Do investors care about carbon emissions under the European Environmental Policy?

We explore the extent to which cross-sectional differences in carbon dioxide emissions matter for future valuations of European firms regulated under the European Union Trading Scheme (EU ETS). Counterintuitively, we find that firm-level emissions share a robust concave relationship with future market valuations. Initially, market valuations increase in emissions potentially because emissions are considered essential for normal production processes; however, the valuation premium decreases and becomes negative beyond a threshold of emissions due to looming regulatory and transition risks. Firms in the lower quartile of emissions trade at an average premium of 2.42%, against a 20.78% discount in the upper quartile (the peak is 3.85%). Importantly, the concave relationship obtains only in smaller firms with lower analyst coverage and lower institutional ownership, and the predictive power of emissions is limited to firms with no reported investments in clean technology. Therefore, policymakers might consider promoting the development and diffusion of green technologies.

Automated summary

The study found that there is a concave relationship between a firm's carbon emissions and future market valuations, with valuations initially increasing as emissions rise before decreasing due to regulatory and transition risks. This relationship is only observed in smaller firms with lower analyst coverage and institutional ownership, and the predictive power of emissions is limited to firms with no reported investments in clean technology.