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Journal Article | Is “Being Green” Rewarded in the Market? An Empirical Investigation of Decarbonization Risk and Stock Returns

Soh Young In
Ki Young Park
Ashby H. B. Monk
IAEE Energy Forum

While investors are increasingly prioritizing climate finance and looking for investment opportunities of “yield with impact,” they seem still reluctant. It is mainly because they need more clear understanding on the return-risk relationship related to investing for a clean energy economy. To shed more light on the market evaluation of decarbonization, this study empirically investigates the relationship among firm-level decarbonization, financial characteristics, and stock returns by analyzing 75,638 observations of 739 U.S. firms during the period of January 2005 to December 2015. The main research questions include: (1) what types of firms are more likely to take decarbonization actions; (2) whether carbon-efficient firms’ stocks are likely to outperform carbon-intensive firms’ stocks; (3) and if so, whether these excess returns on decarbonization are from a pure alpha or market compensation from bearing additional risk. We define firm-level carbon intensity as the actual amount of greenhouse gas (GHG) divided by company revenue, construct EMI (“efficient-minus-inefficient”) portfolio based on carbon intensity, and find that EMI portfolio exhibits a large positive cumulative return from 2009. By applying multi-factor asset pricing models using factor-mimicking portfolios of market, size, value, operating profitability, investment, and momentum, we find that those well-known risk factors cannot fully explain EMI portfolio return and the estimated positive alphas of EMI portfolio amount to 7.7~8.9 percent of abnormal returns per year. In addition, estimating factor loadings on industry portfolios, we also find that EMI portfolio has explanatory power that is independent from well-known risk factors. We discuss how carbon intensity is related to other firm-level characteristics concerning corporate governance and financial performance, along with implications for climate finance in the viewpoints of investors, firms and policymakers.