thesis about financial instruments

Background of Financial Instruments

• First Online: 01 January 2012

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• Sven-Eric Bärsch 2  

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Since the current financial and economic environment presents many challenges for most economic agents, financial transactions and their instruments are likely be one of those challenges. Hereby, this thesis deals with the treatment of hybrid financial instruments for corporate income tax purposes in an international and cross-border context. But, before focusing on the relevant tax aspects on this matter, it is essential to depict a more detailed overview of what hybrid financial instruments are, the extent to which they influence or are influenced by the environment from an economic and legal perspective, and the general tax consequences of financial instruments in a cross-border context. This outline is necessary to assess how hybrid financial instruments affect the design of tax rules as well as how the given fundamental corporate income tax treatment limits this design.

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Cf. MacNeil 2005 : 208; Brealey et al. 2008 : 386 et seq.; Hillier et al. 2008 : 3 et seq.

Based on the following distinction both instruments can be labeled as non-mezzanine and non-structured financial instruments.

Cf. Sect. 3.2.1; Hillier et al. 2008 : 5, 32; Helminen 2010 : 166.

Cf. Schneider 1992 : 21; Drukarczyk 1993 : 35; Pratt 2000 : 1056 et seq.

Representative for many other cf. Eber-Huber 1996 : 8; Jänisch et al. 2002 : 2451; Schrell and Kirchner 2003 : 13; Bogenschütz 2008a : 533; Bogenschütz 2008b : 50; Küting et al. 2008 : 941; Bock 2010 : 66.

Cf. OECD 1994 : 7 et seq.; Funk 1998 : 138; Duncan 2000 : 22 et seq.; Pistone and Romano 2001 : 35; Krause 2006 : 58 et seq.; Briesemeister 2006 : 12 et seq., with further references; Helminen 2010 : 164, with further references.

Cf. Sect. 3.2.1.

Figure  2.1 presents a classification of financial instruments with a focus on hybrid financial instruments. However, since each kind of classification is purpose-driven, there is no universally correct classification. With regard to the scope of this thesis the emphasis is on the demarcation of such hybrid financial instruments which are affected by the debt/equity distinction. In simple terms see also Krause 2006 : 79 et seq. Regarding an exchange market segment-based classification see also Krause 2006 : 79 et seq.; Bogenschütz 2008b : 51 et seq. For another classification with a focus on derivative components see e.g. Laukkanen 2007 : 18 et seq.

Cf. Brealey et al. 2008 ; Hillier et al. 2008 ; Ross et al. 2008 . See also IAS 32 Para. AG15.

Cf. inter alia MacNeil 2005 : 108 et seq. See also IAS 32 Para. AG15 and IAS 39 Para. 9; Herzig 2000: 482.

Yet, their terms are not used consistently in practice and theory. Cf. inter alia Briesemeister 2006 : 14 et seq., with further references.

Cf. Briesemeister 2006 : 14 et seq., with further references; Schulz 2006 : 9; Natusch 2007 : 22 et seq.; Bogenschütz 2008b : 51 et seq.; Mäntysaari 2010 : 283. See further Lang 1991 : 14; Drukarczyk 1993 : 581; Eber-Huber 1996 : 8; Haun 1996 : 7 et seq., with further references; Herzig 2000: 482; MacNeil 2005 : 209; Eilers and Rödding 2007 : 84 et seq.; Helminen 2010 : 164 et seq.; Lampreave 2011 : Footnote 67. However, the term ‘hybrid financial instrument’ will be used oftentimes synonymously for mezzanine financial instruments in practice and theory. See e.g. Eber-Huber 1996 : 8; Haun 1996 : 10; Wagner 2005c : 499; Laukkanen 2007 : 37; Bogenschütz 2008a : 533; Bogenschütz 2008b : 50; Bock 2010 : 65 et seq.; Helminen 2010 : 164.

Cf. Dombek 2002 : 1065 et seq.; Briesemeister 2006 : 17 et seq., with further references; German Institute of Public Auditors 2008 : 455; Schaber et al. 2008 : 1; Reiner and Schacht 2010 : 387; Murre 2012 : 25 et seq. See further also Luttermann 2001 : 1901. These financial instruments fulfill the definition of financial instruments in accordance to IAS 39 Para. 8 and IAS 39 Para. 11.

Cf. Chaps. 4 and 5 .

Cf. e.g. Storck 2011 : 29 et seq. Although the focus is on the capital market as a part of the financial markets, both are used synonymously here.

Cf. Allen and Santomero 1998 : 1464; Alworth 1998 : 509; Hillier et al. 2008 : 25; Ledure et al. 2010 : 352.

Other developments, which are not within the scope of the further analysis, are in particular the proliferation of derivative instruments (representative for many see Warren 1993 : 460 et seq.; Hull 2009 : 1 et seq.; Hartmann-Wendels et al. 2010 : 271 et seq.; Valdez and Molyneux 2010 : 381 et seq.) and securization transactions (see e.g. Allen and Santomero 1998 : 1474; Hartmann-Wendels et al. 2010 : 207 et seq.; Valdez and Molyneux 2010 : 273 et seq.).

For a distinction between direct and portfolio investments cf. Herman 2002 : 71 et seq.; Graetz and Grinberg 2003 : 547 et seq.

Cf. Bulow et al. 1990 : 135, 139; Polito 1998 : 778; Benshalom 2010 : 1238, 1246. See further also Avi-Yonah 2004 : 1232.

Cf. Pratt 2000 : 1072 et seq.; Teichmann 2001 : 651 et seq.; Graetz and Grinberg 2003 : 542 et seq.;European Commission 2004b : 9. See further also Allen and Santomero 1998 : 1464; Avi-Yonah 2004 : 1232. In practice, see also e.g. Storck and Spori 2008 : 250 et seq.; Siemens 2010a : 59.

Cf. Kopcke and Rosengren 1989 : 4; Herman 2002 : 9 et seq.; Benshalom 2010 : 1239. See further also Allen 1989 : 16 et seq.; Allen and Santomero 1998 : 1464 et seq.

Cf. Hariton 1988 : 770; Franke and Hax 2009 : 56; Semer 2010 : 1478.

Cf. Allen 1989 : 17; Teichmann 2001 : 651 et seq.

Cf. IFRS Framework Para. 12. See also Brinkmann 2007 : 229 et seq.; Cuzmann et al. 2010 : 284 et seq.

Cf. Brealey et al. 2008 : 944 et seq.; Hillier et al. 2008 : 19, 21. See further also Rudolph 2006 : 400 et seq.; Bundgaard 2010a : 442.

Cf. inter alia Rudolf 2005 : 2. See also Grinblatt and Titman 2002 : 19; Friderichs and Körting 2011 : 31 et seq., both for Germany. See further also Hillier et al. 2008 : 20.

Cf. Ledure et al. 2010 : 352, 354; Valdez and Molyneux 2010 : 299. In practice, see e.g. Siemens 2010b : 103. However, a remarkable stability in bank financing could be observed in particular for Germany. Cf. Friderichs and Körting 2011 : 36 et seq.

Cf. Sect.  2.2.2 ; Waschbusch et al. 2009 : 353.

Cf. Ledure et al. 2010 : 354; Bourtourault and Bénard 2011 : 187; Storck 2011 : 29. See further also Friderichs and Körting 2011 : 35.

Cf. Herman 2002 : 9 et seq.; Allen and Santomero 1998 : 1464 et seq.; Teichmann 2001 : 652; Brealey et al. 2008 : 390 et seq., 396 et seq., 400 et seq., 946; Hartmann-Wendels et al. 2010 : 18. When markets were complete and perfect, the allocation of resources is efficient, so that there is no need for intermediaries to improve welfare. Cf. Fama 1980 : 39 et seq.; Franke and Hax 2009 : 501; Hartmann-Wendels et al. 2010 : 123. However, markets are characterized by asymmetric information and transaction costs. Cf. Allen and Santomero 1998 : 1464 et seq.; Hartmann-Wendels et al. 2010 : 123 et seq., both with further references.

Cf. Bodie 1989 : 107; Gebhardt et al. 1993 : 10 et seq.; Allen and Santomero 1998 : 1482; MacNeil 2005 : 7; Hartmann-Wendels et al. 2010 : 18. Nevertheless, there is also a trend towards the market (instead of the intermediaries) allowing borrowers to occupy the financial markets directly for fund raising, inter alia due to recent technological developments as well as financial innovation (disintermediation). Cf. Horne 1985 : 621; Gebhardt et al. 1993 : 14; Herman 2002 : 17 et seq.; Hartmann-Wendels et al. 2010 : 18; Valdez and Molyneux 2010 : 170. However, financial intermediaries have not become obsolete (in fact, quite the reverse has happened), but rather their role has moved from between lender and borrower to between lender and market since financial instruments and markets have become more complex and riskier. Cf. Allen and Santomero 1998 : 1483.

Cf. Allen and Santomero 1998 : 1464; Alworth 1998 : 509; Brealey et al. 2008 : 390 et seq., 396 et seq.; Valdez and Molyneux 2010 : 235 et seq. See further also Bulow et al. 1990 : 139; Eilers and Rödding 2007 : 83; Kalss 2007 : 523. See also Board of Governors of the Federal Reserve System 2010 : 10, for the United States; OECD 2009 : 72, for OECD Member States. For a distinction between bank and non-bank financial intermediaries see in more detail e.g. Valdez and Molyneux 2010 : 73 et seq., 235 et seq.

Cf. e.g. Allen and Santomero 1998 : 1464, 1474.

Cf. further Valdez and Molyneux 2010 : 469.

Cf. Horne 1985 : 630; Bodie 1989 : 116 et seq.; Herman 2002 : 15. See further also Kalss 2007 : 523.

Cf. Kopcke and Rosengren 1989 : 1; Herman 2002 : 15. In practice, see also Siemens 2010b : 58. For the factors as causes of financial innovation in more detail see Finnerty 1988 : 16 et seq.

Cf. Pratt 2000 : 1075 et seq.; Hillier et al. 2008 : 53 et seq. See further also Jacobs and Haun 1995 : 405; Bundgaard 2010a : 442. Besides the introduction of new financial products, this includes also pure derivative instruments which are, however, not within the scope of this thesis. Cf. Allen and Santomero 1998 : 1464. With regard thereto see fundamentally Hull 2009 : 1 et seq.; Hartmann-Wendels et al. 2010 : 271 et seq. The dynamic development is attributed in particular to both the increase in economic uncertainty and rapid technological developments. Cf. Ramsler 1993 : 434 et seq.; Herman 2002 : 19 et seq. See further also Horne 1985 : 630; Bodie 1989 : 116.

Cf. Allen 1989 : 12; Bulow et al. 1990 : 135; Cerny 1994 : 333; Polito 1998 : 778. However, this dichotomy constitutes merely a simplification, since already in history an array of financial instruments has been issued albeit at a slower pace. Cf. Allen 1989 : 14 et seq.; Allen and Gale 1994 : 11 et seq. Against it, recent past’s as well as today’s pace and volume of financial innovation has no equal in history. Cf. Miller 1986 : 459 et seq.; Allen and Santomero 1998 : 1464; Alworth 1998 : 509; Edgar 2000 : 25; Hillier et al. 2008 : 53 et seq.

Cf. Schneider 1992 : 21; Drukarczyk 1993 : 35; Pratt 2000 : 1056 et seq. With regard to bonds see e.g. Hillier et al. 2008 : 44.

Cf. Hariton 1994 : 501 et seq.; Santangelo 1997 : 332; Edgar 2000 : 92 et seq. For a classification of the precise risks associated with financial investments see MacNeil 2005 : 5 et seq.

Cf. Kopcke and Rosengren 1989 : 3; Normandin 1989 : 65; Bulow et al. 1990 : 135 et seq.

Cf. e.g. Allen 1989 : 16 et seq.

Cf. also Hariton 1988 : 775; Kopcke and Rosengren 1989 : 1 et seq., 11; Hariton 1994 : 501 et seq.; Santangelo 1997 : 332. See further also Elschen 1993 : 586; Ramsler 1993 : 439; Edgar 2000 : 25, 93 et seq.; Hillier et al. 2008 : 25, 52 et seq. From the market perspective, financial innovations may make financial markets more efficient and complete in terms of enhanced prospects for risk sharing between investors. Cf. e.g. Horne 1985 : 621 et seq. For the development of equivalent cash flows under the use of the put-call parity theorem see Warren 1993 : 465 et seq.; Shaviro 1995 : 652 et seq.; Edgar 2000 : 21 et seq., 94 et seq.

Cf. Arouri et al. 2010 : 145, 148; Eiteman et al. 2010 : 377 et seq.; Zodrow 2010 : 866; Martínez Bárbara 2011 : 270. See further also Alworth 1998 : 509; Herman 2002 : 48 et seq.; Hillier et al. 2008 : 20 et seq., 25.

Cf. Herman 2002 : 63; Arouri et al. 2010 : 152 et seq.; Eiteman et al. 2010 : 432 et seq.

