Do Environmental Externalities Influence a Firm’s Zero Leverage Propensity?

The persistent presence of zero-leverage firms remains a notable puzzle in corporate finance. Conventional explanations typically emphasize firm-level demand factors, such as financial flexibility, or focus on credit supply constraints; however, empirical investigations often conflate these two elements. This research introduces an innovative supply-side mechanism that links a firm’s environmental externalities to its access to debt capital. Based on the well-documented "brown premium” observed in equity markets, we contend that creditors with short-term horizons tend to favor firms with high negative externalities because of their robust current cash flows, whereas they discount sustainable firms that incur substantial initial costs. This dynamic establishes a supply-side constraint that fosters zero leverage among environmentally friendly firms. To distinguish between demand and supply effects, we employ a bivariate probit model with partial observability, applied to a comprehensive sample of 1,022 firms across 54 countries from 2011 to 2022. Our findings indicate that environmental impact notably reduces the likelihood of debt availability—an outcome that conventional univariate models fail to detect. In particular, firms with lower environmental externalities are more likely to be credit-constrained, resulting in zero leverage. Additionally, we observe that this effect is moderated by the firm’s stage of development and that firm value exerts asymmetric effects: it negatively affects demand while positively affecting supply. Methodologically, we demonstrate that the joint estimation of debt demand and supply is essential to prevent biased conclusions. These results contribute to the theoretical understanding of the zero-leverage phenomenon, identify a critical friction in sustainable strategies, and suggest that capital markets may unintentionally penalize green pioneers through debt rationing.