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Investors and Climate Change

Periodic Reporting for period 2 - FinanceCC (Investors and Climate Change)

Reporting period: 2022-01-01 to 2023-06-30

The general theme of the research project relates to the challenges posed by climate change for corporate finance and corporate governance. How do investors and corporations respond to the climate crisis? This theme had barely emerged as an academic research topic when this ERC project was approved. It has now grown into a major subfield of finance. By 2019, when this proposal was submitted there were fewer than 40 research papers touching on this general topic. By the end of 2021 there were over 160 (see Gasparini and Tufano, 2023 “The Evolving Academic Field of Climate Finance”).

My first research article in this area “Hedging Climate Risk” published in 2016 in the Financial Analysts Journal (FAJ) has framed the problem of climate change as a risk management problem for investors and proposed low carbon market indexes as a way for passive investors to hedge carbon transition risk. At the time I submitted my proposal very little was known about how investors are pricing carbon transition risk and about how companies are planning to align their future operations with global net zero government commitments. In conjunction with my application, I had undertaken a piece of empirical research with Marcin Kacperczyk on stock returns and corporate carbon emissions of US listed companies. Over the first year of my ERC grant I completed this research, which has been published in the Journal of Financial Economics in 2021 under the title Do Investors Care about Carbon Risk?

This research has attracted a lot of attention because it provides a first concrete assessment of how financial value is linked to carbon emissions. Our finding that investors increasingly demand compensation for their exposure to decarbonization risk has revealed that US listed companies are facing material financial penalties for their carbon emissions. Investors and financial markets are beginning to reflect the future decarbonization costs companies face in stock prices. Thus, financial markets are playing a part in bringing about the transition to clean energy. This is a novel perspective which had not been highlighted by economists before. Indeed, most of the economic analysis was focused on public policy, carbon taxation and cap & trade systems. Having pointed at the role of finance in the carbon transition, the goal of this research is to determine how widespread this pricing of corporate carbon emissions is, what are its determinants, and its effects on corporate behaviour, in particular changes in future carbon emissions.
Besides completing and publishing Do investors care about carbon risk? with Marcin Kacperczyk, Journal of financial economics 2021 (750 google citations) I have produced six working papers, published six articles and three reports.

The six working papers are:
1. “Stability and Evolution in Investor Ideology”, with Enrichetta Ravina, Howard Rosenthal, and Chris Tausanovitch (2022)
2. “Firm Commitments”, with Marcin Kacperczyk (2021) https://ssrn.com/abstract=3840813
3. “Carbon Disclosure and the Cost of Capital,” with Marcin Kacperczyk (2021) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3755613
4. “The great carbon arbitrage”, with Tobias Adrian and Alissa Kleinnijenhuis (2022) https://cepr.org/multimedia/great-carbon-arbitrage
5. “Do Carbon Prices Affect Stock Prices?”’ with Adrian Lam and Mirabelle Muûls (2022)
6. “The CO2 Question: Technical Progress and the Climate Crisis”, with Marcin Kacperczyk and Moritz Wiedemann https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4212567

The six articles are:
1. “Investor Ideology” with Tao Li, Enrichetta Ravina, and Howard Rosenthal, Journal of Financial Economics 2020 (131 google citations)
2. “Central banks, financial stability and policy coordination in the age of climate uncertainty: a three-layered analytical and operational framework”, with Romain Svartzman, Morgan Despres, Luiz Awazu Pereira Da Silva, and Frédéric Samama (2021) Climate Policy 2021 (41 google citations)
3. “Mandatory Corporate Carbon Disclosures and the Path to Net Zero”, with Stefan Reichelstein, Marcin Kacperczyk, Christian Leuz, Gaizka Ormazabal, and Dirk Schoenmaker (2021) Management and Business Review (20 google citations)
4. “Net-Zero Carbon Portfolio Alignment” with Marcin Kacperczyk and Frédéric Samama Financial Analysts Journal 2022 (17 google citations)
5. “The Financial Cost of Carbon,” with Zachery Halem and Marcin Kacperczyk Journal of Applied Corporate Finance 2022 (5 google citations)
6. “Global Pricing of Carbon-Transition Risk,” with Marcin Kacperczyk, Journal of Finance, 2022 (forthcoming) (200 google citations)

The three reports are:
1. “The Green Swan,” with Morgan Després, Luiz Awazu Pereira da Silva, Frédéric Samama, and Romain Svartzman (2020) (416 google citations) https://www.bis.org/publ/othp31.pdf
2. “Resilience of the Financial System to Natural Disasters,” with Marcin Kacperczyk, Harrison Hong, and Xavier Vives (2021) https://cepr.org/publications/books-and-reports/barcelona-3-resilience-financial-system-natural-disasters
3. “Climate and Debt,” with Lee Buchheit, Mitu Gulati, Ugo Panizza, Beatrice Weder di Mauro, and Jeromin Zettelmeyer (2022) (3 google citations) https://cepr.org/publications/books-and-reports/geneva-25-climate-and-debt
This research project covers multiple facets relating to corporate carbon emissions.

A first aspect is valuation and financial performance. The main findings here are that there is a valuation discount worldwide for listed companies with high carbon emissions. The higher are carbon emissions (direct or indirect) the higher the expected return, or equivalently the lower the company’s market to book (or price-earnings) ratio. This is true across all sectors in Europe, North America, and Asia.

A second key finding is that companies that choose to disclose their carbon emissions are perceived to be safer companies (there is less uncertainty around their carbon emissions) and therefore have a lower valuation discount, other things equal.

A third finding is that the EU ETS carbon allowance prices have reached a sufficiently high level in the second part of Phase 3 that they have significant material effects on the financial performance and carbon emissions of the listed companies that are subject to this regulation.

A second aspect is corporate behaviour to curb carbon emissions. The main finding here is that the companies that have committed to decarbonization are the best in class, the ones with the lowest carbon emissions to begin with. Even though over a thousand listed companies have made such commitments there has been no reduction in carbon emissions in aggregate in the corporate sector.

A second key finding is that green innovation, although it has been steadily on the rise, has had no significant impact in reducing carbon emission, whether in the short or medium term.

A third aspect is related to public policy, specifically to the benefits from targeting coal by phasing out coal and replacing it with renewable energy worldwide. Here the headline finding is that if coal were to be phased out (and replaced with renewables) along the NGFS 2050 net zero pathway then avoided emissions would amount to over 1,400 GtCO2 and the net global benefit would add up to $85 trillion.