk and cost of capital
Climate change poses risks to a firm's value through several channels
including the prospect of increased costs of compliance to carbon pol-
icies; the prospect of increased costs of operation and reduced reve-
nue due to bad weather, uncontrollable accidents, and so forth; and
reputational and market value penalties from increasing GHG emis-
sions (Chapple et al., 2013; Clarkson et al., 2008; Garber & Hammitt,
1998; Hughes, 2000; Labatt & White, 2007; Peters & Romi, 2014).
These impacts of climate change have direct bearing on firm's future
cash flows and, by extension, its ability to repay debts and maintain
regular dividend payments. Furthermore, capital providers may face
reputational risks if their financial dealings with high carbon risk firms
are viewed in a negative light by stakeholders which, in turn, may
affect a capital provider's ability to attract future customers, and thus,
its's ability to generate future revenue streams. Thus, several scholars
contend that capital providers incorporate the firm's carbon risk into
their capital allocation decisions (Cogan, 2006; Jung et al., 2018; Kolk
et al., 2008; Subramaniam et al., 2015; Weber, 2012).
The available empirical evidence corroborates the argument that a
firm's carbon risk exacerbates its cost of capital. For instance, Li et al.
(2014) show that a firm's cost of equity increases with its emissions
intensity, although they report that they find little evidence to corrob-
orate such an association with respect to its cost of debt. Similarly,
Chen and Gao (2012) demonstrate that both costs of equity and debt
increase with increase in a firm's carbon emissions. Still, Jung et al.
(2018) demonstrate a positive association between a firm's cost of
debt and its carbon emissions and that the association is weaker for
firms that voluntarily disclose their carbon emissions. In a related vein,
several empirical studies demonstrated that lending institutions, faced
with the challenges of potential damages to their reputation and abil-
ity to generate future customers, incorporate borrowers' environmen-
tal/carbon risk exposures into their capital allocation decisions
(Coulson & Monks, 1999; Subramaniam et al., 2015; Thompson,
1998; Thompson & Cowton, 2004). Nonetheless, several studies
find no association between environmental performance and a firm's
economic performance (e.g., Freedman & Jaggi, 1992; Rockness,
Schlachter, & Rockness, 1986). In sum, the results of empirical studies
are inconclusive. Thus, in line with the dominant empirical evidence,
we propose our third hypothesis (in alternative form) as follows:
ET AL.
Hypothesis 3. : There is positive association between
corporate carbon risk and cost of capital.
Freedman and Patten (2004) examined stock market reaction to the
announcement of a firm's environmental performance and found a
positive association between environmental performance and stock
market reaction; that is, the market reacted negatively to firm's pollu-
tion performance. However, the authors also found that firms could
mitigate the impact of poor performance on market reaction through
extensive environmental disclosures. In a similar vein, He et al.
(2013) argue that firms with good carbon performance face a smaller
legitimacy problem, and investors are probably less sensitive to the
carbon disclosure of such firms; thus, the association between volun-
tary carbon disclosure and a firm's cost of capital would be weaker
for firms with low carbon risk. Thus, we state the fourth hypothesis
(in the alternative form) as follows:
Hypothesis 4. : The association between voluntary car-
bon disclosure and cost of capital is weaker for firms with
lower carbon risk.
3 | R E S E A RC H D E S I G N
In sync with prior studies (e.g., Sharfman & Fernando, 2008), we use
the weighted average cost of capital (WACCi,t), described in the sem-
inal work of Modigliani and Miller (1958), as a proxy for a firm's cost
of capital, based on estimates obtained directly from INET BFA data-
base. Both Al‐Tuwaijri et al. (2004) and Ullmann (1985) contend that
a firm's overall strategy is likely to codetermine its economic perfor-
mance, environmental performance, and voluntary disclosure implying
potential endogeneity problems among the variables. And failure to
account for endogeneity among the variables could result in biased
and inconsistent results if we use ordinary or generalized‐least
squares single‐equation estimation procedures (see also Hassan &
Romilly, 2018). In sync with this argument, He et al. (2013) imple-
mented joint estimates of the interaction among carbon disclosure,
carbon performance, and cost of capital. Thus, we develop a system
of simultaneous equations for examining joint interactions among
corporate carbon risk, voluntary disclosure, and cost of capital as
follows:
WACCi;t ¼ DSCRi;t þ BETAi;t þ ICOV i;t þ LEV i;t þ SIZEi;t þ GRW i;t
þ PRFT i;t þ TANGi;t þ VLT i;t þ INTENSIVEi;t ; (1a)
DSCRi;t ¼ CRi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t þ INTENSIVEi;t (2)
CRi;t ¼ DSCRi;t−1 þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (3)
where WACCi,t denotes the weighted average cost of capital of firm i
E D
in year t estimated using WACCi;t ¼ KEi;t þ KDi:t ð1 − T Þ;
DþE DþE
KEi,t refers to the cost of equity capital of firm i in year t estimated
using the capital asset pricing model (CAPM); KDi.t denotes the cost
LEMMA ET AL.
of debt of firm i in year t; E is market value of the firm's equity; D is
market value of the firm's debt; and T is the firm's rate of corporate
taxation (Jung et al., 2018; Sharfman & Fernando, 2008).
Unlike prior studies that employ self‐constructed indices (Plumlee
et al., 2015), or dummy variables based on whether or not carbon
information was publicly disclosed (Liao et al., 2015), we use the car-
bon disclosure score that is publicly available on annual CDP reports,
to proxy voluntary carbon disclosure, for two reasons. First, the CDP's
carbon disclosure score is more comprehensive and covers many
dimensions of a firm's activity regarding climate change (Luo, Lan, &
Tang, 2012; Tang & Luo, 2014). Second, CDP has been identified as
a leading source of quality carbon emissions information disclosure
(Griffin, Lont, & Sun, 2017; Rankin, Windsor, & Wahyuni, 2011). The
carbon disclosure variable (DSCRi,t) in our models refers to the carbon
disclosure score of firm i in year t. It measures the quality and compre-
hensiveness of the information provided in a company's response to
CDP's annual climate change survey questionnaire. The score also
serves as a metric of good internal management, an understanding
of climate change issues and company transparency on climate
change; higher values indicate that the firm's carbon‐related strategies
and actions are more transparent and visible than those with lower
values (Tang & Luo, 2014).
Following prior research (Gray, Koh, & Tong, 2009; Jung et al.,
2018), our cost of capital model (Equation 1a) includes firm size (SIZEi,t),
a proxy for collateral and inverse information asymmetry, as a control
variable. Both Jung et al. (2018) and Chen and Gao (2012) submit that
firm's default risk, and hence its cost of capital, increases with leverage
(LEVi,t). Companies with high growth prospects (GRWi,t) tend to have
higher levels of information asymmetry (Lemma, Negash, Mlilo &
Lulseged, 2018; Lemma, 2015; Lemma & Negash, 2011, 2012,
2013), which may increase the risk premium that lenders would
require to provide capital to a firm.
More profitable (PRFT i,t) firms tend to have lower default risk and
benefit from lower cost of capital (Dhaliwal, Gleason, Heitzman, &
Melendrez, 2008; Ge & Kim, 2010; Lopes & Alencar, 2010). Bank-
ruptcy recovery rates tend to be higher in firms with higher holdings
of tangible assets (TANGi,t), reducing a creditor's loss on repayment
and lowering the cost of debt (Bharath, Sunder, & Sunder, 2008; Jung
et al., 2018). The literature suggests that lenders charge risk premia to
those borrowers which exhibit volatile and less predictable earnings
(VLT i,t) increasing their cost of debt (Francis, Khurana, & Pereira,
2005; García‐Teruel, Martínez‐Solano, & Sánchez‐Ballesta, 2014;
Trueman & Titman, 1988). Firms with higher interest coverage
(ICOVi,t) are likely to have greater operating income to cover interest
payments, and hence, may have lower default risk. Due to
intersectoral differences in operational technologies and processes,
firms in carbon‐intensive sectors (INTENSIVEi,t) such as materials,
energy, and utilities face higher degrees of carbon‐risks, and hence,
are likely to incur higher carbon‐related costs and liabilities, compared
with those in less carbon‐intensive sectors (Clarkson et al., 2008; Luo
et al., 2012; Stanny & Ely, 2008).
Prior studies use either absolute or relative GHG emissions mea-
sures to proxy corporate carbon risk exposure (Jung et al., 2018; Salo
& Ast, 2009). Nonetheless, these two proxies are designed to capture
different dimensions of a firm's carbon emissions profile. Although the
5
former is designed to capture a firm's potential carbon liabilities, the
latter is designed to capture corporate carbon risk exposure (Clarkson,
Li, Pinnuck, & Richardson, 2015; Jung et al., 2018; Wang, Li, &
Gao, 2013). In addition, relative GHG emissions measures facilitate
comparisons between companies and reduction potentials become
more transparent (Hoffmann & Busch, 2008). Thus, the corporate car-
bon risk (CRi,t) variable in Equation 2, is based on the GHG emissions
data available on the annual CDP reports and computed as the inverse
