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Companies that ignore climate change risks lose market value

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Companies that ignore climate change risks lose market value

A first-of-its-kind study showed that companies that proactively respond to climate risk are rewarded by the market; those that don’t, are punished.
April 23, 2024

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Adapting to climate change and preparing for the green transition entails significant costs for businesses—but is likely to be a good investment, according to a new study. The analysis, one of the first to quantify how climate risk is priced in financial markets, suggests that companies that fail to respond in a proactive way to climate threats lose market value.

In the past there has been relatively little research on climate finance topics. Researchers have lacked good methods to measure climate risk exposure, at least for equity assets (as opposed to real estate where projections of flood risk, sea level rise, and so on serve as clear-cut indicators of climate risk).

The new paper fills the gap with the help of earnings calls, which corporations typically conduct once a quarter to update investors, journalists, and others about their financial situation. Because corporations only have time to convey the most salient information in these brief calls, anything they say about how they perceive their climate risk and what they are doing in response is likely to be highly relevant. The calls also happen on a regular basis, yielding a close to real-time measurement of how climate risk changes and evolves.

The researchers analyzed transcripts of earnings calls that 4,719 U.S. firms conducted between 2002 and 2018. They developed a dictionary of 37 words and 1,649 two-word combinations (or “bigrams”) relevant to climate change, such as “warm winter,” and measured the frequency of these terms in the transcripts.

They used this analysis to quantify three types of climate change risks companies face: acute physical risks from weather impacts like hurricanes and wildfires; chronic physical risks like a prolonged drought or an unusually hot summer; and transition risks from climate regulations, industry shifts to renewable energy, and so on.

 

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They also analyzed the verbs used in climate risk discussions to gauge whether or not the company takes a proactive response to these risks.

By combining this textual analysis with financial and patent data from each firm, the researchers were able to determine how climate risks—and a company’s response to them—shape market value.

The market rewards companies that take a proactive approach to addressing climate risks, the researchers report in The Review of Financial Studies.

Companies facing high transition risks tend to be valued less by investors. “This relationship has only become significant since 2010, likely because of rising aggregate investor attention to climate risk, as well as climate-related initiatives and regulations implemented around this time,” the researchers write.

But how a company responds to the threat of climate change makes a big difference. Those that take a proactive stance in response to transition risk, such as by increasing sustainable investments and green technologies, don’t face the a loss of value. In other words, companies that take concrete steps to respond to climate risk are rewarded by the market; those that don’t are punished.

Proactive firms tend to increase sustainable investments and maintain research spending as transition risks increase, filing more green patents in subsequent years, the researchers found. Passive firms instead cut jobs and R&D budgets when exposed to climate risk.

What’s more, firms that face higher transition risks and adopt a non-proactive stance tend to have higher subsequent carbon emissions, while those that have a proactive response to these risks do not. So the proactive response that’s rewarded by the market is materially better for the climate, too.

Source: Li Q. et al.Corporate Climate Risk: Measurements and Responses.” The Review of Financial Studies 2024.

Image: ©Anthropocene Magazine

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