Why Aren’t Polluters Paying a Higher Market Price?
High-emission firms may be poorly rated on climate factors but their cost of equity is lower than what greener companies get from investors
Wishful thinking would lead us to believe that capital markets reward climate-friendly corporate behaviour. Firms investing in lowering emissions and increasing sustainability should show stronger stock market performance and command more favourable terms for raising money than those making no effort to mitigate the environmental impact of their operations.
In the real world, that’s not always the case. The cold, hard evidence shows mixed or even contradictory results regarding the relationship between environmental performance and market performance, such as stock prices. Some studies have shown that firms mitigate risk and enhance corporate value when they disclose their climate-related impacts. But the evidence is not clear-cut, leaving investors, policymakers and the firms themselves wanting more.
“It’s important for capital providers to know that companies they lend to or invest in have concrete plans to deal with the impacts of climate change, and that they communicate the risks they face and the strategies for dealing with them,” says Sean Cleary, professor of finance at Smith School of Business. “And it’s important regulators ensure this critical information is available to capital allocators to promote capital market efficiency.
A new study by Cleary and Neal Willcott, an assistant professor at Memorial University, takes an important step towards clearing up the uncertainty — but will also force a reassessment of the status quo.
Brown bests green?
Their research, conducted as part of Willcott’s PhD work at Smith, focused on 171 of the world’s largest industrial emitters, members of the Climate Action 100+ (CA 100+) that account for more than 80 per cent of global industrial emissions. These companies are being pressed by institutional investors to do more about lessening their impact on climate change.
It started with a simple question: If investors are considering climate-related risk in their deliberations, are they making it more expensive for polluting firms to raise money? In finance terms, do these firms have a higher cost of equity as a result of poor environmental performance?
According to the study’s findings, “green” concerns were not a primary concern to investors. The study found that a portfolio of the biggest global polluters included in Climate Action 100+ actually outperformed major global stock market indexes between 2016 and 2022. The firms delivered better returns with less risk (according to traditional risk measures).
And the cost of raising money was not unusually high for these firms compared to those without such a heavy environmental footprint. After considering the country and industry in which they operate (such as huge oil and gas companies in Saudi Arabia or the U.S.), their cost of equity was similar to a general benchmark.
The picture became even clearer when the researchers looked at differences within the CA 100+ group itself. They focused on the quality of the companies’ disclosures based on the Task Force on Climate-related Financial Disclosures (TCFD) framework. The study found that companies seen as having the flimsiest plans to reduce emissions and worse TCFD scores about their climate efforts had a lower cost of equity than those with higher scores.
The market, in short, appears not to be penalizing big polluters for their poor environmental performance or lack of transparency – at least not during the time period examined. This raises questions for investors and policymakers alike: Are investors prioritizing financial returns over sustainability considerations? Are they falling for greenwashing claims rather than demanding real emission reductions? Do global mandatory and standardized rules need to replace voluntary climate disclosures by companies, so that investors can compare firms and allocate capital more efficiently.
Cleary and Willcott hope that others will pick up where this study leaves off by examining how the pricing of climate risk evolves with changing regulatory pressures, investor preferences and corporate sustainability strategies.
As for whether market players overall are not really concerned about environmental issues—a potential takeaway from the study—the researchers caution against taking that leap.
“The CA 100+ is a specific subset of companies that are the top of the high-emitter class,” says Willcott. “As a result, the conclusion that our results show that ‘it doesn’t pay to decarbonize’ paints with too broad a brush.”
