Unlocking Green Leverage: Determinants and Constraints in Sustainable Capital Structure Decisions

Abstract

This study investigates the determinants and constraints of green leverage—the use of debt to finance environmentally sustainable projects—within AIM-listed firms from 2005 to 2020. Utilizing a unique green index, the research applies Ordinary Least Squares (OLS) with robust standard errors to explore how factors such as cash flow, dividend policy, credit rating, and profit growth influence firms' capital structure decisions. Grounded in Trade-Off and Pecking Order theories, the study extends these frameworks to green finance. The findings suggest that traditional financial determinants such as cash flow and firm size maintain a significant influence on leverage decisions. The results for green variables, such as carbon tax, underscore the growing impact of environmental factors on capital structure choices. while credit rating positively influences debt financing. Dividend pay-out exhibits a negative correlation with green leverage, indicating that firms prioritizing shareholder returns tend to avoid debt for green projects. Interestingly, macroeconomic variables such as carbon tax and financial sector growth play an enabling role, driving firms towards greater leverage in green financing.

This study contributes to the literature by identifying the enablers and barriers to green financial leverage, providing insights for policymakers and financial institutions to promote sustainable financing practices. The findings suggest that while traditional financial determinants remain crucial, emerging environmental factors are shaping capital structure decisions in an increasingly green-conscious market.