The informational role of corporate carbon performance in the stock market

Abstract

This thesis examines the informational role of corporate carbon performance in the stock market using a sample of publicly listed firms regulated under the European Union Emission Trading Scheme (EU_ETS). Based on carbon information compiled from the facility-level records within the transaction log under the operation of the EU_ETS from 2006 to 2015, this thesis calibrates the informational role of corporate carbon performance at the firm-level by exploring: (1) whether corporate carbon performance information affects firms’ information environments; and (2) whether corporate carbon performance affects firms’ cost of equity. Employing a synchronicity measure capturing the relative amount of firm specific information flows compared with market- and industry-wide information, the first empirical study in this thesis provides evidence that corporate carbon performance information plays a key informational role in the stock market by impounding more firm-specific information into share prices. In particular, this study finds that: (1) more firm-specific information relative to market- and industry-wide information is incorporated into share prices of firms with less carbon intensity; and (2) leadership in managing carbon performance relative to industry peers increases firm-specific information captured in share prices. Further, using an ex-ante implied cost of equity measure, the second empirical study in this thesis examines the impact of corporate carbon performance on investors’ perception of firm riskiness. This study provides evidence supporting the market assessment of carbon risks manifested in a higher required rate of return on equity. Specifically, this study finds that the magnitude of carbon intensity neither increases nor decreases the cost of equity financing for the full sample. However, a higher cost of equity is observed for high-emitting firms, suggesting that investors condition their assessment of carbon risks on a firm’s relative emission profile. This study also finds that firms with a higher carbon risk profile relative to industry peers have a higher cost of equity, suggesting that firms’ capacity to pass-on carbon costs affects the market pricing of carbon risks. Taken together, the empirical findings of this thesis show that corporate carbon performance serves an important information role in the stock market by producing more firm-specific information that reduces the level of information asymmetry and thereby lowers the cost of equity. This thesis therefore provides confirmatory evidence of the usefulness of carbon disclosures mandated through an enacted ETS. This thesis contributes to the literature on the market value effects of carbon information in several important ways. First, it provides robust empirical evidence that corporate carbon performance information affects the level of firm-specific information impounded in share prices. Second, this thesis provides unique insights into how corporate carbon performance enhances firm value through the cost of equity. This thesis also has several important implications for financial market regulators, policy makers, corporate executives and institutional investors. For instance, evidence that firm disclosures of carbon performance provide benefits by enabling industry benchmarking can inform the development of carbon disclosure requirements to improve the transparency of carbon disclosure and the efficiency of capital allocation. Corporate decision makers may take into account the potential benefit of a lower cost of equity in addition to accounting earnings in assessing the viability of investments in green technologies. Further, this thesis has implications for portfolio managers in constructing indices that track firms exhibiting lower carbon profile than industry peers to address the preferences of eco/green investors.