Cf. Cerny 1994 : 330 et seq.; Lothian 2002 : 723; Hillier et al. 2008 : 26; Arouri et al. 2010 : 148, 151; Zodrow 2010 : 866; Martínez Bárbara 2011 : 270. See further also Alworth 1998 : 509; Herman 2002 : 56; Eidenmüller 2007 : 487; Kalss 2007 : 523. For the main advantages and disadvantages of an enhanced international financial integration see e.g. Arouri et al. 2010 : 152 et seq.

Cf. Fukao and Hanazaki 1986 : 6, 13; European Commission 2004b : 9; Heathcotea and Perri 2004 : 207 et seq.; Hillier et al. 2008 : 74 et seq.; Arouri et al. 2010 : 145; Zodrow 2010 : 866. See also Jacobs and Haun 1995 : 405. In practice, see e.g. Siemens 2010b: 104. This development is by no means a new phenomenon, but reaches back much further in history. Cf. Herman 2002 : 30; Lothian 2002 : 700 et seq. However, the financial integration today is more complete and more geographically ubiquitous and the number of financial markets has grown enormously. Cf. Lothian 2002 : 700, 723. For instance, today’s emerging countries have started to participate effectively in international integration of financial markets since only the 1990s. Cf. Haggard and Maxfield 1996 : 35 et seq.; Arouri et al. 2010 : 147.

Cf. Kose et al. 2006 : 23 et seq.; Hines 2007 : 268 et seq.; Griffith et al. 2010 917; Zodrow 2010 : 866. See Graetz and Grinberg 2003 : 542 et seq., for the United States. For a distinction between direct and portfolio investments see Herman 2002 : 71 et seq.; Graetz and Grinberg 2003 : 547 et seq.

Cf. Fukao and Hanazaki 1986 : 13; Hines 2007 : 268 et seq.; Arouri et al. 2010 : 147; Zodrow 2010 : 866.

Cf. Emmerich 1985 : 134; Eiteman et al. 2010 : 24 et seq.; 410 et seq. See further also Perridon et al. 2009 : 10 et seq.

Cf. Modigliani and Miller 1958 : 261 et seq. See also Myers 2001 : 84 et seq.; Brealey et al. 2008 : 472 et seq.; Hillier et al. 2008 : 508 et seq.; Ross et al. 2008 : 428 et seq.; Wüstemann and Bischof 2011 : 214 et seq.

Cf. Brealey et al. 2008 : 487.

Cf. Modigliani and Miller 1963 : 433 et seq.; Myers 2001 : 86 et seq.; Brealey et al. 2008 : 497 et seq.; Hillier et al. 2008 : 516 et seq.; Ross et al. 2008 : 441 et seq., 465. More controversially see Miller 1977 : 268 et seq. Regarding the prevailing concept of the tax deductibility of debt financing costs see in more detail Sect.  2.3 .

Cf. Graham 2000 : 1901 et seq.; Myers 2001 : 82 et seq.; Ross et al. 2008 : 479 et seq.

Cf. Baxter 1967 : 396 et seq. Such costs include, for instance, legal and administrative costs as well as the interrupted ability to conduct business and to make appropriate investments. Cf. Brealey et al. 2008 : 487, 503 et seq.; Ross et al. 2008 : 455 et seq. See further Miller 1977 : 262 et seq.; Edgar 2000 : 99 et seq., with further references; Hillier et al. 2008 : 569 et seq.

Considering company law, obligations derived from financial instruments classified as debt differ from those derived from financial instruments classified as equity as, for instance, the latter do not legally entitle a company to remuneration payments in the way the former provides legal entitlement. Cf. Sect. 3.2.1.

Cf. Scott 1976 : 33 et seq.; DeAngelo and Masulis 1980 : 3 et seq.; Graham and Harvey 2001 : 210; Myers 2001 : 88 et seq.; Brealey et al. 2008 : 503 et seq., 515 et seq.; Ross et al. 2008 : 465 et seq.; Cotei and Farhat 2009 : 4.

Cf. Bradley et al. 1984 : 869 et seq.; Rajan and Zingales 1991 : 1421 et seq.; Graham and Harvey 2001 : 209 et seq.; Myers 2001 : 82 et seq.; Hillier et al. 2008 : 625 et seq.; Ross et al. 2008 : 481. In practice, see also Siemens 2010b : 58 et seq., 100.

Cf. Ackermann and Jäckle 2006 : 879; Rudolph 2006 : 404; Blaurock 2007 : 609 et seq.; Wiehe et al. 2007 : 222 et seq.; Kessler et al. 2008 : 903; Horst 2011 : 590; Sheppard 2011 : 1107; Storck 2011 : 30.

Cf. Graham and Harvey 2001 : 211; Storck 2011 : 30. In practice, see also Siemens 2010a : 59;Siemens 2010b : 99. For the rating methodologies of Moody’s and Standard & Poor’s see e.g. Rüßmann and Vögtle 2010: 209 et seq.

Cf. Wald 1999 : 161 et seq.; Brealey et al. 2008 : 516 et seq. See also Noulas and Genimakis 2011 : 384 et seq. Moreover, there are critics pointing out that costs of financial distress seem to be much smaller than the tax benefits. Cf. e.g. Miller 1977 : 262 et seq. However, the pure threat of bankruptcy can be also cost-increasing with regard to stakeholders, who do not have capital stakes in the corporations such as e.g. customers and suppliers, since such stakeholders are increasingly reluctant to do business with financially distressed corporations. Cf. in more detail Hillier et al. 2008 : 607 et seq.

Cf. Myers and Majluf 1984 : 203 et seq.; Graham and Harvey 2001 : 219; Myers 2001 : 91 et seq.; Frank and Goyal 2003 : 220; Brealey et al. 2008 : 517 et seq.; Ross et al. 2008 : 472 et seq.; Cotei and Farhat 2009 : 3.

Cf. Myers 1984 : 581 et seq.; Graham and Harvey 2001 : 215; Myers 2001 : 91 et seq.; Brealey et al. 2008 : 519 et seq.; Hillier et al. 2008 : 622 et seq.; Ross et al. 2008 : 473 et seq. However, this theory could be observed only conditionally. Cf. Graham and Harvey 2001 : 219 et seq. See further also Helwege and Liang 1996 : 457.

Cf. Ghosh and Cai 1999 : 32 et seq.; Brealey et al. 2008 : 520 et seq.

Cf. Shyam-Sunder and Myers 1999 : 219 et seq.; Brealey et al. 2008 : 521.

Cf. also Sect.  2.2.1.1 .

Cf. Hackbarth et al. 2007 , 1389 et seq. See further Teichmann 2001 : 655 et seq.

Cf. also Sect. 4.2.4.3 “ First Test Layer: International Financial Accounting Purposes ”.

Cf. Baetge et al. 2004 : 228 et seq.; Coenenberg 2009 : 1054 et seq.; Franke and Hax 2009 : 113 et seq.; Küting and Weber 2009 : 135 et seq. Furthermore, the classification of financial instruments for financial accounting purposes also affects the judgments of external financial analysts. Cf. Hopkins 1996 : 33 et seq.

Cf. Rüßmann and Vögtle 2010: 208.

Cf. in more detail Sect. 4.2.4.3 “ Debt/Equity Test ”.

Cf. Assef and Morris 2005 : 147 et seq.; Ryan 2007 : 24; Cottani and Liebentritt 2008 : 62 et seq.; Kraay and Bloom 2012 : 529 et seq. For the specific requirements in the United States see Ryan 2007 : 24 et seq. For the Australian requirements see Joseph 2006b : 231 et seq.

Cf. Santos 2001 : 52 et seq., with further references; Ryan 2007 : 24; Cottani and Liebentritt 2008 : 62 et seq.; Kraay and Bloom 2012 : 529.

Cf. Santos 2001 : 46 et seq.

Assef and Morris 2005 : 147 et seq.; Cottani and Liebentritt 2008 : 62 et seq.

Cf. e.g. Lühn 2006a : 27.

Cf. Behnes and Helios 2012 : 25 et seq.; Krause 2012 : 11; Haisch and Renner 2012: 135 et seq. See further also Becker et al. 2011 : 375 et seq.; Kraay and Bloom 2012 : 528 et seq.

However, Iceland and Israel will be neglected due to the limited scope of this thesis and the limited information basis.

Estonia is the only member state which has eliminated the ‘traditional’ corporate income tax and has introduced a distribution tax on distributed profits. Cf. IBFD 2011a : Chap. 1 (Estonia).

Cf. Bird 1996 : 1 et seq.

Cf. Endres et al. 2007 : 18 et seq.; IBFD 2011a : Sect. 1.1.4. See also McDaniel et al. 2005 : 16, for the United States; Jacobs 2009 : 92 et seq., for Germany.

Cf. Bird 1996 : 3 et seq.; Mintz 1996 : 24 et seq.; Avi-Yonah 2004 : 1200 et seq.

Cf. McLure 1979 : 20; Mintz 1996 : 25 et seq.; Avi-Yonah 2004 : 1201.

Cf. Bird 1996 : 9; Mintz 1996 : 25 et seq.

Cf. Bird 1996 : 9 et seq.

Cf. Mintz 1996 : 25 et seq.; Avi-Yonah 2004 : 1202.

Cf. Mintz 1996 : 27. See also Sect.  2.3.2 .

Cf. Avi-Yonah 2004 : 1202 et seq.

Cf. Bird 1996 : 4 et seq.; Mintz 1996 : 25.

Cf. Bird 1996 : 4 et seq.; Mintz 1996 : 25; Graetz and O’Hear 1997 : 1036 et seq. A precised benefit can be seen, for instance, in the greater liquidity granted by access to the capital market. Cf. Rudnick 1989 : 985 et seq.; Avi-Yonah 2004 : 1206 et seq., with further references.

Cf. Mintz 1996 : 25.

Cf. Avi-Yonah 2004 : 1207.

Cf. Mintz 1996 : 34; Wendt 2009 : 31.

Cf. Bird 1996 : 5.

Cf. Mintz 1996 : 35.

Cf. Avi-Yonah 2004 : 1211 et seq.; Devereux and Sørensen 2006 : 23.

Cf. Musgrave and Musgrave 1989 : 372 et seq.; Bird 1996 : 1 et seq.

Cf. Avi-Yonah 2004 : 1208, with further reference.

Cf. Avi-Yonah 2004 : 1231 et seq.; IBFD 2011a : Sect. 0.1. See also Jacobs 2009 : 92 et seq., for Germany.

Cf. Avi-Yonah 2004 : 1212 et seq., 1231 et seq.

Avi-Yonah 2004 : 1210.

Bird 1996 : 13.

For these elements in more detail see e.g. Endres et al. 2007 : 17 et seq.; Jacobs et al. 2011 : 122 et seq.

Cf. inter alia Endres et al. (eds.) 2007 : 17.

Across the globe national GAAP converges to a considerable extent. Cf. Schön 2005a : 112 et seq.

Cf. Schön 2005a : 111 et seq., 115 et seq.; Endres et al. 2007 : 25 et seq.; Wendt 2009 : 55; Ault and Arnold 2010 : 18 et seq., 38 et seq., 61, 87 et seq., 107 et seq., 164 et seq.; IBFD 2011a : Sect. 1.1.2, 1.2. See also Grimes and Maguire 2006 : 577 et seq., for the Republic of Ireland; IBFD 2011a : Sect. 12.1, for the Republic of Korea. Iceland and Israel will be neglected here and in the following due to limited information.

Cf. e.g. IAS 32 Para. 35 et seq.

Cf. e.g. IFRS Framework Para. 4.29; IAS 18 Para. 29 et seq.

Cf. IBFD 2011a : Sects. 1.2.1 and 1.4.4. See also IBFD 2011a : Sects. 2.3.1 and 2.3.3.6, for Luxembourg; IBFD 2011b : Sects. 1.3.3.2, for the United States.

For the notional interest deduction for equity implemented in Belgium see in more detail Heyvaert and Deschrijver 2005 : 459 et seq.; Vanhaute 2008 : 157 et seq.; IBFD 2011a : Sect. 1.9.6. In the past, this concept has been implemented also in Austria and Italy. Cf. inter alia de Mooij and Devereux 2011 : 97. However, Italy has recently reintroduced this concept at least for newly contributed equity. Cf. Sect. 4.2.4.2. .

In Estonia, profits before taxes are distributed, but are subsequently subject to the distribution tax. Cf. IBFD 2011a : Chap. 1.

Cf. Endres et al. 2007 : 18 et seq.; IBFD 2011a : Sects. 1.2.3 and 6.1. See also IBFD 2011a : Chaps. 9 and 11, for Luxembourg. In addition, see McDaniel et al. 2005 : 9 et seq.; IBFD 2011b : Sect. 2.2, both for the United States. Although with a partially differing division see further also de Wilde 2011 : 67.