of the ratio of Scope 1 GHG emissions to sales revenue.4 Higher
(lower) values of CRi,t suggest poorer (better) carbon efficiency and
higher (lower) corporate carbon risk. We control for leverage (LEVi,t),
as more geared companies would have stricter debt covenants and
creditors would require more information to monitor the behavior of
such firms (Leftwich, Watts, & Zimmerman, 1981). We also control
for firm size (SIZEi,t), as it captures several factors including financial
resources, political costs, and information asymmetry (Lemma et al.,
2018) that motivate carbon disclosure (Shan & Taylor, 2014; Stanny
& Ely, 2008).
There are two contrasting views regarding the association
between firm growth (GRWi,t) and voluntary carbon disclosure. On
the one hand, it is argued that growing firms tend to be more finan-
cially constrained, and hence, may lack the resources needed to volun-
tarily produce and disclose information on their carbon risk (Stanny &
Ely, 2008). On the other hand, it could be argued that growing firms
tend to have higher information asymmetry, which may induce them
into voluntarily disclosing their carbon information to attract potential
investors (Dhaliwal, Li, Tsang, & Yang, 2011; Kim & Shi, 2011; Lemma
& Negash, 2012, 2013). Companies with higher profits (PRFT i,t) may
want to signal that they have high quality earnings and that they could
easily afford the expenditures needed to produce and disclose carbon
information to investors (Stanny & Ely, 2008). Finally, firms operating
in carbon‐intensive sectors (INTENSIVEi,t) are exposed to higher regu-
latory risks, and thus, may have higher incentives to voluntarily engage
in carbon disclosure (Labatt & White, 2007).
We extrapolate the argument in Al‐Tuwaijri et al. (2004) and
control for prior year's disclosure (DSCRi,t−1) as a proxy for an upper
bound for current year's carbon risk (CRi,t), in Equation 3. Al‐Tuwaijri
et al. (2004) contend that investors' expectations of corporate carbon
risk are conditioned on information provided by prior carbon disclo-
sures. A firm may feel that it is necessary or prudent to signal the
possibility of high carbon risk to investors, thereby reducing the pos-
sibility of litigation if firm value fails (Al‐Tuwaijri et al., 2004; Hassan
& Romilly, 2018). We expect a negative association between prior
year's carbon disclosure score (DSCRi,t−1) and the current year's proxy
for carbon risk (CRi,t). We also control for variables that account for
4
The annual CDP reports present three “scopes” of GHG emissions: scopes 1, 2,
and 3. Scope 1 consists of direct emissions that come from sources owned or
controlled by the firm. Scope 2 emissions refer to indirect emissions caused
by the firm's consumption of electricity, heat, cooling, or steam brought into
its reporting boundary. Scope 3 emissions are those that are generated by
employee business travel, suppliers, customers, and contractors. We use scope
1 GHG emissions in our main analysis because they account for most of the
reported GHG emissions and a firm can be held directly accountable for such
emissions (Jung et al., 2018; Matsumura et al., 2014). We consider scope 2
emissions later in our sensitivity analyses.
6 LEMMA
intercompany differences in financial resources, carbon risks, and
management capabilities that help explain intercompany variations
in corporate carbon risk (see Equation 3 above) by incorporating
leverage (LEVi,t), firm size (SIZEi,t), growth prospect (GRWi,t), profitabil-
ity (PRFT i,t), and intensive industry (INTENSIVEi,t), into our models
(Clarkson et al., 2011; de Villiers, Naiker, & van Staden, 2011;
McKendall, Sánchez, & Sicilian, 1999; Walls, Berrone, & Phan, 2012).
Next, we model the attenuating (or accentuating) role of a firm's
carbon risk (CRi,t) on the association between voluntary carbon disclo-
sure (DSCRi,t) and cost of capital (WACCi,t). To this end, we bifurcate
the sample into high and low carbon risk companies by creating a
dummy variable (HCRi,t) that takes a value of 1 if a firm's CRi,t is
greater than the sample median (i.e., low carbon risk subsample) and
0 otherwise (i.e., high carbon risk subsample). Then, we develop an
augmented model of Equation 1 by including the dummy variable
(HCRi,t) and its interaction with the carbon disclosure (DSCRi,t*HCRi,t)
variable. The purpose of the interaction term is to determine whether
a firm's carbon risk attenuates (or accentuates) the association
between voluntary carbon disclosure and a firm's cost of capital. Thus,
the revised system of equation would be the following:
WACCi;t ¼ DSCRi;t þ HCRi;t þ HCRi;t *DSCRi;t þ BETAi;t þ ICOV i;t
þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t þ TANGi;t
þ VLT i;t þ INTENSIVEi;t
DSCRi;t ¼ CRi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t þ INTENSIVEi;t
CRi;t ¼ DSCRi;t−1 þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t
4 | SAM P LE AND R ESULTS
4.1 | Sample and data
Financial and other firm‐level data for this study were from INET BFA
database, whereas data on carbon emissions and disclosure were
hand‐collected from publicly available CDP reports. Because the
annual CDP survey questionnaire covers only the top 100 firms
(JSE100), our initial sample is composed of JSE100 firms for the 6‐year
period 2010 to 2015. We excluded firms with missing carbon disclo-
sure scores. This process resulted in a preliminary sample of 417
firm‐year observations. We further eliminated companies with missing
financial information resulting in a final sample of 98 firm‐year obser-
vations. As this is a relatively small sample, we also examine the data
using nonparametric procedures that are robust to small samples.
4.2 | Preliminary results
Table 1 presents the descriptive statistics and shows that the median
cost of capital for all sample firms is 9.3%. The mean value of 4,185.63
for our corporate carbon risk (CRi,t) indicates that JSE 100 firms,
on average, emit 0.2389t of Scope 1 GHG emissions per ZAR1,000
of sales revenue, which is very high compared with 0.4838t of
A$1,000 for Australian firms (Jung et al., 2018), after taking the
ET AL.
currency exchange rate differences into account.5 The mean carbon
disclosure score of 83.956, compared with an average of 64.16 for
the S&P 500 firms (He et al., 2013), arguably suggests that the JSE
100 firms are more transparent when it comes to carbon disclosure.
Consistent with prior studies that conduct univariate analyses
between high and low carbon risk firms (Jung et al., 2018), we com-
pare differences in the means (and medians) of all variables. Panel A
presents statistics for the sample partitioned into high (128 firm‐year
observations) and low (145 firm‐year observations) carbon risk firms
based on the median value of carbon risk (CRi,t). It indicates that the
median cost of capital of high carbon risk firms (8.8%) is lower, albeit
insignificantly so (p‐value = 0.578), than that of low‐risk firms (9.6%).
Panel A also shows that the median carbon disclosure score (DSCRi,t)
of high carbon risk firms (86) is greater, although insignificantly so
(p value = 0.120), than that of low carbon firms (85). In terms of the
control variables, high carbon risk firms tend to have lower interest
coverage, more tangible assets, lower profitability, higher earnings
volatility, and lower growth compared with low carbon risk firms.
These results are consistent with those reported in Jung et al.,
(2018) for Australia.
Panel B presents statistics for the sample partitioned into high
(128 firm‐year observations) and low (145 firm‐year observations) dis-
closure firms based on the median carbon disclosure score. Consistent
(1b) with our expectations, Table 1 (Panel B) reveals that the median cost
of capital of high carbon disclosure firms (8.2%) is significantly lower
(2) (p value = 0.000), than that of low carbon disclosure firms (10.0%).
Panel B also shows that the level of corporate carbon risk for high dis-
closure firms (130.583) is slightly lower, albeit insignificantly (p
value = 0.704), than that of low disclosure firms (137.493). In terms
(3)
of the control variables, high carbon disclosure firms are likely to have
bigger firm size, more tangible assets, and higher profitability.
Table 2 presents pairwise correlation coefficients (both the para-
metric and nonparametric) for the variables used in our tests. As is
to be expected, there are significant correlations among many of the
variables. Of note, consistent with our expectations and in line with
our observations in the bivariate tests reported in Table 1, Table 2
shows a negative correlation between the cost of (debt, equity, and
overall) capital and a firm's carbon disclosure score.
4.3 | Regression results
Our primary goal is to investigate the interplay among corporate car-
bon risk, carbon disclosure and cost of capital. Table 3 reports the
results based on three‐stage least squares (3SLS) regressions for our
simultaneous equations models. As discussed elsewhere, the results
on the left side of Table 3 pertain to a system of equations which
includes a reduced form of the cost of capital model (that includes only
the carbon disclosure score) and models for carbon disclosure and cor-
porate carbon risk. On the other hand, the results on the right side of
Table 3 pertain to the full model which augments the reduced model
with a new variable, HCRi,t, and an interaction term, HCRi,t * DSCRi,t.
Each model includes all control variables as described in Section 5.
5
ZAR denotes the South African official currency, the rand whereas the A$
denotes the Australian dollar.
LEMMA ET AL. 7

