Firms’ Carbon Emissions and Stock Returns
Published in Working Paper, 2023
In recent years, unanticipated climate change risks have propelled green portfolios to achieve superior returns compared to their brown counterparts. Paradoxically, both empirical and theoretical evidence underscore a perplexing phenomenon: brown firms, characterized by higher carbon emissions or lower ESG (Environmental, Social, and Governance) scores, tend to yield greater expected stock returns. This discrepancy is primarily attributed to investors’ demand for climate change-related risk premiums from these brown firms’ stocks. This paper seeks to explore this apparent contradiction. Despite the consistent outperformance of green portfolios over their brown counterparts, empirical studies at the firm level frequently uncover the reverse trend. By conducting empirical analyses encompassing all publicly listed companies in the U.S. stock market spanning the years 2002 to 2021, our objective is to furnish a comprehensive explanation for this intriguing and seemingly contradictory disparity.