Cf. IBFD 2011a : Chaps. 11 and 12, for Belgium and the Netherlands.

Cf. Gutiérrez et al. 2010 : Sect. 1.3.3.; HM Treasury 2010 : 14; IBFD 2011a : Sect. 1.4.5. See also IBFD 2011a : Sect. 2.3.3.4, for Luxembourg. IBFD 2011a : Chap. 12, for the Republic of Korea. In addition, see McDaniel et al. 2005 : 7 et seq., 11; IBFD 2011b : Sect. 1.3.3.1, both for the United States. See further also Wendt 2009 : 82.

Cf. Sects. 4.2.3.1 and 4.2.4.1 . See also instead of many Wendt 2009 : 82 et seq.; IBFD 2011a : Sect. 10.3; Jacobs et al. 2011 : 980 et seq., 1008 et seq.; de Wilde 2011 : 67 et seq. Nevertheless, these interest deduction limitation mechanisms are not within the scope of this thesis and will not be further considered.

Cf. Gutiérrez et al. 2010 : Sect. 1.3.; IBFD 2011a : Sect. 1.2. For the Republic of Korea see IBFD 2011a : Sect. 14; for Luxembourg IBFD 2011a : Sect. 2.3. For the United States see McDaniel et al. 2005 : 7; IBFD 2011b : Sects. 1.3.1 and 1.3.2. See further also Endres et al. 2007 : 31.

Cf. in more detail for Hungary Felkai 2009 : 611 et seq. See also Dikmans 2007 : 162 et seq.; Storck 2011 : 35 et seq.; Smit et al. 2011 : 508 et seq., all for the Netherlands. For the Dutch group interest box see e.g. Flipsen and Burgers 2010 : 22 et seq.

Cf. Sect.  2.3.2.2 .

Cf. Jacobs et al. 2011 : 6 et seq. See also Schäfer 2006 : 31 et seq.; Panayi 2007 : 2 et seq.; Wendt 2009 : 91 et seq., all with further references.

Cf. Jacobs et al. 2011 : 10 et seq. See also Braunagel 2008 : 35 et seq.

For the mechanisms to avoid/mitigate the economic double taxation see also Sect.  2.3.1.2 .

Cf. Sect. 3.1.3.

Cf. Sect.  2.3.1.2 .

Cf. IBFD 2011a : Sect. 7.2.1.

Cf. Tables A.2 and A.3, both in the annex; IBFD 2011b : Sects. 6.3.1 and 6.3.5.

Additionally, dividends paid to non-resident pension funds, investment funds and/or insurance companies may be exempted from withholding tax in some countries (e.g. in Poland and Slovenia).

For the precise withholding tax rates on dividends (portfolio shareholding) of the agreed income tax treaties between all regarded EEA/EU/OECD Member States see Table A.2 in the annex.

For the precise withholding tax rates on dividends (substantial shareholding) of the agreed income tax treaties between all regarded EEA/EU/OECD Member States see Table A.3 in the annex.

Cf. Council Directive, 90/435/EEC: 6, as lastly amended by Council Directive, 2003/123/EC: 41. See in more detail Sect. 4.2.1.2 ; Jacobs et al. 2011 : 167 et seq.

Cf. IBFD 2011a : Sect. 7.2.1. In some countries exceptions for specific types of income are made under domestic tax law by the application of the territoriality principle. See IBFD 2011a : Sect. 7.2.1 (Denmark); IBFD 2011a : Sect. 7.2.1 (France). See also Gouthière 2011 : 188, 191 et seq., for France.

Cf. IBFD 2011a : Chap. 7; IBFD 2011b : Chap. 6. See also Bieber et al. 2008 : 583 et seq., for Austria; IBFD 2011a : Chap. 8, for Luxembourg. In Austria, from 2011 the tax exemption method for portfolio participations shall be extended to apply as well to Non-EEA/EU-situations. Cf. IBFD 2011b : Sect. 6.1 (Austria).

Corporations in the United Kingdom may elect for a non-application of the tax exemption method, but contemporaneously for an avoidance of jurisdiction double taxation.

Corporations in the United Kingdom may elect for a non-application of the tax exemption method, but contemporaneously for direct and indirect tax credits.

These limitations may be used either in a cross-border situation or, in addition, in a pure domestic context as already indicated above. Cf. Zielke 2010 : 69 et seq.; IBFD 2011a : Sect. 10.3. Nevertheless, these regimes are not within the scope of this thesis and will not be further considered.

Cf. Sects. 4.2.3.2 and 4.2.4.2 .

Cf. IBFD 2011b : Sects. 6.3.2 and 6.3.5.

For the precise withholding tax rates on interest payments of the agreed upon income tax treaties between all regarded EEA/EU/OECD Member States see Table A.4 in the annex.

Cf. Council Directive, 2003/49/EC: 49. See in more detail Sect. 4.2.1.2 ; Jacobs et al. 2011 : 179 et seq.

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Bärsch, SE. (2012). Background of Financial Instruments. In: Taxation of Hybrid Financial Instruments and the Remuneration Derived Therefrom in an International and Cross-border Context. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-32457-4_2

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What Is a Financial Instrument?

Understanding financial instruments, types of financial instruments, types of asset classes of financial instruments.

• Financial Instruments FAQs

The Bottom Line

• Investing Basics

Financial Instruments Explained: Types and Asset Classes

Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded. Most types of financial instruments provide efficient flow and transfer of capital throughout the world’s investors . These assets can be in the form of cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one’s ownership in some entity.

Examples of financial instruments include stocks, exchange-traded funds (ETFs), bonds, certificates of deposit (CDs), mutual funds, loans, and derivatives contracts, among others.

Key Takeaways

• A financial instrument is a real or virtual document representing a legal agreement involving any kind of monetary value. 

Financial instruments may be divided into two types: cash instruments and derivative instruments.

• Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based.
• Foreign exchange instruments comprise a third, unique type of financial instrument.

Madelyn Goodnight / Investopedia

Financial instruments can be real or virtual documents representing a legal agreement involving any kind of monetary value. Equity-based financial instruments represent ownership of an asset. Debt-based financial instruments represent a loan made by an investor to the owner of the asset.

Foreign exchange instruments comprise a third, unique type of financial instrument. Different subcategories of each instrument type exist, such as preferred share equity and common share equity.

International Accounting Standards (IAS) define financial instruments as “any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.”

Cash Instruments

• The values of cash instruments are directly influenced and determined by the markets. These can be securities that are easily transferable. Stocks and bonds are common examples of such primary instruments .
• Cash instruments may also be deposits and loans agreed upon by borrowers and lenders . Checks are an example of a cash instrument because they transmit payment from one bank account to another.

Derivative Instruments

• The value and characteristics of derivative instruments are based on the vehicle’s underlying components, such as assets, interest rates, or indices.
• An equity options contract—such as a call option on a particular stock, for example—is a derivative because it derives its value from the underlying shares. The call option gives the right, but not the obligation, to buy shares of the stock at a specified price and by a certain date. As the price of the underlying stock rises and falls, so does the value of the option, although not necessarily by the same percentage.
• There can be over-the-counter (OTC) derivatives or exchange-traded derivatives. OTC is a market or process whereby securities—which are not listed on formal exchanges—are priced and traded.

Financial instruments may also be divided according to an asset class , which depends on whether they are debt-based or equity-based.

Debt-Based Financial Instruments

Debt-based instruments are essentially loans made by an investor to the owner of the asset. Short-term debt-based financial instruments last for one year or less. Securities of this kind come in the form of Treasury bills (T-bills) and commercial paper . Bank deposits and certificates of deposit (CDs) are also technically debt-based instruments that credit depositors with interest payments.

Exchange-traded derivatives exist for short-term, debt-based financial instruments, such as short-dated interest rate futures. OTC derivatives also exist, such as forward rate agreements (FRAs) .

Long-term debt-based financial instruments last for more than a year. Long-term debt securities are typically issued as bonds or mortgage-backed securities (MBS) . Exchange-traded derivatives on these instruments are traded in the form of fixed-income futures and options. OTC derivatives on long-term debts include interest rate swaps, interest rate caps and floors, and long-dated interest rate options.

Equity-Based Financial Instruments

Equity-based instruments represent ownership of an asset. Securities that trade under the banner of equity-based financial instruments are most often stocks , which can be either common stock or preferred shares. ETFs and mutual funds may also be equity-based instruments.

Exchange-traded derivatives in this category include stock options and equity futures.

Foreign Exchange Instruments

Foreign exchange (forex, or FX) instruments include derivatives such as forwards , futures , and options on currency pairs , as well as contracts for difference (CFDs) . Currency swaps are another common form of forex instrument. In addition, forex traders may engage in spot transactions for the immediate conversion of one currency into another.

What Are Some Examples of Financial Instruments?

Financial instruments come in many forms and types. What makes them financial instruments is that they confer a financial obligation or right to the holder . Common examples of financial instruments include stocks, exchange-traded funds (ETFs), mutual funds, real estate investment trusts (REITs) , bonds, derivatives contracts (such as options, futures, and swaps), checks, certificates of deposit (CDs), bank deposits, and loans.

Are Commodities Financial Instruments?

While commodities themselves, such as precious metals, energy products, raw materials, or agricultural products, are traded on global markets, they do not typically meet the definition of a financial instrument. That’s because they do not confer a claim or obligation over something else. But commodities derivatives are financial instruments, They include futures, forwards, and options contracts that use a commodity as the underlying asset.

Are Insurance Policies Financial Instruments?

An insurance policy is a legally binding contract established with the insurance company and policy owner that provides monetary benefits if certain conditions are met (e.g., death in the case of life insurance). If the insurer is a mutual company, the policy may also confer ownership and a claim to dividends. Insurance policies also have a specified value in terms of both the death benefit and living benefits (e.g., cash value) for permanent policies.

Insurance policies are not considered securities, but one could possibly view them as an alternative type of financial instrument because they confer a claim and certain rights to the policyholder and obligations to the insurer.

A financial instrument is effectively a monetary contract (real or virtual) that confers a right or claim against some counterparty in the form of a payment ( checks , bearer instruments ), equity ownership or dividends (stocks), debt (bonds, loans, deposit accounts), currency (forex), or derivatives (futures, forwards, options, and swaps). Financial instruments can be segmented by asset class and as cash-based, securities, or derivatives.

Depending on their type, financial instruments may be exchangeable on listed or OTC markets.

Emanuel Camilleri and Roxanne Camilleri, via Google Books. “ Accounting for Financial Instruments: A Guide to Valuation and Risk Management .” Page 62. Taylor & Francis, 2017.

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Financial Instruments: The Main Types Term Paper

Introduction.

Generally, in active financial markets business organizations depend on financial instruments (FI) such as bonds, and equities to help them reduce potential risks they might encounter during their operations. For instance, issues such as increasing interest rates and changes in commodity prices are more likely to affect enterprises thus they rely on the various forms of securities to reduce the impacts. Apart from the aspect of reducing potential business hazards, the FIs are useful in enabling business owners to generate the required capital. In most cases, companies trade shares to raise additional funds for their operations. The approach allows investors to own a portion of the respective business organization. Therefore, the concept of FI is an essential facet of the money market hence it is necessary to have proper knowledge about it to ensure effective financial reporting by enterprises.

The Concept of FI

The term FI refers to a form of assets that can be traded in the money market. In financial institutions, FI provides an effective and efficient flow of funds from different investors across the world. In other words, FI can be defined as either a virtual or real document that represents a legal arrangement involving any form of monetary value between two or more parties (Stolowy & Ding, 2017). In general, FI is a contract for a monetary value that can be created, modified, purchased, or even settled. In terms of the agreement, FI requires a contractual obligation between the people or institutions involved in the transactions of FI. In other words, FI encompasses a two-way commitment whereby each party must comply with the agreed conditions. For instance, assuming a company is supposed to obtain cash from investors, it will be required to provide shares for the respective financier while the individual is obligated to issue the arranged funds.

Types and Categories of FI

The FI are grouped into two broad types namely; derivative instruments, cash instruments, and foreign exchange instruments as shown in figure 1 below. Each of the categories functions differently making them unique from one another. Furthermore, the FI is categorized into two main asset classes which are debt-based FI and equity-based FI (Kańduła & Przybylska, 2021). The mentioned sets make the FI have wide functions that enable business organizations and potential investors to achieve their objectives in the money market.

Cash Instruments

Cash instruments are types of FI whose values are impacted directly by the prevailing condition of the general market. This type of FI further known as cash equivalents is categorized into additional two groups. The classes include securities and loans, and deposits which investors and business organizations can choose from depending on their needs in the financial market (Parameswaran, 2022). Generally, securities are FI that has monetary value and are mostly traded in the stock exchange market (SEM). There are a number of marketable securities that investors and business organizations can opt to purchase or buy in the money market. They include bonds, stocks, preferred shares, and debentures. When the given securities are purchased, they represent a significant portion of the publicly-traded enterprise in the SEM. In addition, the other category of cash instruments that are loans and deposits represent assets having monetary value. The cash equivalents require parties involved to have a well-formulated contractual agreement to which the participants must adhere to.