TABLE 1 Summary statistics and results of T‐tests (Wilcoxon‐tests) for mean (and median) comparisons

Panel A: CRi,t (bottom 50% = 0, top 50% = 1) Panel B: DSCRi,t (bottom 50% = 0, top 50% = 1)
Full Sample CRi,t = 0 CRi,t = 1 DSCRi,t = 0 DSCRi,t = 1
t‐stat Wilcoxon t‐stat Wilcoxon
Mean Median Mean Median Mean Median (p‐value) (P‐value) Mean Median Mean Median (p‐value) (P‐value)
LEVi,t 0.538 0.531 0.528 0.502 0.547 0.587 0.475 0.126 0.522 0.525 0.552 0.532 0.268 0.387
SIZEi,t 16.579 16.641 16.525 16.569 16.632 16.935 0.484 0.143 16.530 16.518 16.624 16.758 0.536 0.099
ICOVi,t 16.400 6.221 11.648 5.166 21.654 7.979 0.001 0.009 17.805 6.709 15.187 6.073 0.395 0.245
TANGi,t 0.628 0.655 0.691 0.717 0.565 0.488 0.000 0.000 0.585 0.622 0.667 0.689 0.004 0.004
PRFT i,t 0.129 0.097 0.114 0.091 0.144 0.110 0.027 0.035 0.143 0.108 0.116 0.084 0.046 0.014
VLT i,t 0.530 0.329 0.558 0.382 0.502 0.302 0.374 0.024 0.502 0.325 0.557 0.331 0.380 0.498
GRWi,t 0.075 0.069 0.054 0.059 0.095 0.083 0.049 0.063 0.067 0.068 0.082 0.076 0.493 0.670
BETAi,t 0.547 0.560 0.529 0.502 0.565 0.659 0.654 0.452 0.566 0.596 0.521 0.442 0.615 0.493
DSCRi,t 83.956 85.000 84.657 86.000 83.250 85.000 0.334 0.120 73.805 77.000 92.917 94.000 0.000 0.000
CRi,t 4185.63 131.352 38.293 26.990 8363.5 627.55 0.001 0.000 3982.78 137.943 4364.69 130.583 0.883 0.704
KEi,t 10.2 10.1 10.3 10.2 10.1 10.0 0.723 0.963 10.7 10.4 9.8 9.6 0.010 0.006
KDi,t 9.5 6.1 8.8 6.2 10.3 6.0 0.397 0.625 10.2 6.7 8.9 5.8 0.429 0.024
WACCi,t 9.5 9.3 9.4 8.8 9.5 9.6 0.805 0.578 10.2 10.0 8.8 8.2 0.001 0.000

All continuous variables are winsorized at the 1st and 99th percentiles. LEVi,t is the sum of current liabilities and non‐current liabilities of firm i in year t
scaled by its total assets. SIZEi,t is the natural logarithm of annual sales turnover of firm i in year t. ICOVi,t is earnings before interest and tax of firm i in year
t scaled by its interest expenses. TANGi,t is total fixed assets of firm i in year t scaled by its total assets. PRFT i,t is earnings before interest and taxes of firm i
in year t scaled by its total assets. VLT i,t is a five‐year rolling standard deviation of earnings before interest and taxes of firm i in year t. GRWi,t is the first
difference of the natural logarithm of annual sales turnover of firm i in year t. BETAi,t is the unleveraged beta of firm i in year t, obtained from INET BFA
database. DSCRi,t is carbon disclosure score of firm i in year t, obtained from the publicly available annual CDP reports. CRi,t is the inverse of Scope 1 GHG
emissions of firm i in year t, as reported on the annual CDP reports, scaled by its total annual sales turnover. KEi,t is the cost of equity capital of firm i in year
t estimated using the CAPM and is obtained from INET BFA database. KDi,t is annual interest paid of firm i in year t scaled by its total interesting bearing
debt and is obtained from the INET BFA database. WACCi,t is the weighted average cost of capital of firm i in year t as described in Modigliani and Miller
(1958) and is obtained from the INET BFA database.

