Stock Price Rewards to Climate Saints and Sinners:Evidence from the Trump Election

Stefano Ramelli, Alexander F. Wagner, Richard J. Zeckhauser, and Alexandre Ziegler

“Promoting Sustainable Finance” ConferenceBrussels, January 9, 2019

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Research question

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Does corporate climate-related performance affect firms’ stock market valuation?

Motivation:

• Increasing emphasis on the role of market forces in supporting the transition to a low-carbon economy.

• A growing number of investors consider climate change in their investment decisions, …

• …but this does not necessarily imply that the market overall really values firm climate-related performance. Still scant empirical evidence in this respect.

The 2016 climate policy shock

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Donald Trump’s election: Nov 8, 2016 Scott Pruitt’s EPA nomination: Dec 7, 2016

Main empirical strategy:

• Standard event study: Regress (abnormal) returns on firms’ climate-related performance and other characteristics (see WZZ, 2017).

• Sample: Russell 3000 stocks.• Accounting information from Compustat and Bloomberg, stock

prices from CRSP.

Measures of climate-related performance

Firms differ both with respect to current climate footprints (say GHG emissions) and with respect to their climate strategies (Climate responsibility).

MSCI KLD Stats:

• Climate responsibility (kld): Climate strength (Env-str-d, 0 or 1) minus Climate weakness (Env-con-f, 0 or 1).

• 2016 data available for 2,070 Russell 3000 firms.

Vigeo Eiris:

• Climate responsibility (ve): Strategic approach to climate change risks and opportunities (from 0 to 100).

• Carbon intensity: GHG emissions in kt of CO2eq divided by market value of equity.

• 2016 data available for 766 Russell 3000 firms. 4

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Dirty industries benefited…(CAPM-adjusted returns shown, 2,677 firms)

Current Preferences: Warm glow / cold shiver effect for pro-environmental investors

Climate responsibility is rewarded (+)Future Expectations:

• “Regulatory boomerang”• Anticipation of a “warmer

warm glow” effect

…, but what about climate responsibility?Much less obvious than one might think

Economic consideration Prediction

Expected regulatory costs and risks less likely to materialize in the short run

Climate responsibility is penalized (-)

OUR FINDINGS:

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0.4

0.6

0.8

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Nov 9 3 days 5 days 10 days Dec 7 3 days 5 days 10 days

Clim

ate

resp

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bilit

y pr

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m in

%

Climate responsibility and stock returns(cumulative CAPM-adjusted)

Trump Election Pruitt Nomination

Climate responsibility is rewarded

p<0.05, p<0.1,p<0.01, p≥0.1.

Climate responsibility is rewarded (continued)

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Robustness:

• Controlling for finer sector classifications.• Controlling for corporate governance.• Using alternative sets of returns (raw and Fama-French-adjusted).

Why is there a climate responsibility premium?

Two possible explanations

Current Preferences:• Investors value corporate climate responsibility on the basis of social

preferences (e.g., Riedl and Smeets, 2017). • After Trump's election, their willingness to pay for the “warm glow”

effect (Andreoni, 1989) of climate responsibility increases.• Climate responsible stocks appreciate now, and return less going

forward.

Future Expectations:• Investors value climate responsibility for strategic reasons.• Anticipation of a “regulatory boomerang”: Climate regulation will be

more stringent after Trump (global warming gets worse, pro-environmental movements get stronger).

• Investors may also foresee that in the future pro-environmental investors will pay more for climate-responsible firms.

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To test these hypotheses, we analyze how different 13F institutional investors adjusted their portfolio holdings after the policy shock.

Dependent variable:

Δ Portfolio CR: Quarterly change in the investor’s exposure to climate-responsible firms due to active trading (i.e., adjusting for price changes) between Q3 2016 and following quarters.

Our conjectures:

Current Preferences Stronger shift towards climate-responsible firms by investors with a higher prior exposure to climate-responsible firms.

Future Expectations Stronger shift towards climate-responsible firms by longer-horizon investors (low portfolio turnover).

Current Preferences and Future Expectations

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Consistent with the idea that the climate responsibility premium can be at least partially attributed to the Future Expectations explanation.

Current Preferences and Future ExpectationsResults

• Decrease in portfolio CR by investors with high prior portfolio CR.

• Increase in Portfolio CR by investors with low prior portfolio CR.

• Increase in Portfolio CR stronger for long-horizon investors.

Concluding remarks

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Three practical implications:

• Investors at large should pay more attention to corporate climate-related performance since it boosts firm value.

• Long-term investors such as pension funds can ignore short-term fluctuations in climate policy in their investment decisions, and increasingly incorporate long-term considerations related to climate change in their portfolios.

• Corporate managers can be reassured that their investments in climate-related performance will be rewarded by markets even –and especially – under climate-adverse political contexts.

Thank you!

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References

• Andreoni, James, 1989, Giving with impure altruism: Applications to charity and Ricardian equivalence, Journal of Political Economy 97, 1447-1458.

• Bénabou, Roland, and Jean Tirole, 2010, Individual and corporate social responsibility, Economica 77, 1-19.

• Fama, Eugene F., and Kenneth R. French, 2000, Forecasting profitability and earnings, The Journal of Business 73, 161-175.

• Gaspar, José-Miguel, Massimo Massa, and Pedro Matos, 2005, Shareholder investment horizons and the market for corporate control, Journal of Financial Economics 76, 135-165.

• Gibson, Rajna, and Philipp Krueger, 2017, The sustainability footprint of institutional investors, Working Paper.

• Riedl, Arno, and Paul Smeets, 2017, Why do investors hold socially responsible mutual funds?, The Journal of Finance 72, 2505-2550.

• Wagner, Alexander F., Richard J. Zeckhauser, and Alexandre Ziegler, 2017, Company stock price reactions to the 2016 election shock: Trump, taxes, and trade, Journal of Financial Economics, forthcoming.

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Appendix

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Assessing statistical significance

Our empirical strategy investigates the cross-sectional variation of returns following two market-wide events.

Since stock returns are likely to be correlated cross-sectionally, conventional t-statistics might be biased upwards (e.g., Fama and French, 2000).

How we deal with this (Cohn, Gillan, and Hartzell, 2016):

1. Run the cross-sectional regression using daily returns over a non-event period (Oct 1, 2015 - Sept 30, 2016).

2. Re-run the same cross-sectional regression using event period returns.

3. Adjusted t-statistic = Event coefficient −Mean non−event coefficientSD of time−series of coefficients

Correlations between variables

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Climate responsibility is rewarded (Vigeo Eiris sample)

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Climate responsibility is rewarded (Vigeo Eiris sample)

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From Inauguration through the end of 2017, Climate responsibility is perceived as more valuable on days when Trump’s approval rating rises:

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Pricing of climate responsibility over the long run

Pruitt Nomination

Withdrawal from Paris

From Inauguration through the end of 2017, Climate responsibility is perceived as more valuable on days when Trump’s approval rating rises.

Institutional investor characteristics

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Current Preferences and Future Expectations

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• One SD longer-term orientation (lower portfolio turnover) is associated with an increase of 8.7% of one SD of Δ Portfolio CR at Q4-2016.

• Δ Portfolio CR is negatively related to the investor’s prior exposure to climate responsible firms.