Carbon Emissions Impact on Institutional Performance

An influential stream of research finds that companies that emit more carbon have higher stock returns. This "carbon premium" has been interpreted as evidence that emitting companies suffer a higher cost of capital and thus markets are correctly pricing in carbon risk. However, the ESG literature typically interprets higher stock returns as outperformance due to mispricing. In a new paper with Yigit Atilgan, Özgür Demirtaş, and Doruk Gunaydin, we study earnings surprises to disentangle these explanations. We find that emitting companies enjoy positive earnings surprises, and the four earnings announcements per year explain 30-50% of the annual carbon premium. Consistent with prior results, our findings only hold for levels of and changes in emissions, but not emissions intensities or disclosed emissions only. Our results suggest that, where it exists, the carbon premium arises from an unpriced externality - emitting companies are able to "get away with" contributing to global warming. Markets are not fully pricing in carbon risk, highlighting the need for government action. https://lnkd.in/e9QnXars

Happy to share a recent working paper, "Carbon Risk and Corporate Creditworthiness: Evidence from a Major Emerging Economy," led by Dr Marcin Borsuk. This is part of our research in the India Transition Finance Program (https://lnkd.in/gPiXXi77) and Environmental Stress Testing and Scenarios (https://lnkd.in/gQBjGpiv) projects at the Oxford Sustainable Finance Group at the Smith School of Enterprise and the Environment - University of Oxford as well as the UK Centre for Greening Finance and Investment (CGFI). Context: - Addressing climate change requires a swift transition to a low-carbon economy.  - Governments are introducing stringent climate policies to accelerate this transition.  - Evidence suggests that financial markets penalize heavy emitters in developed countries. This study: - India is increasingly exposed to transition risks as it engages with global climate efforts.  - This study examines how transition risk is priced into credit risk of Indian companies.  - This study also incorporates climate-economy scenarios to project how different climate policy pathways might impact firms’ default risk. Findings: - Higher carbon emissions are associated with significantly elevated credit risk. - The effect of transition risk on firms’ credit risk is heterogeneous and varies with firm characteristics. - Policy shift around the Paris Agreement has affected investor perceptions of credit risk. - Transition risk affects credit risk through two channels – reputation and cost of capital.  - Forward-looking scenario analysis further indicates deterioration of credit risk. Implications: - Regulators and central banks should incorporate climate risk into credit assessment frameworks to safeguard financial stability.  - Firms should strengthen ESG governance, financial resilience, and sustained low-carbon investment as effective hedges against elevated credit risk stemming from the low-carbon transition. #india #climaterisk #creditrisk #transitionrisk #emissions #reputation #costofcapital #governance #resilience #lowcarbon Working paper is here: https://lnkd.in/dwcBxZpG Executive summary is here: https://lnkd.in/dVmvmFSk