TABLE 2 Spearman/Pearson correlation coefficients

LEVi,t SIZEi,t ICOVi,t TANGi,t PRFT i,t VLT i,t GRWi,t BETAi,t DSCRi,t CRi,t KEi,t KDi,t WACCi,t
LEVi,t 1 0.216* −0.235* −0.359* 0.054 −0.239* −0.100 −0.177* −0.013 0.217* −0.114 0.032 −0.224*
SIZEi,t 0.242* 1 0.259* −0.330* 0.212* −0.136* 0.059 0.243* 0.191* 0.202* 0.187* 0.070 0.155*
ICOVi,t −0.324* −0.018 1 −0.285* 0.646* −0.261* 0.023 0.298* 0.092 0.132* 0.069 −0.079 0.125*
TANGi,t −0.075 −0.338* −0.284* 1 −0.085 0.350* −0.005 −0.027 0.090 −0.272* −0.078 −0.035 −0.136*
PRFT i,t −0.107* 0.215* 0.474* −0.226* 1 −0.379* 0.006 0.087 0.005 0.068 −0.131* 0.020 −0.109
VLT i,t −0.176* −0.206* −0.079 0.351* −0.219* 1 0.045 0.116 0.094 −0.063 0.136 * 0.098 0.177*
GRWi,t 0.032 0.011 0.031 −0.010 0.077 0.080 1 0.030 0.050 0.069 0.075 −0.093 0.007
BETAi,t −0.184* 0.223* 0.150* −0.025 0.138* 0.036 −0.075 1 −0.020 0.005 0.344* 0.010 0.353*
DSCRi,t 0.066 0.074 −0.077 0.186* −0.069 0.071 0.010 −0.015 1 −0.016 −0.192* −0.169* −0.232*
CRi,t 0.124* −0.175* −0.080 0.117* −0.062 0.211* 0.054 −0.076 0.017 1 −0.107* 0.010 0.067
KEi,t −0.211* 0.133* 0.051 −0.047 −0.050 0.183* 0.032 0.227* −0.185* −0.089 1 0.100 0.769*
KDi,t −0.032 0.057 −0.041 −0.103* −0.088 0.019 −0.047 0.003 −0.108* −0.053 0.057 1 0.483*
WACCi,t −0.233* 0.181* 0.089 −0.115* −0.031 0.087 −0.065 0.205* −0.223* −0.100 0.702* 0.404* 1

Note. All continuous variables are winsorized at the first and 99th percentiles. The Spearman (Pearson) correlations are above (below) the diagonal. LEVi,t is
the sum of current liabilities and noncurrent liabilities of firm i in year t scaled by its total assets. SIZEi,t is the natural logarithm of annual sales of firm i in
year t. ICOVi,t is earnings before interest and tax of firm i in year t scaled by its interest expenses. TANGi,t is total fixed assets of firm i in year t scaled by its
total assets. PRFT i,t is earnings before interest and taxes of firm i in year t scaled by its total assets. VLT i,t is a five‐year rolling standard deviation of earnings
before interest and taxes of firm i in year t. GRWi,t is the first difference of the natural logarithm of annual sales turnover of firm i in year t. BETAi,t is the
unleveraged beta of firm i in year t, obtained from INET BFA database. DSCRi,t is carbon disclosure score of firm i in year t, obtained from the publicly avail-
able annual CDP reports. CRi,t is the inverse of Scope 1 GHG emissions of firm i in year t, as reported on the annual CDP reports, scaled by total annual sales
turnover. KEi,t is the cost of equity capital of firm i in year t estimated using the CAPM and is obtained from INET BFA database. KDi,t is annual interest paid
of firm i in year t scaled by to total interesting bearing debt and is obtained from the INET BFA database. WACCi,t is the weighted average cost of capital of
firm i in year t as described in Modigliani and Miller (1958) and is obtained from the INET BFA database.
*The estimated coefficient is statistically significant at 10% level;
**The estimated coefficient is statistically significant at 5% level;
***The estimated coefficient is statistically significant at 1% level.
8 LEMMA ET AL.

TABLE 3 Three‐stage least squares regression results of weighted average cost of capital, carbon disclosure score, and carbon risk proxied by
the inverse of Scope 1 greenhouse gas emissions scaled by annual sales turnover

Dependent variables Dependent variables

Independent Var. WACCi,t DSCRi,t CRi,t WACCi,t DSCRi,t CRi,t
DSCRi,t −0.124*** −0.125***
(−3.37) (−2.88)
DSCRi,t−1 −428.491*** −428.426***
(−3.28) (−3.28)
CRi,t −0.001*** −0.001***
(−2.60) (−2.60)
HCRi,t −1.454
(−0.20)
DSCRi,t* HCRi,t 0.013
(0.14)
BETAi,t 0.030 0.050
(0.05) (0.08)
ICOVi,t 0.001 0.001
(0.50) (0.50)
LEVi,t −2.130 10.775* 43530.12*** −2.094 10.775* 43530.52***
(−0.99) (1.81) (4.39) (−0.95) (1.81) (4.39)
SIZEi,t 1.118*** 3.108*** 2633.143 1.114*** 3.108*** 2632.993
(2.72) (3.00) (1.38) (2.71) (3.00) (1.38)
GRWi,t −0.368 −8.777* −6497.537 −0.262 −8.777* −6497.480
(−0.21) (−1.84) (−0.75) (−0.14) (−1.84) (−0.75)
PRFT i,t −7.718** 4.798 −2086.807 −7.706** 4.798 −2086.579
(−2.51) (0.60) (−0.14) (−2.50) (0.60) (−0.14)
TANGi,t −5.002* −5.127*
(−1.75) (−1.76)
VLT i,t 0.111 0.124
(0.16) (0.17)
INTENSIVEi,t 5.498*** 9.058* 12252.01 5.527** 9.058* 12251.08
(2.61) (1.70) (1.25) (2.56) (1.70) (1.25)
CONSTANT 8.481 43.009*** 7342.256 8.881 43.008*** 7339.001
(1.14) (2.81) (0.26) (1.10) (2.81) (0.26)
Industry Indicators Yes Yes Yes Yes Yes Yes
χ2 41.37*** 35.45*** 58.30*** 41.63*** 35.45*** 58.30***

Note. All continuous variables are winsorized at the first and 99th percentiles. WACCi,t is the weighted average cost of capital of firm i in year t as described
in Modigliani and Miller (1958) and is obtained from the INET BFA database. DSCRi,t is a measure of voluntary carbon disclosure of firm i in year t, obtained
from the publicly available annual CDP reports. DSCRi,t − 1 is a one year lagged carbon disclosure score of firm i in year t. CRi,t is the inverse of Scope 1 GHG
emissions of firm i in year t, as reported on the annual CDP reports, scaled by its total annual sales turnover. HCRi,t is a dummy variable that equals 1 if the
firm's CRi,t in year t is higher than the sample median, and 0 otherwise. BETAi,t denotes the unleveraged beta of firm i in year t obtained from the INET BFA
database. ICOVi,t is earnings before interest and tax of firm i in year t scaled by its interest expenses. LEVi,t is the sum of current liabilities and noncurrent
liabilities of firm i in year t scaled by its total assets. SIZEi,t is the natural logarithm of annual sales of firm i in year t. GRWi,t is the first difference of the
natural logarithm of annual sales turnover of firm i in year t. PRFT i,t is earnings before interest and taxes of firm i in year t scaled by its total assets.
TANGi,t is total fixed assets of firm i in year t scaled by its total assets. VLT i,t is a five‐rolling standard deviation of earnings before interest and taxes of firm
i in year t. INTENSIVEi,t is a dummy variable that equals 1 if the firm operates in a carbon‐intensive industry, and 0 otherwise.
*The estimated coefficient is statistically significant at 10% level;
**The estimated coefficient is statistically significant at 15% level;
***The estimated coefficient is statistically significant at 1% level.

