A new look at the finance–environment nexus: How yield spread affects environmental quality in the United States

Abstract Enhancing environmental quality is currently a key focus for policymakers. Furthermore, researchers are also prioritizing the investigation of novel variables that can influence environmental quality. The yield spread is commonly used as a leading indicator for business cycles in the macro‐finance literature, providing information about future expectations regarding business cycles. The yield spread also presents information about the borrowing costs of firms. None of the existing studies in the environmental economics literature has tested the impact of the yield spread on environmental quality, implying the level of the yield spread has not been considered a variable that can influence environmental quality. This study aims to fill this gap by providing evidence on the effect of yield spread (between 2‐ and 10‐year government bonds) on environmental quality in the United States from June 1976 to September 2023. The results indicate that an increase in the yield spread leads to a rise in environmental destruction. These results suggest two considerable consequences. First, optimistic expectations today lead to the overuse of resources and environmental destruction. Second, firms' higher borrowing costs may be forcing them to use less environmentally friendly production methods to offset more expensive financing costs and increase their profits. This study asserts that companies should enhance their environmental sensitivity, and policymakers should adopt a more proactive stance, based on the results of this study and other research that demonstrates the detrimental impacts of environmental regulation violations and poor environmental performances on companies' stock prices and financial performances.