Derivate Instruments

Derivative instruments are FI that derive their values or performance from the underlying asset. Some of the underlying assets that can determine the values of derivatives include commodities such as oil, gold, and cotton. Other assets are stocks, interest rates, currencies, bonds, and market indices (Parameswaran, 2022). The mentioned items have the potential of influencing the creation of different financial derivatives in the market. Derivative instruments are classified into five main categories namely; options, future, interest rate swaps, and forwards. In most cases, the derivatives mentioned above are used for the precautionary purpose to enable business organizations and investors to manage possible risks and further facilitate the aspect of speculation in the market (Kang, 2019). Generally, the given types of derivatives fall into two broad classes known as option and lock.

A future is a contract between two parties that is buyer and seller for the purchase of an asset at a pre-determined exchange rate in the future. In most cases, the derivate is used by traders to enable them to hedge possible risks that are likely to occur. Furthermore, a future contract allows investors to speculate the forthcoming price of the underlying asset (Dungore et al., 2022). Based on the agreement, both participants are obligated to accomplish the commitment to sell or buy the given commodity.

Based on the concept of derivative instruments, an option is a FI whereby two parties agree on a given contract to undertake a transaction of an asset at an already determined price before the future date. In other words, the FI permits the owner of the asset to sell or buy the underlying asset at the specified exercise price. In this type of derivative, the buyer is limited from engaging in the buy or sell agreement. The different options include selling a call option, selling a put option, and buying a call or a put option. Generally, options are used by investors to speculate the probable prices of the underlying asset.

Swaps are types of FI mostly used by business organizations to facilitate the altercation of one cash flow with another. The agreement is made between two parties to involve in the swapping of the interest rates (Dungore et al., 2022). For instance, an investor may opt to use an interest rate swap to switch from a fixed to a variable interest rate. The FI is essential to business organizations because it allows companies to effectively revise the conditions of the debts in order to benefit the expected or even current situations of the market.

Forward contracts are FI involving an agreement between two parties to undertake the exchange of the given asset at a specified price during the end of the arrangement. In most cases, the forwards are traded over the counter (OTC) (Dungore et al., 2022). In the process of the transaction, both the buyer and seller may agree to customize the size, terms, and even procedures of settlements once the contract has been created. Its OTC feature makes the forward derivate bear a significant counterparty risk that has the potential of affecting any of the involved participants. For example, one of the participants may fail to adhere to the obligation stated in the contract. In such a situation, the affected party will be forced to take the risks.

Foreign Exchange Instruments

Generally, foreign exchange instruments are usually derivatives. These are FI that are fully represented in the foreign markets. The FI is mainly the spot markets, swaps, option, future, and forward markets. This type of FI is designed to facilitate the management of financial risks that involves foreign exchange. The aspect makes the FI an essential tool that business organizations can use to reduce the hazards they are likely to encounter following the fluctuations in currencies in the money market.

The Asset Classes of FI

Apart from the various types of FI discussed above, FI can be further classified on the basis of assets. The two main categories are debt-based FI and equity-based FI. Each of the groups presents business organizations with essential opportunities for instance; the former presents business organizations with the ability to increase their capital base for smooth operations (Kańduła & Przybylska, 2021). They include mortgages, credit cards, debentures, bonds, and lines of credit. In most cases, the mentioned FI is short-term and last for about 12 months. On the other hand, long-term debt-based FI usually takes more than a year and they are mainly cash equivalents and exotic derivatives. The latter provides investors with the capacity of legal ownership of the company offering securities in the market. In this group, the FI includes preferred stock, common stock, transferrable subscription rights, and convertible debentures. Even though both classes enable corporations to raise the necessary capital, equity-based FI provides funds for the firms over a long period of time than debt-based FI.

Importance of the FI Concept

The concept is useful, especially to investors and business organizations which operate in the money market. The topic equips individuals with adequate knowledge about the various types of FI thus making it easier to choose the best option when engaging in any contractual obligation. With such understanding, a person may opt to advice companies concerning the nature of FI to enable them to gain effectively from their usage.

Furthermore, the topic increases the individual’s perspective of FI and how business organizations through the use of various types of FI can limit or avoid the potential risks in the market. The FI concept further makes it easier to speculate the future changes in market prices which is important for making an effective and informed decision for the business. Having a proper understanding of the FI idea, it will be easier to conduct a thorough research about the performance of securities in the financial industry.

In addition, the FI concept is essential in enabling accountants to classify various forms of derivatives and cash equivalents in financial statements. When the entries are made accordingly, it allows investors to have a clear picture of the respective organization based on its financial performance in relation to both equity and debt (Havemann et al., 2020). Furthermore, the FI idea allows investors to hedge their assets effectively hence they face limited financial risks.

Furthermore, the concept of FI is important because it gives people an opportunity to understand different ways of generating capital for business operations. Since there are various options in the market, with efficient knowledge it becomes easier to choose the best alternative to raise the necessary funds.

The concept of FI enables people to understand the importance of transferring risks to the other party. For instance, an investor may opt to buy instruments such as interest-rate swaps to give them the ability to protect their businesses against losses. Based on the FI idea, it becomes easier to remain effective in the market despite the challenges a firm may encounter. The FI topic is fundamental, especially in speculating sectors that are more likely to face frequent fluctuations leading to high risks in the market.

New Areas Learned in the FI Topic

In the process of exploring the FI concept, several new pieces of information I encountered. For instance, I learned about floating rate bonds which are essential financial securities that provide various interest influenced by the coupon rate that changes based on the market interest rates. In the US, the floating rate bond is preferred by most business organizations because of its feature that allows it to increase in value depending on the current status of the market. In other words, floaters make it possible for investors to continue receiving benefits following changes in the rates. Furthermore, the securities are less affected by market volatility hence they are effective and productive. However, despite the benefits associated with investing in a floating-rate bond, the FI experiences significant limitations. For example, in terms of rates, the security offers lower rates than their counterparts the fixed-rate bonds. The aspect makes them less attractive to business organizations that are attracted to higher rates.

Relationship between the FI and Financial Reporting and Analysis

Generally, the aspect of financial reporting and analysis encompasses the recording of the monetary details in the books of account. The practice is aimed at making a comprehensive financial statement that captures all the facets of a company’s financial information. Most sources of funds for the business organization include loans and equities which are major parts of the FI. The concept of FI makes it easier for accountants to effectively classify the various FI as financial assets, liabilities, or equities. The relationship between the reporting and FI makes it easier to analyze core aspects such as bank loans, amortized cost accounting, fair value, and balance sheets. After a proper examination of the FI, the analysts are then able to provide an accurate and reliable financial statement containing the necessary details that can be used by potential investors. Furthermore, the correlation ensures the reporting provides details of possible risks that are associated with different types of FI in the market.

To sum up, the concept of FI is essential, especially for business organizations that depend on the performance of the financial market. The FI are classified into three broad categories namely; cash instruments, foreign exchange instruments, and derivatives. The various types of FI play a vital role in enabling companies to have access to adequate sources of capital. In addition, the equity-based FI allows investors to own a portion of companies that are publicly traded in the SEM. By using the FI, business organizations have the ability to reduce potential risks through hedging practices. Similarly, the companies enhance their chances of benefiting future operations following effective speculations accompanied by either sell or purchase of the underlying asset. Based on the financial details in the FI concept, it is important for people especially accountants to have adequate knowledge about the FI topic. The aspect will enable them to develop effective financial reports that capture the key types of FI and classify them accordingly.

Dungore, P. P., Singh, K., & Pai, R. (2022). An analytical study of equity derivatives traded on the NSE of India . Cogent Business & Management , 9 (1). Web.

Havemann, T., Negra, C., & Werneck, F. (2020). Blended finance for agriculture: Exploring the constraints and possibilities of combining financial instruments for sustainable transitions . Agriculture and Human Values , 37 (4), 1281-1292. Web.

Kańduła, S., & Przybylska, J. (2021). Financial instruments used by Polish municipalities in response to the first wave of COVID-19 . Public Organization Review , 21 (4), 665-686. Web.

Kang, B. J. (2019). Economic benefits of derivatives for long term investments-equity linked securities . Journal of Derivatives and Quantitative Studies . Web.

Parameswaran, S. K. (2022). Fundamentals of financial instruments: An introduction to stocks, bonds, foreign exchange, and derivatives . John Wiley & Sons.

Stolowy, H., & Ding, Y. (2017). Financial accounting and reporting: A global perspective , (5th ed.). London: South-Western Cengage Learning.

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Bibliography

IvyPanda . "Financial Instruments: The Main Types." May 10, 2024. https://ivypanda.com/essays/financial-instruments-the-main-types/.

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Green finance, sustainability disclosure and economic implications

Fulbright Review of Economics and Policy

ISSN : 2635-0173

Article publication date: 19 April 2023

Issue publication date: 6 June 2023

In this study, the authors provide a systematic literature review of articles in the emerging areas of green finance and discuss the status and challenges in sustainability disclosure, which is crucial for the efficiency of green financial instruments. The authors then review the literature on the economic implications of green finance and outline future research directions.

Design/methodology/approach

The authors use the analytical framework – Search, Appraisal, Synthesis, and Analysis (SALSA) to conduct the systematic review of the literature.

Increasing public attention to the environment motivates the use of green finance to fund environmentally sustainable projects, and the rise of green finance intensifies the demand for environmental disclosure. Literature has documented tremendous growth in sustainability reporting over time and around the globe, as well as raised concerns about how such reporting lack consistency, comparability, and assurance. Despite these challenges, the authors find that in general, the literature agrees that a firm’s green practice is positively associated with its financial performance and negatively related to a firm’s cost of capital. Green finance is also found to bring about enhanced risk management and economic development.

Originality/value

The authors provide one of the first reviews of green finance, sustainability disclosure and the impact of green finance on financial performance, capital market and economic development.

• Green finance
• Sustainability disclosure
• Sustainable investing

Liu, C. and Wu, S.S. (2023), "Green finance, sustainability disclosure and economic implications", Fulbright Review of Economics and Policy , Vol. 3 No. 1, pp. 1-24. https://doi.org/10.1108/FREP-03-2022-0021

Emerald Publishing Limited

Copyright © 2023, Chen Liu and Serena Shuo Wu

Published in Fulbright Review of Economics and Policy . Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/ legalcode

1. Introduction

As the world economy recovers from the impacts of COVID-19, the “green recovery” approach was proposed, making it a critical time to review existing research on green finance. In this paper, we follow G20’s definition and consider green finance as the financial instruments (such as green bonds), arrangements, mechanisms, and environmentally friendly operational practices, and the disclosure of these arrangements toward reducing carbon emissions and developing climate-resilient and environmentally sustainable infrastructure [1] , [2] .

While some scholars believe that the green path leads to a more sustainable, resilient and urgent recovery as financial services are well-positioned to contribute to the transformation needed for sustainable recovery (e.g. Crona, Folke, & Galaz, 2021 ; Navickas, Kontautienė, Stravinskienė, & Bilan, 2021 ), others view the green approach as confusing or counterproductive (e.g. Bebchuk & Tallarita, 2022 ). Therefore, a comprehensive review of the literature is critical for a balanced view and understanding of green finance and its real economic impact.

In this paper, we first provide some background and context for green financial instruments such as green bonds and green debt and discuss the motives for green finance. An indispensable aspect of green finance is the corporate disclosure of environmental performance to the capital market and other stakeholders of companies. Therefore, we next review the literature in the area of sustainability disclosure to summarize its trend, enabler and value. In line with the rise of green financial instruments directing resources to more environmentally sustainable businesses/projects, the literature has found that the corporate reporting of sustainability grows tremendously over the past decades and around the globe.

Current literature assures the value of green finance and sustainability disclosure; however, some controversies are identified. Due to the lack of one generally accepted set of standards that guide the reporting of sustainability and the lagged development of third-party assurance, the main challenges for sustainability reporting are its reliability, consistency and comparability. These issues further confound the effectiveness of green financial instruments and raise concerns about the potential opportunistic use of the proceeds (i.e. greenwashing). Mindful of the challenges, we then review the literature to examine the economic consequences of green finance and green practice.

In general, the literature agrees that green finance leads to green results such as emission reduction and energy saving. Overall, a firm’s green practice [3] is positively associated with its financial performance measured by stock market valuation and accounting-based measurements and negatively related to a firm’s cost of capital. Our review suggests that there are primarily three channels. First, the green practice lowers a company’s real and perceived risk of environmental violation and the associated potential financial and reputational costs. Second, green practice is consistent with the general sentiment of environmental concerns and is favored by capital market participants as they see the green practice as consistent with their personal beliefs or as a way for them to make an impact through investment. Third, green firms may see improved cash flow as green practices are supported by national and regional governments in the form of government procurement, subsidy and tax credit. As a result, the literature has also documented that green financial instruments contribute to firms’ access to capital and innovation related to environmental efforts. In addition, we also find a positive association between green finance and poverty alleviation and economic development.

