Integrating Carbon Externalities into Corporate Finance: A Theory of Carbon-Contingent Cost of Capital

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? Traditional market mechanisms like carbon taxes, emission quotas, and voluntary carbon pricing remain insufficient. We introduce a novel theoretical and practical framework explicitly embedding existential externalities into the cost of capital via innovative carbon financial instruments (CLI, CCI, CNI). Carbon Contingent Common Stocks (CCCS) and Carbon-Contingent Senior Bonds (CCSB) uniquely transfer financial risks associated with carbon performance to investors, fundamentally reshaping corporate incentives, governance, and financial theory.