Externality-Contingent Cost of Capital Theory

How can we integrate existential externalities into financial decision-making, so that the cost of capital for firms and projects reflects their true impact on long-term societal, ecological survival and well-being? This paper extends financial economics by developing an Externality-Contingent Cost of Capital Theory, aiming to internalize existential externalities—severe external effects threatening economic and ecological sustainability. To achieve this, we propose new financial instruments, Carbon Contingent Common Stocks (CCCS) and Carbon Contingent Sustainability Bonds (CCSB), explicitly linking a firm’s cost of capital to its sustainability outcomes. We explore theoretical implications for classical finance principles and argue that integrating existential externalities into financial decisions is both practical and essential, aligning financial incentives with societal and ecological welfare. We conclude with policy recommendations and outline directions for future empirical validation.