Our literature review on green finance and sustainability disclosure can find theoretical underpinnings in stakeholder theory, agency theory and others. The stakeholders’ theory ( Freeman, 1984 ; Hill & Jones, 1992 ) emphasizes that economic and financial performance should not be the only goal of firms and that company actions do have an impact on various groups of stakeholders, the environment and society at large. Agency theory ( Jensen & Meckling, 1976 ) addresses the agency problem that stems from the separation of ownership and management and provides theoretical support for monitoring management actions through various mechanisms including transparent information environment. Information economics theories, which can be applied to sustainability reporting, suggest that voluntary disclosure (in addition to mandatory reports) helps reduce information asymmetry and enhance information environment. Accountability to stakeholders, the pursuit of positive socio-environmental impacts and demand for information (to alleviate the agency problem and information asymmetry) together contribute to underpinning the importance of green finance, green practice, and enhanced transparency in sustainability initiatives and outcomes.

Our review offers three key contributions. First, we summarize extant research in green finance and sustainability disclosure to enhance the understanding of the emerging lines of research. The multidisciplinary review aims to lay a foundation for the future query of knowledge. Second, we provide one of the first comprehensive reviews of green finance, sustainability disclosure and the economic implications, offering a big-picture framework to study the impact of green finance on economic development and recovery. Finally, we outline future research agendas for scholars in accounting and finance areas. The integration of multidisciplinary knowledge can serve as a platform for future interdependent research that investigates new phenomena, leveraging theories from across disciplines and with new datasets and methodologies.

2. Methodology and research design

To conduct the systematic literature review, we use a framework of Search, Appraisal, Synthesis, and Analysis (SALSA). The SALSA framework is a commonly used method to conduct systematic research review and synthesis to find trustworthy answers to specific review questions and to identify gaps in the literature that requires further research ( Booth, Sutton, Clowes, & Martyn-St James, 2021 ).

As the first step of the review process, we identified the research topic as green finance and sustainability disclosure and their economic impact. Then we searched all relevant studies, starting from peer-reviewed journal articles, books and book chapters from EBSCO, ProQuest, Web of Science and Google Scholar. Primary keywords included green finance, sustainable finance, climate finance, carbon finance, green bond, sustainable investing, sustainability disclosure and carbon accounting. In the preliminary search, we choose not to limit ourselves to specific journals or years such that we could explore the field’s entire development rather than a narrower presentation of findings from a particular academic domain or journal type. We included published or in-press articles (including in conference proceedings) as well as a publicly available working paper (e.g. SSRN (social science research network)).

In the second step “Appraisal”, we screened the abstracts of the selected articles and compiled a pool of articles that were reviewed, validated and if applicable used for this work. In this stage, we also conducted a reverse search technique in which additional papers were sourced from the citations in the selected articles. Through this process, we identified 199 published articles and working papers in the finance area and 77 articles in the accounting area. We then narrow down the total number of studies to 151 to be used in this study.

We then conducted step 3 “Synthesis” and step 4 “Analysis” by categorizing, summarizing and examining existing research on the tools, motivations, enablers, and impacts of green finance and sustainability disclosure. We also identified connections, contractions, and gaps in existing research, discussed controversial issues, and suggested future research directions.

Table 1 discusses the SALSA approach and steps in detail.

3. Background: green finance instruments, motivations and challenges

In this section, we provide some background for green financial instruments and their motivations. We also identify the demand for and gap in the disclosure of green practices.

3.1 Green financial instruments

Extant literature (e.g. Bai, Chu, Shen, & Wan, 2021 ; Falcone & Sica, 2019 ; Heinkel, Kraus, & Zechner, 2001 ; Maltais & Nykvist, 2020 ; Miroshnichenko & Mostovaya, 2019 ) has examined and defined various green financial instruments. Synthesizing these definitions, we define green financial instruments as private loans, public bonds (corporate, municipal and sovereign), private equity, public equity, investment funds and other financial instruments that fund environmental and climate-friendly projects such as renewable energy, recycling and green infrastructure that supports the net-zero carbon economy and mitigates climate change.

Surveying the trends and developments of green financial instruments, the most common and influential financial instruments are green bank loans and green bonds ( Gilchrist, Yu, & Zhong, 2021 ). Specifically, Buchner et al. (2021) find that in 2021, the majority of the green finance (61%) was raised as green debt (loans and bonds), 33% was equity investment and 6% was government and institutional grants. Other common green financial instruments include green derivatives ( Little, Hobday, Parslow, Davies, & Grafton, 2015 ), green insurance ( Mills, 2012 ), carbon tax ( O’Mahony, 2022 ) and carbon investing and pricing instruments ( Hafner, Jones, Anger-Kraavi, & Pohl, 2020 ).

In terms of the main areas of investment targets, most of the green financial instruments are used to fund renewable energy (e.g. solar and onshore wind), primarily from the private sector, with the low-carbon transport being the second largest and fastest-growing sector in attracting investment ( Buchner et al. , 2021 ).

In terms of the adoption of green instruments, studies found that East Asia-Pacific countries taking the lead in promoting green instruments to support the innovation and development of publicly listed companies ( Buchner et al. , 2021 ; Taghizadeh-Hesary & Yoshino, 2019 ). In addition, green financial instruments are adopted faster by the private sector than the public sector with private banks playing a leading role in extending green loans ( Lalon, 2015 ). We call for policymakers to learn from more developed markets to increase green practices and encourage public sector engagement, and to do so efficiently and equitably.

3.2 Motivations of green finance practice

With the increased global and regional environmental policies, there is a significant increase in green finance practices, and the adoption of green financial instruments as investors become more sensitive to climate-related matters. Specifically, the pressure on governments, financial institutions and firms to implement environmental protection and climate change has risen after the signing of the Paris Climate Agreement in 2015 ( Tolliver, Keeley, & Managi, 2020 ). Global and regional bodies such as United Nations, World Bank, International Monetary Fund (IMF), European Union and G20 are increasingly mounting pressure on their members and trading partners to implement green finance policies in their finance systems ( Bhandary, Gallagher, & Zhang, 2021 ).

Due to these pressures, governments, financial institutions and firms are accepting environmentally focused reforms in the world. Therefore, we synthesize the literature and argue that there are two primary motivations for firms' adoption of green practices: (1) violating environmental policies imposes a negative consequence on firms in the form of direct financial penalty and (2) firms lose social capital and reputation with an increase in the actual or perceived investment risk.

Specifically, extant literature has documented declines in firms’ market values following the announcement of environmental violations (e.g. Karpoff, Lott, & Wehrly, 2005 ; Capelle-Blancard & Laguna, 2010 ). Similar stock market reactions to environmental problems have been documented in the global markets – in China ( Xu, Zeng, & Tam, 2012 ; Wang, Zhang, Lu, Wang, & Song, 2019 ), Japan ( Nakao et al. , 2007 ; Takeda & Tomozawa, 2006 ), Korea ( Dasgupta, Hong, Laplante, & Mamingi, 2006 ) and India ( Gupta & Goldar, 2005 ).

As a result of the negative market reaction to environmental misconduct and violations, firms move toward green practices to capture the high social capital and mobilize community and government support, easing tension between firms and regulators and reducing compliance costs. And they use green instruments to finance their green practices.

3.3 Demand for disclosure

Regardless of the form of green finance, what is embedded in these green instruments is a commitment made by the issuer/borrower that the funds raised will be used toward “green projects”. The efficiency of these instruments, therefore, depends on the confidence of market participants in how the proceeds are used for their intended purpose and the actual sustainability performance of the projects funded. Taking green bonds as an example, the key difference between a green bond and a traditional bond is that the issuer of the bond would self-designate the bond as green. Such a label conveys commitment that the funds raised from the bond would be used exclusively to support low-carbon and climate-resilient investment projects.

Naturally, market participants of green finance demand standards and criteria to define what projects qualify the “green” label and standards/frameworks to regulate issuers’ disclosure of the usage of bond proceeds and the environmental, social and governance (ESG) performance of the projects invested. For example, the Royal Bank of Canada (RBC) is advocating for clear standards, taxonomy and parameters for sustainable finance ( Institute for Sustainable Finance, 2019 ). As part of its plan to reach $100bn in sustainable financing by 2025, the RBC issued its first €500m ($752m) green bonds in 2019 that target to fund renewable-energy projects and sustainable buildings.

Existing research provides insights into the unique nature of green instruments and how transparency regarding project selection and performance monitoring is the key to the credibility of the green finance market. Park (2019) discussed the earmarking process for green bonds and reviewed public regulation as well as private governance of the green bond market in relation to establishing standards and guidelines to define green bonds and monitor the issuers’ use of proceeds. Sartzetakis (2021) reviewed the Green Bond Principles (GBP), which is the first and most recognized set of voluntary guidelines for green bonds issued by the International Capital Market Association (ICMA), and other similar guidelines developed by different countries and/or issuing authorities. Not surprisingly, all these guidelines provide frameworks that cover the definition of “green” projects, transparency regarding project selection and fund allocation, as well as subsequent reporting to the public regarding the use of the proceeds and the environmental performance of the projects funded. While disclosure about project selection and fund allocation occurs at the early stage and is most likely one-time, subsequent reporting of the environmental outcome of the use of proceeds is ongoing and the quality of which is crucial to ensure the integrity of the financial instrument.

We would therefore in the next section provide a review of research on corporate sustainability reporting. Understanding the current status of sustainability reporting helps one evaluate the benefits and limitations of green finance. Insights into the value of sustainability reporting and mechanisms to enhance such disclosure help one identify directions for further development and regulation of the green financial market.

4. Sustainability reporting: trend and determinants

An indispensable aspect of green finance is the disclosure of environmental impacts of business operations, green initiatives and performance and environmental risk management practices to the stakeholders of companies. As green finance directs investment toward environmentally sustainable businesses, demand rises for business entities to provide transparent information about their green initiatives and sustainability performance to the public in order to facilitate investment decisions and hold the business entities accountable. In this section of the paper, we review the literature in the area of sustainability reporting and summarize the current trend, factors that affect the reporting of sustainability and the impact of such reporting on firm performance.

4.1 The trend of sustainability reporting and assurance

4.1.1 sustainability reporting.

Sustainability reporting started as voluntary disclosures. As this trend increases, some countries established regulations that require mandatory disclosure. Corporate disclosure of sustainability benefits the reporting entities and leads to “improved reputation, better risk management, and increased customer and employee loyalty” ( Schooley & English, 2015 ). As green finance gains popularity, the capital market demands high-quality information reported by participating companies to guide the allocation of resources toward sustainable business projects and models.

The literature documents an increase in environmental disclosure over the past few decades around the globe and the environmentally sensitive industries tend to be the ones that see the most reports ( Alali & Romero, 2012 ; Deegan, 2002 ; Deegan & Gordon, 1996 ). The growing demand and supply of sustainability reports call for a set of standards that govern the reporting practice. Multiple standards co-exist at the current stage. One example is the Global Reporting Initiative (GRI), which came into being in 1997 with the goal of developing global standards for sustainability reporting. Another example is the Sustainability Accounting Standards Board (SASB) in the US, established in 2011 to develop a framework to guide publicly listed companies in terms of sustainability accounting and reporting.

Quantifying the impact of environmental initiatives is an important task in sustainability reporting. Jeffers (2007 , 2008) discusses what should be considered when developing a framework to measure green initiatives and notes the importance to identify and estimate relevant variables in translating environmental initiatives into quantifiable financial data. Gray (2006) offers critiques about sustainability reporting by demonstrating the tension that such reports, especially the high-quality ones, would simply show how incompatible prevailing economic goals are with environmental and social goals. Adams (2020) revisits Gray's (2006) study incorporating recent developments in sustainability reporting standard setting and suggests that the development of GRI standards has brought positive changes.

4.1.2 Carbon accounting

One aspect of quantifying the environmental impact of decision-making is measuring greenhouse gas (GHG) emissions. Carbon accounting as the name suggests specifically focuses on the recognition and measurement of GHG emissions. Through a systematic review of existing literature, Stechemesser and Guenther (2012) derive a definition of carbon accounting as follows: “carbon accounting comprises the recognition, the non-monetary and monetary evaluation and the monitoring of greenhouse gas emissions on all levels of the value chain and the recognition, evaluation, and monitoring of the effects of these emissions on the carbon cycle of ecosystems.”

Based on Stechemesser and Guenther (2012) ’s definition, Marlowe and Clarke (2022) review the carbon accounting literature focusing on the business organization level as well as city-level quantification of GHG emissions. They identify a global trend of increasing emissions and conclude that quantifying carbon emissions involves significant measurement uncertainty and lack of comparability. They thus call for policies, procedures and academic work to improve the reporting of carbon accounting.

