Abstract

We investigate the financing strategies of environmentally responsible firms to understand how they set target capital structures and make incremental financing decisions. Literature shows that firms with better environmental performance have lower risk and better access to financing. However, it is not obvious how these firms choose to finance their investments. Using an extensive data set of U.S. firms, we find that firms with superior environmental performance have significantly lower debt ratios and use mostly short‐term debt for temporary financing needs. In doing so, environmentally responsible firms are able to achieve more tax savings and experience lower costs of financial distress. Our results provide new empirical facts about environmental performance and financing decisions, and they help explain the observed relationship between environmental performance and economic performance.