Share Repurchase under Diverging Beliefs about Carbon Risk

41 Pages Posted: 15 Jul 2020

See all articles by Emilie Rosenlund Soysal

Emilie Rosenlund Soysal

Potsdam Institute of Climate Impact Research (PIK)

Kai Lessmann

Potsdam Institute of Climate Impact Research

Date Written: June 22, 2020

Abstract

Diverging beliefs about the impact of climate policy on the value of fossil fuel assets can lead investors to different valuations of fossil fuel companies. This paper models the share price formation in a market where one group of investors systematically overestimate future prices, and explores how firms can maximise firm value through share repurchases by responding to changing investor beliefs. We find that the optimal buyback strategy reduces the impact of price volatility on share prices, i.e. the optimal response of the firm is to counteract price variations. When expectations to future prices drop, the optimal response is to buy back shares. Furthermore, we show that the optimal buyback strategy can lead to a persistent and higher share of investors who overestimate future share value compared to the case where the supply of shares are fixed. The result implies that buybacks can dampen price signals originating from fossil fuel divestment. In the light of substantial engagement in buyback programs observed in the US oil sector, divestment is unlikely to have had any significant effect on share prices or firm valuations in this sector.

Keywords: buyback; stranded assets; portfolio optimization; false expectations

JEL Classification: G11;Q50

Suggested Citation

Rosenlund Soysal, Emilie and Lessmann, Kai, Share Repurchase under Diverging Beliefs about Carbon Risk (June 22, 2020). Available at SSRN: https://ssrn.com/abstract=3632867 or http://dx.doi.org/10.2139/ssrn.3632867

Emilie Rosenlund Soysal (Contact Author)

Potsdam Institute of Climate Impact Research (PIK) ( email )

Telegrafenberg 31
Potsdam, Brandenburg 14473
Germany

Kai Lessmann

Potsdam Institute of Climate Impact Research ( email )

HOME PAGE: http://https://pik-potsdam.de/members/lessmann

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
40
Abstract Views
283
PlumX Metrics