4.1.3 The assurance of sustainability reporting

Like financial reporting and disclosure, sustainability reporting provides information for decision-making. The efficiency of resource allocation hinges on the quality of information reported by business entities. As sustainability reporting and the use of information in sustainability reports grow, there is a call for independent assurance of such reporting by third parties. Junior, Best, and Cotter (2014) review the literature and analyze the Fortune Global 500 companies to provide comparative and trend analyses of sustainability reporting and assurance of these reports. They find that while an increasing percentage of organizations issue sustainability reports over time, there is no such trend in the practice of having the sustainability reports assured.

A recent study by Alsahali and Malagueño (2021) provides an updated overview of sustainability assurance practices based on a sample of 13,000 companies around the world. The period that they focus on is the recent decade to match the emergence of countries mandating sustainability reports. The study addresses the following aspects of sustainability assurance. First, they examine the trend of sustainability assurance and find that even though significant growth in assurance is observed from 2012 onward, it lagged behind the growth of the sustainability reports. Second, they examine three types of assurance providers, i.e. accounting, engineering and consulting firms, and find that while accounting firms have the largest market share, the most growth is seen in engineering firms. Considering the existence of multiple assurance standards, e.g. the International Standard for Assurance Engagements (ISAE 3000) and the AA1000 AccountAbility Standard (AA1000 AS), the study investigates the choices of standards and finds that different types of assurance providers have different preferences, which raises the concern of inconsistency in the assurance practice. Third, they examine the incidence of companies changing assurance providers from one type to another and find more switches toward engineering and consulting firms than toward accounting firms.

4.2 Determinants of sustainability reporting

In this subsection, we discuss and summarize factors found to have an impact on the practice of sustainability reporting, including firm characteristics, monitoring of stakeholders and regulatory changes.

4.2.1 Firm-level determinants of sustainability reporting

Hahn and Kühnen (2013) review existing literature from 1999 to 2011 on determinants of sustainability reporting and disentangle factors that have received consistent evidence regarding their impact on sustainability reporting from other factors around which evidence is inconsistent and ambiguous. Company size is the only internal factor found to have a positive influence on sustainability reporting, whereas evidence is mixed regarding the impact of financial performance and social and environmental performance. Among the external factors, the literature generates consistent results on how media exposure as a proxy for visibility is positively associated with sustainability reporting and that companies from industries with more significant environmental impacts tend to engage more in sustainability reporting. At the time of this review, very limited research has examined the impact of regulation even though countries such as Denmark, Norway and Sweden already started to impose policies and legislation to require companies to make sustainability disclosure.

4.2.2 Regulation, governance, and sustainability reporting

The European Union (EU) Emission Trading Scheme introduced in 2005 represents a significant movement toward governing and incentivizing low-carbon initiatives. Based on a “cap and trade” principle, companies must keep their carbon emission under the cap and at the same time can buy or receive emission allowances to trade with one another.

In terms of regulation of sustainability disclosure, the EU adopted D irective 2014/95/EU , also called the Non-Financial Reporting Directive (NFRD), which was then incorporated by member states into their legislation requiring large European companies to publish regular reports on the social and environmental impacts of their activities. Jackson, Bartosch, Avetisyan, Kinderman, and Knudsen (2020) investigate the effectiveness of mandatory non-financial disclosure requirements and found that firms in countries with such mandates adopt more socially responsible activities without reducing socially irresponsible activities.

Evidence from outside of the EU suggests a positive impact of mandatory disclosure requirements. Ioannou and Serafeim (2017) study the effect of mandatory sustainability reporting by looking at companies in mandating countries including China, Denmark, Malaysia and South Africa surrounding the passage of related regulations. They find that firms not only increasingly provide sustainability disclosure in response to the regulation but also increasingly have their reports assured on a voluntary basis to signal the quality of their reports. The regulation-driven disclosure of sustainability is also found to have a positive association with firm value as proxied by Tobin’s Q. Ren, Huang, Liu, and Yan (2023) test whether the mandatory corporate social responsibility (CSR) reporting requirement in China leads to improved environmental practices and find that firms bound by this mandate show increased green innovation and that such effects are positively moderated by local enforcement intensity, state ownership, and media coverage.

Internal and external governance mechanisms have also been found to promote information disclosure. Using a global sample of 1,047 companies, Fernandez-Feijoo et al. (2013) find evidence that the pressure of stakeholders leads to improved transparency of sustainability reports. Recent literature has provided consistent results on the influence of corporate governance on sustainability reporting around the globe. For instance, Masud, Kaium, Nurunnabi, and Bae (2018) document that in their sample of South Asian countries companies with foreign and institutional ownership, more independent and larger boards tend to have better sustainability reporting performance. Based on a sample of Australian resources companies, Ong and Djajadikerta (2020) show that more independent boards, multiple directorships and representation of female directors are positively associated with the extent of sustainability disclosure, proxied by Ong et al. ’s (2016) index. Gallego-Álvarez and Ortas (2017) find evidence consistent with the stakeholder theory in the governance literature in that corporate sustainability reporting practices are responsive to stakeholders’ demands, which in turn are influenced by the cultural environment.

4.3 The value of sustainability disclosure

4.3.1 sustainability disclosure and firm performance.

Early evidence on how sustainability translates into company value has been mixed ( Romero, Lin, Jeffers, & DeGaetano, 2014 ). While research has found a positive association between sustainability initiatives and corporate value (e.g. Burnett, Skousen, & Wright, 2011 ; Clark & Allen, 2012 ), other studies find no significant stock market impact imposed by sustainability reports ( Guidry & Patten, 2010 ) or even negative association between corporate social performance and financial performance ( Lee, Faff, & Langfield-Smith, 2009 ).

More recent research provides evidence on the positive side. Alshehhi, Nobanee, and Khare (2018) analyze the literature on the relationship between corporate sustainability practices and financial performance. Reviewing 132 research papers shows the majority of evidence of the positive relationship between the two. International evidence suggests largely consistent results. Lo and Sheu (2007) examine US companies and find a positive relationship between corporate sustainability and firm value as proxied by Tobin’s q. Similar results are found among listed companies in Singapore ( Loh, Thomas, & Wang, 2017 ). Kuzey and Uyar (2017) examine a sample of Turkish public companies and document a growth of sustainability reporting in the country and find evidence that sustainability is value relevant. Bachoo Tan and Wilson (2013) add Australian evidence to the literature and find that high-quality sustainability reporting reduces the cost of capital and enhances the market’s expectation of future firm performance.

Consistently, carbon accounting research suggests that GHG emission has a negative impact on firm valuation. Griffin, Lont, and Sun (2017) document a negative pricing impact of GHG emission and quantify such impact to be a $79 price discount per ton of GHG emission. Matsumura, Prakash, and Vera-Munoz (2014) examine the effect of carbon emissions on firm valuation and document a negative impact in the magnitude of a $212,000 decrease in firm value for every thousand incremental metric tons of carbon emissions. Further, they find that companies that voluntarily disclose carbon emissions receive a valuation benefit compared to the companies that do not disclose such information.

Most existing research excludes financial institutions from their sample due to the unique feature of the financial industry. Buallay (2019) however specifically study 342 financial institutions from 20 different countries and associate their ESG score with firm performance. The findings show a positive impact of sustainability on market valuation whereas a negative impact on financial and operational performance. The evidence offers insights from the financial industry and suggests that the long-term and short-term effects of sustainability efforts can be different.

4.3.2 Sustainability disclosure and value relevance

A set of research specifically investigates the impact of sustainability reporting on how the market evaluates financial statement metrics, that is, value relevance. Lourenço, Callen, Branco, and Curto (2014) refer to the inclusion of the company in the Dow Jones Sustainability United States Index as a proxy for sustainability reputation. They find that the index companies’ financial data have higher value relevance, suggesting that sustainability reputation is valued by the market. Comparing a set of Indonesian companies that received the Sustainability Report Award with their counterparts, Sutopo, Kot, Adiati, and Ardila (2018) find that the value relevance of award-winning companies is higher, suggesting that high-quality sustainability reporting increases the perceived value of financial statement data. Berthelot, Coulmont, and Serret (2012) provide Canadian evidence that the capital market positively values the reporting of corporate sustainability even when it is voluntary.

Evidence on value relevance points to the capital market benefits of sustainability reporting, which by enhancing transparency and firm reputation improves the market perception of financial reporting. Sustainability as non-financial disclosure has a spillover effect on the efficiency of the capital market while incorporating information contained in financial disclosure into the market valuation.

5. Challenges in green finance and sustainability disclosure

The main challenges in the areas of green finance and sustainability disclosure center around the measurement of the green effects and the reliability and comparability of the reported corporate environmental performance data.

Due to the lack of one generally accepted set of standards that guide the reporting of sustainability and the lag of growth in the third-party assurance of such reporting, the main challenges for sustainability reporting are its reliability, consistency and comparability. Dragomir (2012) examines the corporate sustainability reports of the largest five European energy companies for assessment of their reporting quality in terms of corporate environmental performance and finds that the reports lack clarity and consistency in the methodologies used, suggesting that research based on cross-sectional data drawn from corporate sustainability reports can be risky due to incomparability of such data.

Similar concerns and challenges apply to carbon accounting. Wegener, Labelle, and Jerman (2019) examine the GHG emissions reports across corporations and document the lack of comparability in these facility-level quantified emissions data and that therefore relying on such information can mislead the readers. Bowen and Wittneben (2011) show that the challenges carbon accounting faces are a result of tension and negotiation between different goals, such as accuracy, consistency and certainty, across different reporting levels.

The measurement issue then leads to concerns about the legitimacy of using sustainability indicators in contracts such as executive compensation. Bebchuk and Tallarita (2022) find that in almost all cases in which S&P 100 companies use ESG metrics, it is difficult if not impossible for outside observers to assess whether this use provides valuable incentives or rather merely lines the chief executive officer’s pockets with performance-insensitive pay. They, therefore, conclude that the current ESG metrics likely serve the interests of executives, not of stakeholders and that the expansion of ESG metrics should not be supported even by those who care deeply about stakeholder welfare.

Lack of reliable and comparable sustainability disclosure further confounds the effectiveness of green financial instruments, in view of the potential opportunistic use of the proceeds (i.e. greenwashing). Greenwashing is the practice of marketing products, services and financial instruments as “green,” “sustainable,” “carbon neutral” or “net zero” when in fact they do not meet basic environmental, climate, or sustainability standards of verifiability or credibility ( Schumacher, 2022 ). Green bonds present an incentive for companies to raise funds with potentially lower financing costs under the name of green. Wang, Chen, Li, Yu, and Zhong (2020) document a higher pricing premium for corporate green bonds in China, as reflected by a lower yield spread, compared to their conventional counterparties. The favorable pricing, thus lower financing costs, accompanies the boom of the green bonds market in China around 2019 as well as an exponential growth of green bonds globally in over 20 countries. As more issuers race for the low-cost financing tool, the potential for greenwashing draws the attention of researchers and regulators. Inconsistency of the definition of green bonds, lax restriction on the eligible use of proceeds and divergence of the transparency requirements all contribute to the potential opportunistic use of green bonds with proceeds from such investment being “green-washed” ( Zhang, 2020 ; Xu, Lu, & Tong, 2022 ). Research thus calls for strengthened oversight and regulation over the green bond market for the integrity and success of green investments ( Banahan, 2018 ; Zhang, 2020 ).

With economic recovery from the impact of COVID-19 an eminent task around the globe, the incentive for companies to fund various projects through the use of green bonds may be intensified. A challenge is therefore posed for the governments and self-regulating bodies to improve the existing policies, regulations and guidelines for clarity, transparency, consistency and accountability.

Mindful of the challenges, a natural question arises regarding the effectiveness of green financial instruments and green practice in general. We will therefore review existing research on the economic implications of green finance in the next section, without a directional association expected ex ante .

6. Economic implications of green finance

6.1 relationship between green instruments and green results.

To better understand the economic implications of green finance, we first examine whether and through what channel green finance leads to green results such as emission reduction and energy saving. Several tools exist to measure the green results, such as carbon emission reduction, qualitative sustainability, benchmarking standards, and survey-based approaches ( Truant, Corazza, & Scagnelli, 2017 ). Using data from 30 Chinese provinces from 2005 and 2018, Chen and Chen (2021) find that the development of green financial instruments contributes to carbon emission reduction, and this has a spatial spillover effect of not only reducing the emissions of a local region but also inhibiting the emission of adjacent areas. The authors argue that this is because the development of green finance leads to a decrease in carbon emissions by reducing financing constraints and boosting green technology innovation. Similarly, Khan, Riaz, Ahmed, and Saeed (2022) find that green finance reduced the ecological footprints in the Asia and Pacific area, and the findings are robust to using alternative measures and estimation strategies.

We next examine the literature on the mechanisms through which green finance is associated with green results. Synthesizing the literature, we argue that green finance can penetrate environmental protection through two mechanisms of funding: fund orientation and policy guidance.