Table 3 shows, in both the left (and the right) systems of equations,
the coefficient of DSCRi,t on WACCi,t is −0.124 (and −0.125) is signifi-
cant at 1% level (Z = −3.37 and −2.88, respectively), suggesting a nega-
tive relationship between carbon disclosure (DSCRi,t) and the overall
cost of capital (WACCi,t), which supports the hypothesis (H1) that
carbon disclosure reduces the firm's cost of capital, through its effect
on investor preferences, information asymmetry, and estimation of
information risk (Richardson et al., 1999). In addition, it is also in sync
with the argument that carbon disclosure may be seen as a firm's cred-
ible commitment to environmental issues in its long‐term strategic and
production systems (Plumlee et al., 2015). This finding is similar with
those reported in Clarkson et al. (2013), Dhaliwal et al. (2011), and He
et al. (2013). In terms of economic significance, the coefficient estimate
of −0.125 implies that a one standard deviation in carbon disclosure
score (DSCRi,t) leads to a decrease in the firm's overall cost of capital
by 1.5% (i.e., −0.125 * 12.156).6 As expected, although larger compa-
nies (p value = 0.006) and companies operating in carbon‐intensive
sectors (p value = 0.009) tend to incur higher overall cost of capital,
firms with higher profitability (p value = 0.012) and those with more
tangible assets (p value = 0.081) tend to incur lower overall cost of capital.
6
12.156 refers to the standard deviation of carbon disclosure score for our sample.
LEMMA ET AL. 9

TABLE 4 3SLS regression results of weighted average cost of capital, carbon disclosure score, and carbon risk proxied by the inverse of Scope 1
& Scope 2 GHG emissions scaled by sales turnover

Dependent Variables Dependent Variables

Independent Var. WACCi,t DSCRi,t CRi,t WACCi,t DSCRi,t CRi,t
DSCRi,t −0.122*** −0.155***
(−3.320) (−3.570)
DSCRi,t−1 −13.072 −13.016
(−3.520)*** (−3.510)***
CRi,t −0.005 −0.005
(−2.450)** (−2.450)**
HCRi,t −9.940
(−1.530)
DSCRi,t* HCRi,t 0.116
(1.470)
BETAi,t −0.030 −0.091
(−0.050) (−0.150)
ICOVi,t 0.007 0.009
(0.310) (0.430)
LEVi,t −2.025 10.844 1337.300 −2.292 10.842 1337.637
(−0.850) (1.790)* (4.740)*** (−0.910) (1.790)* (4.740)***
SIZEi,t 1.110*** 3.115 81.695 1.132*** 3.115*** 81.566
(2.720) (2.990)*** (1.510) (2.700) (2.990) (1.510)
GRWi,t −0.326 −8.465* −128.419 −0.504 −8.464* −128.371
(−0.180) (−1.770) (−0.520) (−0.290) (−1.770) (−0.520)
PRFT i,t −8.015** 4.974 −24.758 −8.724** 4.974 −24.563
(−2.080) (0.620) (−0.060) (−2.260) (0.620) (−0.060)
TANGi,t −4.404 −5.326*
(−1.410) (−1.660)
VLT i,t 0.161 −0.041
(0.230) (−0.060)
INTENSIVEi,t 5.357** 8.987* 357.510 6.003*** 8.987* 356.719
(2.530) (1.690) (1.280) (2.810) (1.690) (1.280)
CONSTANT 7.758 42.394*** 90.268 11.489 42.395*** 87.480
(1.010) (2.760) (0.110) (1.400) (2.760) (0.110)
Industry Indicators Yes Yes Yes Yes Yes Yes
X2 40.870*** 34.510*** 58.310*** 43.970*** 34.510*** 58.230***

Note. All continuous variables are winsorized at the first and 99th percentiles. WACCi,t is the weighted average cost of capital of firm i in year t as described
in Modigliani and Miller (1958) and is obtained from the INET BFA database. DSCRi,t is a measure of voluntary carbon disclosure of firm i in year t, obtained
from the publicly available annual CDP reports. DSCRi,t−1 is a one year lagged carbon disclosure score of firm i in year t. CRi,t is the inverse of Scope 1 plus
Scope 2 GHG emissions of firm i in year t, as reported on the annual CDP reports, scaled by its total annual sales turnover. HCRi,t is a dummy variable that
equals 1 if the firm's CRi,t in year t is higher than the sample median, and 0 otherwise. BETAi,t denotes the unleveraged beta of firm i in year t obtained from
the INET BFA database. ICOVi,t is earnings before interest and tax of firm i in year t scaled by its interest expenses. LEVi,t is the sum of current liabilities and
noncurrent liabilities of firm i in year t scaled by its total assets. SIZEi,t is the natural logarithm of annual sales of firm i in year t. GRWi,t is the first difference
of the natural logarithm of annual sales turnover of firm i in year t. PRFT i,t is earnings before interest and taxes of firm i in year t scaled by its total assets.
TANGi,t is total fixed assets of firm i in year t scaled by its total assets. VLT i,t is a five‐rolling standard deviation of earnings before interest and taxes of firm i
in year t. INTENSIVEi,t is a dummy variable that equals 1 if the firm operates in a carbon‐intensive industry, and 0 otherwise.
*The estimated coefficient is statistically significant at 10% level;
**The estimated coefficient is statistically significant at 5% level;
***The estimated coefficient is statistically significant at 1% level.

Furthermore, Table 3 shows that the coefficient of CRi,t on DSCRi,t
is −0.001 at 1% level of significance (Z = −2.60), suggesting a positive
relationship between the corporate carbon risk (CRi,t) and voluntary
carbon disclosure (DSCRi,t), which supports the conjecture based on
sociopolitical theories (H2). That is, it corroborates the hypothesis that
firms with high carbon risk with threatened legitimacy would voluntar-
ily engage in disclosure of carbon‐related information to deflect or
nullify suspicion or doubt with regard to their environmental activities
(Adams, 2004; Gray et al., 1995; Hughes et al., 2001). Similar results
were reported in Hassan and Romilly (2018) and He et al. (2013). This
association is economically meaningful too. The coefficient estimate
−0.001 implies that a one standard deviation increase in the measure
of corporate carbon risk (CRi,t) would map into a 21.37 (i.e.,
−0.001 * 21,365.01) increase in the carbon disclosure score (DSCRi,t).7
Also, the results indicate that more leveraged (p value = 0.071), larger
firms (p value = 0.003) and firms operating in carbon‐intensive sectors
(p value = 0.088) tend to voluntarily provide more carbon information.
Contrarily, the extent of voluntary carbon disclosure decreases in firm
level growth opportunities (p value = 0.065).
7
21,365.01 refers to the standard deviation of the corporate carbon risk
variable.
10 LEMMA ET AL.

The results in Table 3 also indicate a negative regression
coefficient (−428.426) between CRi,t and one‐year‐lagged carbon
disclosure score of a firm (DSCRi,t−1), significant at the 1% level
(Z = −3.28), suggesting a positive association between previous year's
carbon disclosure score and the current years corporate carbon risk.
This finding is consistent with the argument that firms with high car-
bon risk may find it necessary or prudent to provide signals regarding
the possibility of poor carbon performance to avoid negative sur-
prises and future market punishments caused by withholding carbon
information (Al‐Tuwaijri et al., 2004). He et al. (2013) reports similar
results.
Nonetheless, we do not find support for the hypothesis that firms
with high carbon risk would incur higher cost of capital (H3) nor for
the argument that corporate carbon risk would affect the relationship
between voluntary carbon disclosure and a firm's cost of capital (H4).
This finding is contrary to the findings documented in Jung et al.
(2018) and He et al. (2013). However, it is consistent with a number
of other studies that found no association between environmental
and economic performance of firms (e.g., Freedman & Jaggi, 1992;
Rockness et al., 1986). Finally, the positive coefficient between LEVi,t
and CRi,t suggests that companies with higher gearing tend to be com-
panies with a lower carbon risk exposure.

