Back to the Future: The Role of Forward-looking Climate Metrics in Decarbonization Portfolios

Abstract

We find that forward-looking climate metrics, such as a firm’s carbon emission target, contain information about future carbon emission growth rates. Better forward-looking metrics are associated with lower future carbon emission growth rates relative to otherwise similar firms. This relation is stronger in the period after the Paris Agreement. However, firms with better forward-looking metrics are associated with inferior backward-looking metrics such as higher current carbon emissions. Thus, there is a tradeoff between forward- and backward-looking metrics when constructing decarbonization portfolios. Finally, we find evidence that mutual funds are more focused on backward-looking metrics even though this could hinder them from investing in many companies that contribute to decarbonizing the global economy.

Keywords: Carbon Emissions, Climate Change, Climate Targets, Decarbonization, ESG, Green Patents

JEL Classification: G11, G18, Q54