The funding-oriented mechanism presents an increase in the financing constraints of high-polluting enterprises and guides funding (in the form of debt or equity) towards low-emission and low-polluting industries ( Wang & Zhi, 2016 ). Meanwhile, the funds into green firms and industries force the transformation and upgrading of high-polluting firms, leading to positive impacts on carbon emission reduction ( Liang, Yu, & Ke, 2021 ). The funding-oriented mechanism improves access to capital and reduces the cost of capital for green firms.

The policy-guidance mechanism argues that government and other regulatory bodies’ green finance policies support the development of green industries through government procurement, financial support, tax reduction, fee reduction, etc. For instance, Flammer (2018) finds that the firms that use green bonds usually improve green innovation and are more likely to win government procurement contracts. Also, it will ultimately guide the improvement and attainment of a greener industrial structure and infrastructure. This mechanism improves the cash flow of green firms, boosting the profitability and competitiveness of green firms and industries ( Hu, Jiang, & Zhong, 2020 ). Furthermore, with the resources from national policies, it will effectively reduce carbon emissions as well as speed up the transformation and improvement of high-pollution industrial structures.

As green projects usually require significant capital investment with long-term effects ( Edmans, 2023 ), the presence of funding-oriented and policy-guidance mechanisms, along with the reputation gain of being green, reduces the overall risks of the projects. This will force firms to consider environmental factors in production, operation and innovation activities, and it can reduce social and reputational risks caused by climate change, environmental pollution and other environmental damage. In addition, society’s long-term view of green projects, available funding and policy support encourages firms to be more innovative in their financing and operational efforts. Studies find that green loans fund green innovation, supporting firms to develop innovative products ( Díaz-García, González-Moreno, & Sáez-Martínez, 2015 ) and making them more competitive, particularly among high-tech companies ( Chen, Huang, Drakeford, & Failler, 2019 ). Therefore, Andreeva, Vovchenko, Ivanova, and Kostoglodova (2018) highlight the importance of green finance and the need for innovative financial tools for funding the green economy.

6.2 Firm financial performance and corporate responses

6.2.1 firm financial performance.

In this subsection, we review literature that examines the relationship between a firm’s financial performance and its green finance practices.

In general, the literature tends to find a positive relationship between green practices and financial performance, although there is disagreement in existing studies. In Alshehhi et al. (2018) ’s review paper, 78% of the 132 articles reviewed report a positive relationship between green practice and financial performance, 6% report a negative relationship, and 7% report a no-impact relationship.

We examine the literature and argue that three factors could have contributed to the differing results. First, the variation in the results is attributed to the measurement of financial performance as well as that of green practice. Overall, firm financial performance is measured by (1) the stock market returns, (2) market-based measures such as Tobin’s Q, Price to Earnings (P/E) ratio and market valuation or (3) accounting-based measures such as the return on assets (ROA), return on equity (ROE) and earnings per share (EPS). Different choices of measures could have led to different results. In terms of measuring green practice, there is significant disagreement ( Berg, Koelbel, & Rigobon, 2022 ; Zhang Zhang, & Managi, 2019 ) as to which factors and green practices are relevant, how to assess them, and the relative weight to put on each. The measurement issue we discussed earlier in relation to sustainability reporting also confounds the research of green finance. As researchers utilize data collected from corporate reports, the lack of consistent standards and framework that govern such disclosure leads to concerns about the credibility of research findings. For example, Cornell and Damodaran (2020) build a framework to examine how being socially responsible can manifest in the tangible ingredients of value and look at the evidence for whether being socially responsible is creating value for companies and investors. The authors argue that findings of a positive relationship between ESG and financial performance are sensitive to both how ESG and profitability are measured.

Second, extant studies use different research methodologies and study designs, which further exacerbates the problem of inconclusive literature when it comes to the relationship between green practice and financial performance. Commonly used methodologies include regression analysis, survey, content analysis, wavelet analysis, and event study. The positive relationship documented by most studies can be contributed to the mechanisms discussed in subsection 6.1 . In addition, Chang, Fu, Jin, and Liem (2022) find that green practice increases firm value by motivating employees, strengthening relationships with suppliers, boosting long-term growth, increasing dividends and reducing financing costs. Nevertheless, this could also be an endogeneity issue, with firms doing well financially being more likely to initiate green efforts.

Third, differences in firm size, industry, market examined and time period also contribute to the differing results. For instance, the negative relationship between green practice and financial performance, in particular stock return, is usually documented in earlier studies. This calls for research to examine the role of moderating variables such as firm size, economy and institutional background, and industry type, in order to identify potential groupings along the lines of those variables. This also calls for granularity in research that looks at various institutional settings and situations, as we may not have a “one-size-fits-all” result.

6.2.2 The cost of capital

Another way to study the impact on firm performance, in line with the valuation category, is to examine the cost of capital associated with green financial instruments and firms’ green practices. Studies have in general agreed that investors and lenders require a higher return from firms with environmental concerns and that companies with green practices tend to have a lower cost of capital.

In particular, Chava (2014) shows that firms with significant environmental concerns pay a higher interest rate on loans (20% higher loan interest rate, approximately 25 bps) and has a higher cost of equity (approximately 7% higher) and that these firms have fewer banks participate in their loan syndicate and have lower institutional ownership. Similarly, Jung, Herbohn, and Clarkson (2018) find a higher cost of debt associated with firms failing to disclose carbon emissions in the carbon disclosure project survey, with a one standard deviation increase in carbon risk associated with a 38-62 bps increase in the cost of debt. Bolton and Kacperczyk (2021) document that high carbon emission firms face a higher cost of capital for both the US and international stocks. Kim, Wan, Wang, and Yang (2019) find a negative relationship between institutional ownership and toxic release from facilities to which institutions are geographically proximate.

Overall, the price impact of investors’ preferences for green assets has been broadly documented in the literature with the findings that companies with a high environmental performance benefit from a lower cost of capital. Hasan, Hoi, Wu, and Zhang (2017) find that firms with environmental commitment face lower bank loan and bond spreads and less restrictive non-pricing loan terms. Hachenberg and Schiereck (2018) and Zerbib (2019) both document a small negative premium (−1 bps to −2 bps) between green bonds and conventional bonds, and Chen et al. (2019) find less-demanding collateral associated with green loans. Authors mainly attribute this negative yield differential to a financial reality: intangible asset creation (e.g. Flammer, 2015 ) as well as better risk management and mitigation ( Bauer & Hann, 2014 ). These findings are consistent with previous studies that highlight the long-term view of socially responsible firms and an associated reduced level of risk of violation and damaged reputation ( El Ghoul, Guedhami, Kwok, & Mishra, 2011 ). Also, green loans strengthen the capital structure of small businesses to sustain them from financial distress by extending loans to small businesses at lower interest rates and extended repayment periods ( Cullen, 2018 ).

Other studies examine stock response upon green bond announcement. For instance, Zhou and Cui (2019) find that green bond issuance has a positive impact on firms’ stock prices, profitability, operational performance, and innovation capacity. Tang and Zhang (2020) show that the positive stock returns around green bond announcements are associated with an increase in institutional ownership and stock liquidity. Similarly, Wang et al. (2020) find positive abnormal stock returns after the issuance of green bonds consistent with the stakeholder value maximization theory. Specifically, the authors document a significant pricing premium of corporate green bonds relative to matched conventional bonds and that the economic magnitude of this premium is more pronounced for issuers with better performance in corporate social responsibility.

These studies emphasize the relationship between green bonds and equity performance and value creation. However, as discussed in Section 5 , we do not suggest a causal relationship between green bond issuance and firm performance, as green bond issuance can be perceived as a signal of green practice without delivering direct green results.

6.2.3 Implications for investors

With findings on the reduced cost of capital and hence enhanced firm value associated with firms with green practices, a strand of literature examines the green investing practice (also called “sustainable investing”).

Overall, the popularity of green investing is attributed to two motives. The first motive is to change firm behavior in improving their green practice, thus creating more positive externalities. This second motive can be achieved through two channels of exit by divesting from nongreen companies ( Edmans, 2023 ) and voice that involves engaging with a company through voting, private meetings, and public activism to cut its carbon footprint ( Edmans, 2023 ; Hoepner, Oikonomou, Sautner, Starks, & Zhou, 2022 ).

The second motive for green investing is better risk-adjusted returns associated with green stocks. In particular, the asset pricing literature has now included sustainability as a risk factor with Zerbib (2022) developing a sustainable capital asset pricing model (S-CAPM) and Dimson, Karakaş, and Li (2015) demonstrating the value-enhancing effects of shareholder engagement in environmental issues.

A common green investing strategy is to overweight (underweight) assets with low (high) environmental footprints ( Krosinsky & Purdom, 2016 ; Coqueret, 2022 ). These practices are supported by studies that find “green” firms outperform “brown” firms (not environmentally friendly). Examples include Aswani, Raghunandan, and Rajgopal (2022) , Bolton and Kacperczyk (2021 , 2022) , Garvey, Iyer, and Nash (2018) , Görgen et al. (2020) , In, Park, and Monk (2017) , and Hsu, Li, and Tsou (2022) . In addition, Hartzmark and Sussman (2019) suggest that sustainability is viewed as positively predicting future performance, and Pástor, Stambaugh, and Taylor (2022) find that green assets outperform brown assets in particular as climate concerns strengthened.

Investors have recognized the environmental risks and priced them into their investment decisions ( Krueger, Sautner, & Starks, 2020 ; Shen, LaPlante, & Rubtsov, 2019 ). According to Engle, Giglio, Kelly, Lee, and Stroebel (2020) , stock investors can hedge against climate risk by forming dynamic portfolios that are long on the winners of climate change and short on the losers. Additionally, Choi, Gao, and Jiang (2020) offer more direct evidence of investor attention to global warming by showing that the Google search volume index, an indicator of retail investor attention, increases with abnormal local temperature jumps while stocks of carbon-intensive firms underperform firms with low carbon emissions in abnormally warm weather.

As the economy recovers from COVID-19, researchers have uncovered the diversification potential of green investing in the face of crises. The literature on spillover, flight-to-quality cross-market interdependence, and hedging opportunities across assets and financial markets has attracted a lot of attention since the subprime crisis of 2007 and now during COVID-19 and its recovery period. Specifically, studies find that investors started shifting toward sustainable avenues of investment during the COVID-19 period, which is in line with the common parlance that investors shift their preferences toward a broader and holistic perspective during times of crises, using green instruments to hedge against downside risks, especially in the backdrop of a crisis ( Naeem, Mbarki, Alharthi, Omri, & Shahzad, 2021 ; Sharma, Tiwari, Talan, & Jain, 2021 , 2022 ; Talan & Sharma, 2020 ; Umar Gubareva, Tran, and Teplova, 2021 ).

In summary, our study of the literature shows that green financial instruments provide an option that improves investors’ returns and supports the financial markets during and post the COVID-19 period.

6.2.4 Implications for companies

While equity investors hedge the environmental risks by creating portfolios, corporate managers make strategic firm-level decisions in consideration of the climate and related risks. For instance, Flammer (2013) documents a cushioned stock market reaction to negative corporate environmental news for firms with high ex ante environmental performance, suggesting environmental practice as a way to reduce firm risks. Lemoine and Rudik (2017) suggest firms should respond to the carbon tax by delaying reducing emissions and cumulating greater emissions to take advantage of the climate systems’ inertia. Liu (2018) finds board gender diversity reduces environmental infringement. Bai et al. (2021) show that firms tend to manage climate change risk induced by sea-level rise (SLR) by acquiring firms that are unlikely to be directly affected by SLR. Similarly, Xiong, Lam, Hu, Yee, and Blome (2021) find that firms mitigate the negative impacts of environmental violations with improved environmental transparency and supply chain diversity. Also, Li, Lin, and Lin (2021) find that firms manage the country-level climate vulnerability risk they face through corporate innovation in climate change mitigation technologies, exploitative patents and global collaborative patents in innovations and promote international strategic alliances. In addition, as discussed in Section 4.2 of the paper, extant literature also documented that firms strategically choose corporate board composition and provide disclosure of green innovation and sustainability practices.

6.3 The impact of green finance on economic development and recovery

Various authors have also studied the impact of green finance on poverty alleviation and economic development. For instance, Jiang et al. (2020) study 25 Chinese provinces from 2004 to 2017 and show a significant positive correlation between green finance and poverty alleviation. Therefore, the authors suggest that poverty can be better alleviated by improving the level of green finance development, financial asset level, and economic development level. Similarly, Liu, Liu, Xia, Ren and Liang (2020) find a strong relationship between green finance and the green economic development of 30 Chinese provinces for the period 2007–2016. Koengkan, Fuinhas, and Kazemzadeh (2022) document the positive impact of financial incentive policies for renewable energy development and consumption of green energy on economic growth with data from 17 countries in Latin America and the Caribbean from 1990 to 2016. Using more recent data between 2008 and 2019 collected from the central banks of all the Association of Southeast Asian Nation (ASEAN) countries, Ngo, Tran, and Tran (2022) find that green finance along with capital formation and government educational expenditures have a positive association with the economic development of ASEAN countries.