TABLE 5 Three‐stage least squares regression results of weighted average cost of capital, carbon disclosure score, and carbon risk proxied by
the inverse of Scope 1 GHG emissions scaled by total fixed assets
Dependent Variables Dependent Variables
Independent Var. WACC DSCR CR WACC DSCR CR

DSCRi,t ‐0.123*** ‐0.135***

(‐3.330) (‐2.980)
DSCRi,t−1 ‐4323.111*** ‐4317.193***
(‐3.080) (‐3.070)
CRi,t 0.000** 0.000**
(‐2.540) (‐2.540)
HCRi,t ‐2.724
(‐0.450)
DSCRi,t* HCRi,t 0.033
(0.460)
BETAi,t ‐0.039 ‐0.085
(‐0.060) (‐0.140)
ICOVi,t 0.010 0.009
(0.440) (0.390)
LEVi,t ‐1.911 10.350* 444761.700*** ‐2.010 10.351* 444797.400***
(‐0.810) (1.750) (4.180) (‐0.840) (1.750) (4.180)
SIZEi,t 1.110 3.116*** 28617.230 1.099*** 3.116*** 28603.560
(2.720) (3.000) (1.400) (2.680) (3.000) (1.400)
GRWi,t ‐0.346 ‐8.797* ‐72355.880 ‐0.503 ‐8.797* ‐72350.680
(‐0.190) (‐1.850) (‐0.780) (‐0.270) (‐1.850) (‐0.780)
PRFT i,t ‐8.321** 4.734 ‐26606.390 ‐8.254** 4.734 ‐26585.630
(‐2.150) (0.590) (‐0.170) (‐2.130) (0.590) (‐0.170)
TANGi,t ‐4.415 ‐4.375
(‐1.410) (‐1.370)
VLT i,t 0.205 0.165
(0.290) (0.230)
INTENSIVEi,t 5.378** 8.981* 122760.500 5.557** 8.981* 122676.400
(2.540) (1.690) (1.170) (2.550) (1.690) (1.160)
CONSTANT 7.709 43.012*** 62325.940 8.797 43.012*** 62029.380
(1.000) (2.810) (0.200) (1.090) (2.810) (0.200)
Industry Indicators Yes Yes Yes Yes Yes Yes
2
x 41.090*** 35.120*** 56.240*** 41.350** 35.120*** 56.220***

Note. All continuous variables are winsorized at the first and 99th percentiles. WACCi,t is the weighted average cost of capital of firm i in year t as described
in Modigliani and Miller (1958) and is obtained from the INET BFA database. DSCRi,t is a measure of voluntary carbon disclosure of firm i in year t, obtained
from the publicly available annual CDP reports. DSCRi,t−1 is a one year lagged carbon disclosure score of firm i in year t. CRi,t is the inverse of Scope 1 GHG
emissions of firm i in year t, as reported on the annual CDP reports, scaled by total fixed assets. HCRi,t is a dummy variable that equals 1 if the firm's CRi,t in
year t is higher than the sample median, and 0 otherwise. BETAi,t denotes the unleveraged beta of firm i in year t obtained from the INET BFA database.
ICOVi,t is earnings before interest and tax of firm i in year t scaled by its interest expenses. LEVi,t is the sum of current liabilities and noncurrent liabilities of
firm i in year t scaled by its total assets. SIZEi,t is the natural logarithm of annual sales of firm i in year t. GRWi,t is the first difference of the natural logarithm
of annual sales turnover of firm i in year t. PRFT i,t is earnings before interest and taxes of firm i in year t scaled by its total assets. TANGi,t is total fixed assets
of firm i in year t scaled by its total assets. VLT i,t is a five‐rolling standard deviation of earnings before interest and taxes of firm i in year t. INTENSIVEi,t is a
dummy variable that equals 1 if the firm operates in a carbon‐intensive industry, and 0 otherwise.
*The estimated coefficient is statistically significant at 10% level;
**The estimated coefficient is statistically significant at 5% level;
***The estimated coefficient is statistically significant at 1% level.
LEMMA ET AL.
4.4 | Sensitivity analyses
In our main analyses, we used only Scope 1 GHG emissions in the
computation of the corporate carbon risk variable. However, such a
proxy may fail to adequately measure the extent of carbon risk to
which a firm is exposed. To examine the sensitivity of our results to
the choice of GHG emissions' categories in the measurement of cor-
porate carbon risk, we modify our proxy to include both Scope 1
and Scope 2 GHG emissions (Chapple et al., 2013; Jung et al., 2018;
Wang et al., 2013). As reported in Table 4, our results are robust to
the choice of GHG emissions' categories included the computation
of the corporate carbon risk variable.
Again, in our main analyses, we used the annual sales turnover as a
scalar in measuring the corporate carbon risk variable. However, both
Jung et al. (2018) and Clarkson et al. (2011) express concern that the
annual sales turnover of a firm is, in fact, affected by the country's
macroeconomic performance, and thus, our corporate carbon risk
proxy might be impacted by macroeconomic performance of the
country through the scalar rather than corporate carbon risk itself.
Thus, we alternatively use total fixed assets as the scalar, following prior
studies (Clarkson et al., 2011; Jung et al., 2018) and repeat the analyses.
Once again, our results remain broadly the same (see Table 5).
4.5 | Additional analyses
To examine which of the component costs of capital is driving the
observed interrelations among corporate carbon risk, voluntary disclo-
sure, and the overall cost of capital, we carry out additional analysis
using the component costs of capital as dependent variables. First,
we use the cost of equity capital (KEi,t), estimated using the CAPM
described in Sharpe (1964) and Lintner (1956) and based on estimates
from INET BFA database, as our dependent variable. We replace
Equation 1a with Equation 1c, and thus, the revised system of equa-
tions would be as follows:
KEi;t ¼ DSCRi;t þ BETAi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ TANGi;t þ VLT i;t þ INTENSIVEi;t (1c)
DSCRi;t ¼ CRi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (2)
CRi;t ¼ DSCRi;t−1 þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (3)
where KEi,t is the cost of equity capital of firm i in year t estimated
using the CAPM model, KE = r f + BETAi,t(Rm − r f ), as in Sharfman
and Fernando (2008). Pursuant to convention, we used the 10‐year
South African Treasury Bond as a proxy for the risk‐free rate (r f ).
BETAi,t is the covariance of the market's return with the individual
company's common stock return divided by the market's variance,
which measures a market's systemic risk (Botosan, 1997; Dhaliwal
et al., 2011; Sharfman & Fernando, 2008), and is based on estimates
from INET BFA database. We set the default risk premium (Rp = Rm − r f )
at 6.0% following common practice in South Africa (Fernandez,
Aguirreamalloa, & Avendaño, 2011; Hassan & Van Biljon, 2010). All
the remaining variables are as defined in the earlier models.
11
To model the attenuating (or accentuating) role of a firm's carbon
risk (CRi,t) on the association between voluntary carbon disclosure
(DSCRi,t) and equity cost of capital (KEi,t), we replace Equation 1b
with the Equation 1d and the revised system of equations is as
follows:
KEi;t ¼ DSCRi;t þ HCRi;t þ HCRi;t * DSCRi;t þ BETAi;t þ LEV i;t þ SIZEi;t þ
;
GRW i;t þ PRFT i;t þ TANGi;t þ VLT i;t þ INTENSIVEi;t
(1d)
DSCRi;t ¼ CRi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (2)
CRi;t ¼ DSCRi;t−1 þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (3)
Table 1 shows that the median cost of equity for all firms in our
sample is 10.1%. It also shows that top 50% of firms (in terms of dis-
closure score) incur lower cost of equity capital (9.6%) compared with
the bottom 50% of firms (10.4%), significant at 1% level (p
value = 0.006). On the other hand, there are no statistically significant
differences in the cost of equity capital between high carbon risk and
low carbon risk firms. In terms of correlations, Table 2 shows the cost
of equity capital is negatively (not) correlated with disclosure score
(corporate carbon risk). These observations are identical with the ones
reported in the main analysis.
Table 6 shows results in which the cost of equity capital (KEi,t ) is
the dependent variable in Equations 1c and 1d. The results based on
the revised systems of equations were generally consistent with those
presented in the main analysis, except that the coefficient of DSCRi,t is
statistically significant (Z = −2.09, p value = 0.036) only in the system
of equations with HCRi,t and HCRi,t * DSCRi,t, suggesting that cost of
equity capital (KEi,t) is not as sensitive to voluntary carbon disclosure
(DSCRi,t) as the overall cost of capital. Also, although the leverage
(LEVi,t) and volatility (VLT i,t) variables loaded statistically significantly
(with p values of 0.004 and 0.081, respectively), the asset tangibility
(TANGi,t) variable became statistically insignificant (p value = 0.730).
The results of Equation 2 are also broadly consistent with our main
analysis, except that the marginally significant loading that the lever-
age variable (LEVi,t) had on the overall cost of capital disappeared
when cost of equity capital is used as the dependent variable. The
results for Equation 3 were identical.
Next, we use cost of debt (KDi,t) as the dependent variable. Thus,
we replace Equation 1a with Equation 1e in the system of equations:
KDi;t ¼ DSCRi;t þ ICOV i;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ TANGi;t þ VLT i;t þ INTENSIVEi;t (1e)
DSCRi;t ¼ CRi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (2)
CRi;t ¼ DSCRi;t−1 þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t (3)
where KDi,t denotes the cost of debt of firm i in year t computed by
the ratio of interest expenses to total interest‐bearing debt, as in Jung
et al. (2018).
To examine the influence of carbon risk (CRi,t) on cost of debt
(KDi,t) and its relationship with carbon disclosure (DSCRi,t), we intro-
duce HCRi,t and the interaction term (HCRi,t * DSCRi,t). Thus, we replace
12 LEMMA ET AL.

