Market Myopia's Climate Bubble
64 Pages Posted: 16 Feb 2021 Last revised: 1 Feb 2022
Date Written: February 9, 2021
A growing number of financial institutions, ranging from BlackRock to the Bank of England, have warned that markets may not be accurately incorporating climate change-related risks into asset prices. This Article seeks to explain how this mispricing occurs, drawing from scholarship on corporate governance and the mechanisms of market (in)efficiency. Market actors: (1) Lack the fine-grained asset-level data they need in order to assess risk exposure; (2) Continue to rely on outdated means of assessing risk; (3) Have misaligned incentives resulting in climate-specific agency costs; (4) Have myopic biases exacerbated by climate change misinformation; and (5) Are impeded by captured regulators distorting the market. Further, trends in institutional share ownership reinforce apathy toward assessment of firm-specific fundamentals, especially over long-term horizons.
This underpricing of corporate climate risk contributes to the negative effects of climate change itself, as the mispricing of risk in the present leads to a misallocation of investment capital, hindering adaptation and subsidizing future combustion of fossil fuels. These risks could accumulate to the macroeconomic scale, generating a systemic risk to the financial system. While a broad array of government interventions are necessary to mitigate climate-related financial risks, this Article focuses on proposals for corporate governance and securities regulation—and their limits. The Securities and Exchange Commission is currently drafting a rule on mandatory climate risk disclosure. This Article argues that the SEC should seek out climate expertise through interagency collaboration and staff hiring, work with auditors and the Public Company Accounting Oversight Board, and provide guidance on climate risk analytics. This Article argues that climate risk disclosure is necessary, though alone not sufficient, to address the widespread disregard of corporate climate exposure.
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