Akomea-Frimpong, Adeabah, Ofosu, and Tenakwah (2021) argue that green investment ensures that firms have adequate finance to tackle the economic challenges among the minorities, accompanying old age (pension), ensure social cohesion and integration, sound corporate governance and improve labor relations.

The COVID-19 pandemic has changed the priorities of countries, which motivates researchers to examine the issue further. Cheema-Fox, LaPerla, Wang, and Serafeim (2021) find that companies scoring high on a “crisis response” based on ESG measures were associated with higher returns, suggesting a buffering effect of better ESG performance. Similarly, Tu et al. (2021) argue that green finance policies such as carbon pricing and green credit can provide low-cost finances and counteract the adverse effects of COVID-19. Sharma, Sarker, Rao, Talan, and Jain (2022) ’s findings suggest that investors will not lose on risk-adjusted returns if they chose to go green and that investors and fund managers subtly shift their focus toward sustainable indexes post-COVID-19.

Studies have also argued for the necessity of considering total sustainability (the aggregate of economic, environmental, and social dimensions) to achieve sound strategic decisions. Alshehhi et al. (2018) find that the literature started moving towards consolidating a holistic sustainability approach to corporate performance with a social–environmental combination. In particular, the problem with this combination approach is that it overlooks economical sustainability while closely resembling CSR, which underplays environmental sustainability.

Although extant studies are consistent on the impact of green finance and regional economic development, the results are valid only in specific countries or regions and the research investigation lacks generalizability as there are underlying differences and drivers in the world’s vast economies. Although investment in green energy fuels a sustainable green economy, its effectiveness varies from country to country ( Zhang Mohsin, Rasheed, Chang, and Taghizadeh-Hesary, 2021 ). This is similar to the discussion on differing results in subsection 6.2.1 . This calls for a standard scale to evaluate the impacts of green financial development.

7. Conclusion and future research direction

7.1 summary of key findings.

This paper reviews green financial instruments, sustainability disclosure practices and the impact of green finance on firm performance and economic development.

We first provide background for green financial instruments. Literature suggests two primary motivations for firms' adoption of green practices: (1) violating environmental policies imposes a negative consequence on firms in the form of direct financial penalty and (2) firms lose social capital and reputation with an increase in the actual or perceived investment risk.

Increasing public attention to the environment and the rise of green finance intensify the demand for environmental disclosure. Literature has found consistent evidence that sustainability reporting grow tremendously over the past decades and around the globe although the adoption of third-party assurance is found to lag. Along with critics and concerns about how such reporting lack consistency, comparability and assurance, efforts are being made in terms of developing generally accepted standards for reporting and government regulations that mandate sustainability disclosure for large companies.

We find that in general literature agrees that a firm’s green practice is positively associated with its financial performance and negatively related to a firm’s cost of capital. Moreover, green financial instruments contribute to firms’ access to capital and innovation related to environmental efforts. As a response, equity investors hedge the environmental risks by creating portfolios including green companies and corporate managers make strategic firm-level decisions in consideration of the climate and related risks.

7.2 Future research direction

7.2.1 green finance and sustainability disclosure in the traditional framework of finance, accounting, and economics.

As the first research direction, we suggest applying traditional finance, accounting and economics theories and techniques to examining green finance and sustainability disclosure.

For instance, Edmans (2023) posit that insights from mainstream finance and economics can be applied to ESG, as ESG “is economically no different to other intangible assets that create long-term financial and social value.” The same applies to green finance. The rich literature on corporate finance research has examined how to create long-term financial values and how to value investments, and research on asset pricing has explored how the stock market prices risks. Abundant economic research has looked at how to investigate externalities and enhance social welfare. We, therefore, suggest looking at green practices with short-term costs and long-term benefits and examining their relationship with the cost of capital, and firm value impact.

In the area of risk management, in general, green finance is accompanied by potential losses, especially with the long-term nature of investment in green projects ( Chen et al. , 2019 ). We suggest that future studies and framing of policies examine the robustness of the risk management models and embrace more responsible financial conduct with environmental viewpoints.

Similarly, sustainability reporting as one type of information disclosure can benefit from situating related research work in the theoretical framework of information asymmetry, disclosure, efficient market, contract theory and agency theory. Future research providing theoretical underpinnings for the demand and supply of sustainability disclosure and thus guidance for the current development of reporting standards and regulations is expected to be valuable.

7.2.2 Data, model and methodology

To the best of our knowledge, there have not been a generally accepted set of green measures that apply to all major countries, both developing and developed countries. It is not easily accessible to get data on green finance as there is still no consensus on the measure of greenness ( Cui, Geobey, Weber, & Lin, 2018 ). Researchers must build practical models on and institutionalize reliable data on green finance. Further research addressing performance indicators and disclosures and their implications is needed.

As a developing concept, green finance is limited in the scope of issues covered and the dimensions of study. The relevant issues on green finance products in the broader green finance spectrum are unclear. Also, there is an overlap of the issues relating to the products and concepts surrounding green finance and scholars, and practitioners are not clear about these issues. Existing studies have shown and discussed a limited number of issues (social, environmental, legal, technological and others) that affect green finance. These issues remain distinctively presented and analyzed with unclear themes. Another area of concern is the ambiguity and unexplored issues surrounding the dimensional approaches of green finance.

In addition, further research can be conducted on identifying the enablers and the challenges to green finance using the quantitative approach. Statistical techniques need to be applied to study the relationship between the variables. The statistical analysis of the enablers will support policymakers in undertaking strategic initiatives based on the comparative advantage of the country or region. The challenges and barriers should be studied for getting more holistic information on the concept of green finance. Lastly, green investment is the main objective of green financing so further studies can be conducted on quantitatively measuring green investment and its progress.

Research on sustainability reporting suffers from endogeneity issues as the practice of sustainability reporting is a result driven by numerous factors, including firm-level characteristics and external economic factors, which are inevitably associated with variables that are the subject matter of research, such as firm performance. Due to endogeneity, it is hard for research studies to rule out spurious relationships and establish causal inferences. There is an imminent call for rigorous empirical design that addresses endogeneity through statistical methods or natural experiment settings for conclusive evidence on the causes and consequences of sustainability reporting.

7.2.3 Long-term and short-term economic implications of green finance and practices

Our review has identified the scarcity of studies that investigate the long-term vs short-term economic implications of green finance and green practices. An example is Diaye, Ho, and Oueghlissi (2021) who examine 29 Organisation for Economic Co-operation and Development countries during the 1996–2014 period and find that while there is a positive relationship between ESG and gross domestic product per capita in the long run, such a relationship does not exist in the short run. It has been a long-lasting concern whether economic and environmental pursuits are compatible ( Gray, 2006 ). The tension likely intensifies in light of the current economic environment where prioritizing the two imminent tasks, economic recovery and moving toward the carbon-neutral goal, becomes ever more challenging. Future research sheds light on the trade-off of long-term and short-term economic effects of sustainable business pursuits and green investment and thus provides insights into balancing economic and environmental goals at different stages of the economic cycle is expected to be highly valuable.

7.2.4 Policy implications

Our literature review has emphasized the importance of further support of public policy and regulation. First, our studies have shown that green finance is associated with reduced environmental impacts through proper regulation. However, the magnitude and the mechanisms differ in various countries, markets and industries. This calls for policy to be specific to different regions and industries, with consideration of differences in economic development status. Second, more studies on green finance issues from developing and developed countries’ perspectives would be useful to regulators and policymakers to align different policy goals and develop well-defined policy objectives.

The methodological process of this literature review follows the SALSA approach

Source(s): Own study based on ( Booth et al. , 2021 )

The G20 Green Finance Study Group (2016) defines green finance as “ financing of investment that provides environmental benefits in the broader context of environmentally sustainable development[…] for example, reduction in air, water, and land pollution, reduction in greenhouse gas (GHG) emissions, improved energy efficiency while utilizing existing natural resources, as well as mitigation of and adaption to climate change and their co-benefits ” (p. 5).

Various terms are often used interchangeably to green finance are climate finance, carbon finance, environment finance and sustainable finance. In this paper, we use the term “green finance” as a general term to cover all of the terms.

For brevity, we use the term “green practice” to refer to firms’ decision to issue green financial instruments such as green bond and firms’ practice to reduce its environmental footprint such as emission reduction, recycling, waste management, energy consumption and use of renewable energy.

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Further reading

Csedő , Z. , Magyari , J. , & Zavarkó , M. ( 2022 ). Dynamic corporate governance, innovation, and sustainability: Post-covid period . Sustainability , 14 ( 6 ), 3189 .

Eichholtz , P. M. A. , & Quigley , J. M. ( 2012 ). Green building finance and investments: Practice, policy and research . European Economic Review , 56 ( 5 ), 903 – 904 .

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Engels , A. ( 2009 ). The European Emissions Trading Scheme: An exploratory study of how companies learn to account for carbon . Accounting, Organizations and Society , 34 ( 3-4 ), 488 – 498 .

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Pástor , Ľ. , Stambaugh , R .F. , & Taylor , L. A. ( 2021 ). Sustainable investing in equilibrium . Journal of Financial Economics , 142 ( 2 ), 550 – 571 .

Riedl , A. , & Smeets , P. ( 2017 ). Why do investors hold socially responsible mutual funds? . The Journal of Finance , 72 ( 6 ), 2505 – 2550 .

Shapiro , J. S. , & Walker , R. ( 2018 ). Why is pollution from US manufacturing declining? The roles of environmental regulation, productivity, and trade . American Economic Review , 108 ( 12 ), 3814 – 54 .

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Essays on international financial markets, firms’ capital structure and exporting decisions

Bose, Udichibarna (2016) Essays on international financial markets, firms’ capital structure and exporting decisions. PhD thesis, University of Glasgow.

International finance studies the dynamics in the areas such as international portfolio diversification, foreign investments, global financial systems, exchange rates, etc. This thesis brings together a set of chapters that summarises and synthesises varied areas of international finance maintaining a balance between the micro- and macro-level studies. This thesis is composed of three main empirical chapters contributing to varied aspects of international finance, mainly the areas of international portfolio diversification and home bias puzzle; development of bond markets and access to external finance; exchange rate uncertainties, output volatility and exports. Chapter 1 provides an outline and introduction of the thesis. Chapter 2 provides an extensive literature review on home-bias puzzle, explains the evolution and existence of home-bias puzzle, and gives various institutional and behavioural-based explanations which are considered as the main reasons for the existence of this puzzle. It discusses the advantages of international portfolio diversification and also the disadvantages of under-diversification in international portfolios. It gives a detailed empirical literature on the home bias puzzle and the relation between education and portfolio diversification. Further, this chapter empirically analyses a panel of 38 countries over a period of 2001-2010 to study the impact of different levels of education on home bias and international portfolio diversification. The results highlight that education is crucial in reducing equity home bias. After dividing the countries on the basis of their stock market capitalisation the results show that less developed countries with more university graduates have lower equity home bias. Finally, the results show that the benefits of education are larger during the recent financial crisis for the less financially developed economies. Chapter 3 provides a detailed analysis of the trends in Asian financial markets since the 1990s. It provides the main objectives of the Asian bond market policy initiatives. It also gives a detailed empirical literature of external finance, bond market development across the world and external finance-investment spending nexus. This chapter empirically analyses the impact of policy initiatives co-ordinated by Asian national governments on firms' access to external finance by using a unique firm-level database of eight Asian countries- Hong Kong SAR, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand over the period of 1996-2012. Using difference-in-differences approach and controlling for firm-level and macroeconomic factors the results show a significant impact of policy on firms' access to external finance. After splitting firms into constrained and unconstrained, using several criteria, the results document that unconstrained firms benefited significantly in obtaining external finance as compared to their constrained counterparts. Finally, the results show that the increase in access to external finance, after the policy initiative, helped firms to raise their investment spending, especially for unconstrained firms. Chapter 4 focuses on how exporting decision of firms are affected by volatility at the macro and micro levels, using a rich dataset of UK manufacturing firms for the period of 1990-2009. The results show that both types of volatility have an adverse impact on firms’ real export sales. After taking into account firm-level heterogeneity, the results show that the negative impact of exchange rate and firm volatility on exports is higher for constrained firms as compared to unconstrained firms. Further, this chapter considers the European Exchange Rate Mechanism (ERM) crisis of early 1990s and the global financial crisis of 2008. The results indicate that during the ERM crisis constrained firms face a significant adverse impact of exchange rate volatility on exports, while the impact of firm-level volatility is mostly insignificant. On the contrary, during the global financial crisis, constrained firms face a significant negative impact of firm-level volatility on exports and an insignificant impact of exchange rate volatility on exports. Finally, Chapter 5 provides the conclusion of the thesis highlighting the contributions, implications and future research avenues of each empirical chapter.

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