Greenness and its Discontents: Operational Implications of Investor Pressure

Abstract

Publicly traded firms are exerting efforts to reduce their carbon emissions, partially in response to environmental pressure from investors. This pressure can come in the form of influencing the equity and debt markets, as well as advocating for environmental transparency. The positive impact of investor pressure manifests in its ability to foster sustainable business practices. However, investor pressure can also backfire: Firms can respond by selling their carbon-intensive assets to private companies, which reduces transparency and eliminates investor oversight, potentially leading to worse overall societal outcomes: increased pollution, higher unit price, and lower employment. We study the impact of two prominent environmental assessment metrics on a manager's operational strategy (exiting, investment in emission reduction and capacity decisions) by comparing two different mandatory disclosure regimes - where the firm discloses the unit impact under an intensity metric (regime) and the total impact under an absolute metric (regime). We develop a sequential model to analyze the manager's decisions at equilibrium, enhancing the traditional capacity planning modeling framework to capture the effects of investor sentiment, incorporating equity and debt markets within our model. To understand the effect of different metrics on firms' operational strategies, we adopt the real effects perspective developed in accounting into our operational setting. Analysis of our model offers the following insights: (i) Significantly high environmental pressure from the market results in divestment under both disclosure regimes, but the firm value is eroded less under an absolute metric, leading to less divestment. On the other hand, when environmental pressure is not too high, we show that the firm is more likely to invest in corrective action to mitigate emissions under an intensity metric. Thus, utilizing the intensity-based approach may channel investor pressure into more environmentally responsible outcomes, particularly when the pressure from the market is not too intense. (ii) We illustrate settings in which the use of the right metric can potentially harmonize divergent public interests - for example, "federal'' efforts to reduce emissions (i.e., via the Inflation Reduction Act) and "state'' efforts to protect jobs in carbon-intensive industries. (iii) We uncover a possible mechanism to explain the phenomena of "greenhushing,'' in which a firm makes substantive emission-reduction investments while not taking credit for this publicly.

Keywords: Environmentally responsible operations, capital and debt market, absolute vs. intensity metrics, divestment, real effects