Pollution premium in the cost of capital of energy companies: implications for capital budgeting decisions

Purpose The purpose of this study is to quantify the difference in the cost of equity between conventional and renewable energy companies in the EU to propose a way to incorporate the observed divergence into capital budgeting processes of vertically integrated energy companies. Design/methodology/approach The authors compiled data on the cost of equity of sampled listed energy companies from across the EU in 2015–2023. The authors subsequently used student t-test and multivariate static panel regression models to estimate the magnitude of the observed differences between the subsamples of conventional and renewable energy companies. Findings The authors document a statistically significant difference in the cost of equity of conventional and renewable energy companies with an average of 1.9–2.7 percentage points over the studied observation span. The divergence seems to accentuate with time. The observed difference should be incorporated into the capital budgeting policies of vertically integrated energy companies by reducing the cost of capital used to evaluate investment projects in the domain of renewable and conventional energy. The change of approach would improve the allocation of financial resources and increase the flow of capital to the higher-growth renewable energy segments. Originality/value This paper proposes a way to differentiate the cost of capital for renewable and conventional energy projects. The approach represents a deviation from the existing methodological frameworks used by the largest multinational energy companies, which prioritizes nondiscrimination of investment projects in terms of access to financing regardless of business segment.