TABLE 6 Three‐stage least squares regression results of cost of equity capital, carbon disclosure score, and corporate carbon risk proxied by the
inverse of scope 1 greenhouse gas emissions scaled by sales turnover

Dependent variables Dependent variables

Independent var. KEi,t DSCRi,t CRi,t KEi,t DSCRi,t CRi,t
DSCRi,t −0.047 −0.079**
(−1.45) (−2.09)
DSCRi,t−1 −455.851*** −456.662***
(−3.45) (−3.45)
CRi,t −0.001** −0.001**
(−2.50) (−2.50)
HCRi,t −7.795
(−1.21)
DSCRi,t* HCRi,t 0.104
(1.35)
BETAi,t −0.108 −0.278
(−0.21) (−0.54)
LEVi,t −4.587*** 9.281 39 065.670*** −5.060*** 9.281 39 059.950***
(−2.59) (1.64) (4.06) (−2.85) (1.64) (4.06)
SIZEi,t 1.140*** 2.975*** 2240.211 1.155*** 2.975*** 2241.997
(3.25) (2.93) (1.19) (3.33) (2.93) (1.19)
GRWi,t 2.640* −8.864* −6876.068 1.856 −8.864* −6876.864
(1.70) (−1.88) (−0.79) (1.17) (−1.88) (−0.79)
PRFT i,t −7.565*** 3.948 −5453.851 −7.811*** 3.948 −5457.311
(−3.00) (0.50) (−0.38) (−3.13) (0.50) (−0.38)
TANGi,t −0.391 −0.877
(−0.15) (−0.35)
VLT i,t 1.425** 1.114*
(2.30) (1.75)
INTENSIVE 3.135* 9.053* 12 806.910 3.754** 9.053* 12818.470
(1.70) (1.72) (1.30) (2.02) (1.72) (1.30)
CONSTANT −3.525 45.352*** 17 173.430 −0.295 45.352*** 17215.660
(−0.55) (3.04) (0.61) (−0.04) (3.04) (0.61)
Industry Indicators Yes Yes Yes Yes Yes Yes
χ2 58.45*** 35.26*** 57.02*** 63.36*** 35.25*** 57.07***

Note. All continuous variables are winsorized at the first and 99th percentiles. KEi,t is the cost of equity capital of firm i in year t estimated using the CAPM
as described in Sharfman and Fernando (2008) and is obtained from the INET BFA database. DSCRi,t is a measure of voluntary carbon disclosure of firm i in
year t, obtained from the publicly available annual CDP reports. DSCRi,t−1 is a one year lagged carbon disclosure score of firm i in year t. CRi,t is the inverse of
Scope 1 GHG emissions of firm i in year t, as reported on the annual CDP reports, scaled by its total annual sales turnover. HCRi,t is a dummy variable that
equals 1 if the firm's CRi,t in year t is higher than the sample median, and 0 otherwise. BETAi,t denotes the unleveraged beta of firm i in year t obtained from
the INET BFA database. LEVi,t is the sum of current liabilities and noncurrent liabilities of firm i in year t scaled by its total assets. SIZEi,t is the natural log-
arithm of annual sales of firm i in year t. GRWi,t is the first difference of the natural logarithm of annual sales turnover of firm i in year t. PRFT i,t is earnings
before interest and taxes of firm i in year t scaled by its total assets. TANGi,t is total fixed assets of firm i in year t scaled by its total assets. VLT i,t is a five‐
rolling standard deviation of earnings before interest and taxes of firm i in year t. INTENSIVEi,t is a dummy variable that equals 1 if the firm operates in a
carbon‐intensive industry, and 0 otherwise.
*The estimated coefficient is statistically significant at 10% level;
**The estimated coefficient is statistically significant at 5% level;
***The estimated coefficient is statistically significant at 1% level.

Equation 1d with Equation 1f, and thus, the revised system of equa-
tions is as follows:
*
KDi;t ¼ DSCRi;t þ HCRi;t þ HCRi;t DSCRi;t þ ICOV i;t þ LEV i;t
þ SIZEi;t þ GRW i;t þ PRFT i;t þ TANGi;t þ VLT i;t
þ INTENSIVEi;t
DSCRi;t ¼ CRi;t þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t
CRi;t ¼ DSCRi;t−1 þ LEV i;t þ SIZEi;t þ GRW i;t þ PRFT i;t
þ INTENSIVEi;t
Table 1 shows that the median cost of debt for all firms in our sam-
ple is 6.1%. It also shows that top 50% of firms (in terms of
disclosure score) incur lower cost of debt (5.8%) compared with the
bottom 50% of firms (6.7%), significant at 5% level (p value = 0.024).
On the other hand, there are no statistically significant differences in
the cost of debt between high carbon risk and low carbon risk firms.
(1f) In terms of correlations, Table 2 shows the cost of debt is negatively
(not) correlated with carbon disclosure score (corporate carbon risk).
These observations are identical to those observed in our main analysis.
(2)
Table 7 presents results where the cost of debt (KDi,t ) is the
dependent variable in Equations 1e and 1f. The results based on the
revised system of equations were generally consistent with those pre-
(3)
sented in our main analysis, except that the coefficient of DSCRi,t was
statistically insignificant (Z = 0.63, p value = 0.526) suggesting that vol-
untary carbon disclosure (DSCRi,t) is not associated with cost of debt
LEMMA ET AL. 13

