Cascading Effects of Carbon Price Through the Value Chain: Impact on Firm's Valuation

Abstract

To avoid the worst climate change scenario, Greenhouse Gas (GHG) emissions need to be drastically reduced over the coming decades. Placing an adequate price on GHG emissions, by countries adopting of a carbon tax or firms implementing internal carbon pricing mechanisms, is key to internalize the external cost of climate change. In this paper, we assess the impact of carbon pricing in a global framework considering both the cost of idiosyncratic corporate emissions and their cross-sector diffusion. The impact on corporate valuation is shared among intensive firms and less intensive ones through the introduction of a carbon cost pass-through in a sector diffusion model, based on a World Input-Output table. Focusing on the constituents of the MSCI World Index, we show that apart from the usual carbon-intensive sectors, such as Energy, Utilities and Materials, less carbon-intensive ones, such as Industrials, Consumer Staples, Consumer Discretionary and Information Technology can contribute significantly to the global risk, due to the expected pass-through of the carbon cost in the value chain. World indices could experience significant changes in their investment universe and sector composition.

Keywords: Transition risk, Carbon price, Risk diffusion, World input-output table, Cascading effect, Leontief price model

JEL Classification: C67, E22, Q5