Is 'Being Green' Rewarded in the Market?: An Empirical Investigation of Decarbonization and Stock Returns

Abstract

This study empirically investigates the risk-return relationship of low-carbon investment and characteristics of carbon-efficient firms. Based on 74,486 observations of 736 US firms from January 2005 to December 2015, we construct a carbon efficient-minus-inefficient (EMI) portfolio by carbon efficiency, defined as revenue-adjusted greenhouse gas (GHG) emissions at firm-level. Our EMI portfolio generates positive abnormal returns since 2010 and an investment strategy of "long carbon-efficient firms and short carbon-inefficient firms" would earn abnormal returns of 3.5--5.4% per year. The only exception is found in small firms. We find that these carbon-efficient firms tend to be "good firms'' in terms of financial characteristics and corporate governance. Our findings are not driven by a small set of industries, variations in oil price, or changing preferences of bond investors caused by the low-interest-rate regime, starting with the 2008 financial crisis.

Keywords: Environmental, Social, Governance (ESG); Low-Carbon Investment; Asset Pricing; Carbon Efficient-Minus-Inefficient (EMI) Portfolio; Socially Responsible Investment (SRI)

JEL Classification: G12; P18; Q5; Q54; Q56