TABLE 7 Three‐stage least squares regression results of cost of debt, carbon disclosure score, and carbon risk proxied by the inverse of scope 1
greenhouse gas emissions scaled by sales turnover
Dependent variables Dependent variables
Independent var. KDi,t DSCRi,t CRi,t KDi,t DSCRi,t CRi,t

DSCRi,t 0.002 0.003

(0.36) (0.63)
DSCRi,t−1 −493.988*** −493.320***
(−3.76) (−3.75)
CRi,t −0.001*** −0.001***
(−3.12) (−3.12)
HCRi,t 0.973
(1.28)
DSCRi,t* HCRi,t −0.009
(−0.98)
ICOVi,t 0.000 −0.001
(−0.14) (−0.38)
LEVi,t −0.415 12.525** 38547.050*** −0.435* 12.526** 38549.850***
(−1.54) (2.19) (4.05) (−1.65) (2.19) (4.05)
SIZEi,t −0.062 3.332*** 4731.117*** −0.069 3.332*** 4729.653***
(−1.35) (3.48) (2.80) (−1.51) (3.48) (2.80)
GRWi,t 0.291 −8.116** −8133.450 0.255 −8.116* −8130.332
(1.36) (−1.79) (−1.01) (1.19) (−1.79) (−1.01)
PRFT i,t −0.665 −5.319 −6091.924 −0.595 −5.319 −6089.303
(−1.32) (−0.64) (−0.42) (−1.20) (−0.64) (−0.42)
TANGi,t −0.003 0.103
(−0.01) (0.30)
VLT i,t 0.208*** 0.205***
(2.57) (2.57)
INTENSIVE 0.045 10.376** 9750.519 0.007 10.376* 9740.295
(0.17) (1.92) (1.00) (0.02) (1.92) (1.00)
CONSTANT 0.728 43.100*** −14731.230 0.478 43.100*** −14767.660
(3.12) (−0.58) (0.53) (3.12) (−0.58)
Industry Indicators Yes Yes Yes Yes Yes Yes
χ2 26.35** 40.83*** 69.17*** 33.82** 40.83*** 69.12**

Note. All continuous variables are winsorized at the first and 99th percentiles. KDi,t is interest expense of firm i in year t scaled by total interest bearing debt
and is obtained from the INET BFA database. DSCRi,t is a measure of voluntary carbon disclosure of firm i in year t, obtained from the publicly available
annual CDP reports. DSCRi,t−1 is a one year lagged carbon disclosure score of firm i in year t. CRi,t is the inverse of Scope 1 GHG emissions of firm i in year
t, as reported on the annual CDP reports, scaled by its annual total sales turnover. HCRi,t is a dummy variable that equals 1 if the firm's CRi,t in year t is
higher than the sample median, and 0 otherwise. ICOVi,t is earnings before interest and tax of firm i in year t scaled by its interest expenses. LEVi,t is the
sum of current liabilities and noncurrent liabilities of firm i in year t scaled by its total assets. SIZEi,t is the natural logarithm of annual sales of firm i in year
t. GRWi,t is the first difference of the natural logarithm of annual sales turnover of firm i in year t. PRFT i,t is earnings before interest and taxes of firm i in year
t scaled by its total assets. TANGi,t is total fixed assets of firm i in year t scaled by its total assets. VLT i,t is a five‐rolling standard deviation of earnings before
interest and taxes of firm i in year t. INTENSIVEi,t is a dummy variable that equals 1 if the firm operates in a carbon‐intensive industry, and 0 otherwise.
*The estimated coefficient is statistically significant at 10% level;
**The estimated coefficient is statistically significant at 5% level;
***The estimated coefficient is statistically significant at 1% level.

(KDi,t). This is inconsistent with the results we found for the overall
(and equity) cost of capital. As in the cost of equity (KEi,t) model,
although the leverage (LEVi,t) and volatility (VLT i,t) variables loaded
statistically significantly (with p values of 0.100 and 0.010, respec-
tively), the tangibility (TANGi,t) and GHG‐intensive sector
(INTENSIVEi,t) variables became statistically insignificant (with p value
of 0.767 and 0.981, respectively). The results for Equations 2 and 3
were identical across the system of equations.
5 | C O N CL U S I O N S
This study was set out to investigate the interplay among corporate car-
bon risk, voluntary disclosure, and a firm's cost of capital in a unique setting
of South Africa, one of the “rising powers” in the climate policy debate. We
analyzed financial and carbon‐related information pertaining to JSE com-
panies for the period 2010 to 2015. Consistent with our expectation, we
find the voluntary carbon disclosure is negatively associated with a firm's
overall (and equity) cost of capital. The results suggest that JSE companies
utilize voluntary carbon disclosures to manipulate the markets, especially
the stock market, to reduce their overall (and equity) cost of capital.
Like both Jung et al. (2018) and Dhaliwal et al. (2011), we docu-
ment a positive association between past carbon disclosures and cor-
porate carbon risk. This association is consistent with the argument
that a firm may have the incentive to signal the possibility of higher
carbon risk in advance to reduce the possibility of shareholder litiga-
tion that might be triggered by withholding carbon information (Al‐
Tuwaijri et al., 2004; Hassan & Romilly, 2018). The positive association
that we observe between voluntary carbon disclosure and corporate
14
carbon risk is consistent with legitimacy theory. It corroborates the
argument that firms with high corporate carbon risk would be willing
to increase disclosure to obtain legitimacy for their activities and earn
other rewards such as lower cost of capital, which ultimately help
assure their continued existence (He et al., 2013).
In sum, firms making better quality carbon disclosures appear to be
rewarded with a lower cost of capital; more transparency with respect
to carbon‐related information maps into a better outcome for the firm.
Therefore, it encourages firms to be more transparent in providing
information about climate risk. However, from societal and planetary
perspectives, this outcome is only positive if voluntary carbon disclo-
sure mirrors carbon performance. That is, firms that have the best qual-
ity carbon disclosures are also those that have the lowest carbon risk.
Unfortunately, that does not appear to be the case. The findings show
that corporate carbon risk and voluntary carbon disclosure are related
so that those with the highest carbon risk tend to be better disclosers.
If voluntary carbon disclosures can be utilized in a way that has neg-
ative social consequences, regulators mandating these disclosures need
to be cognizant of this in designing their regulations. Mandated stan-
dards need to reflect corporate carbon risk or be structured so that a user
has a clear means to assess that risk. Good quality carbon disclosures
that appropriately reflect corporate carbon risk and result in a lower cost
of capital for the firm would be a win–win for both companies as well as
the society at large. Because our study considered only JSE companies,
the results are obviously skewed towards bigger firms; thus, the findings
should be read with some degree of circumspection. Future research
endeavors could focus on the impact of the recently enacted mandatory
reporting regime. Because our findings imply value relevance of volun-
tary carbon disclosure, future research endeavors might consider the
relation between carbon‐related information and the value of the firm.
ORCID
Tesfaye T. Lemma http://orcid.org/0000-0001-9806-3170
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How to cite this article: Lemma TT, Feedman M, Mlilo M,
Park JD. Corporate carbon risk, voluntary disclosure, and cost
of capital: South African evidence. Bus Strat Env. 2018;1–16.
https://doi.org/10.1002/bse.2242