Companies paying: Climate performance will improve

In most cases, stock markets do not consider firms’ total emissions when determining the impact of carbon price changes on stock prices: only those emissions for which firms need to pay do matter.

IMF paper

Transparency about a company’s emissions isn’t enough, says a new report.

Carbon emissions need to have a financial penalty applied to create shareholder pressure for businesses to improve their climate performance.

That’s the result of new analysis from the International Monetary Fund (IMF), which has released a new paper “The Carrot and the Stock: In Search of Stock-Market Incentives for Decarbonisation”.

The researchers analysed 338 publicly-traded companies in Europe and the European Union (EU) Emissions Trading System and found that just creating transparency over which firms were the highest emitters wasn’t enough to move the dial for investors and create stock market pressure.

Higher investor education

However, if a business faced financial penalties for high emissions, share prices dipped as investors looked elsewhere for companies that weren’t facing emissions payments.

The paper said higher investor education was only matched by action when emissions made the companies less profitable.

“In most cases, stock markets do not consider firms’ total emissions when determining the impact of carbon price changes on stock prices: only those emissions for which firms need to pay do matter.

“In this setting, stock markets can contribute to channelling private investments to lower-emitting firms using high-quality emissions data, but only in conjunction with a carbon pricing scheme.”

A 1 per cent carbon price increase was linked to an average stock price drop of up to 0.21 per cent for the most polluting companies.

The paper said this creates an extra lever to incentivise companies to lower their emissions, particularly because many firms link management pay to share price performance.

Windfall profit

Meanwhile, if a company paid less than 1.7 per cent of its revenue for carbon allowances, the stock price would rise.

This may seem surprising because a lack of a particular cost wouldn’t necessarily make a company more profitable.

However, if other companies are paying carbon costs and passing the price on to consumers, companies that are low emitters within their industry can charge that higher market price but keep costs lower, banking a windfall profit.

The paper’s authors argue their findings show there’s room for harsher carbon pricing to create share price incentives to decarbonise.

They believe it would increase the EU emissions trading scheme’s impact as a climate-change tool, without endangering financial stability.

Because lower-emitting companies had a share price increase, it didn’t hurt the economy overall.

“This relationship does not seem to indicate that a further increase in carbon costs will trigger a widespread stock market crash. Indeed, in recent years, according to the estimated model, the average impact of a 1 per cent rise in carbon prices on stocks of firms in our sample would be no more than -0.003 per cent.”