Investor Rewards to Climate Responsibility: Stock-Price Responses to the Opposite Shocks of the 2016 and 2020 U.S. Elections, Ramelli et al. (2021)

ABSTRACT

• Donald Trump’s 2016 election and his nomination of climate skeptic Scott Pruitt to head the Environmental Protection Agency drastically downshifted expectations about U.S. policy toward climate change. Joseph Biden’s 2020 election shifted them dramatically upward. We study firms’ stock-price movements in reaction to these changes. As expected, the 2016 election boosted carbon- intensive firms. Surprisingly, firms with climate-responsible strategies also gained, especially those firms held by long-run investors. Such investors appear to have bet on a ‘‘boomerang’’ in climate policy. Harbingers of a boomerang appeared during Trump’s term. The 2020 election marked its arrival.

Research target

• Investigate the pricing of uncertainty associated with ESG, by which the authors mean operational, reputational, and/or litigation uncertainty due to poor ESG performance. The study is not so much in the impact of ESG on various risk measures per se but rather in analyzing whether investors recognize these risks and pay a premium,

Methodology

• Event study: U.S. regulatory policy changes in climate - 2016 and 2020 presidential elections, which provide a rare opportunity to study the interconnections between climate regulation, firms’ climate-related performance, and firm value.

• Distinguish the firm's current environmental footprint (measured by carbon intensity) and climate responsibility (commitment to low-carbon operation/curb future carbon emission, measured by 1) binary indicators ‘‘Env-str-d’’ minus ‘‘Env-con-f’’ from MSCI KLD, available for 2102 Russell 3000 firms; 2) Vigeo Eiris ‘‘Energy Transition’’ score, available for 764 firms)

• Regress CAPM adjusted returns to carbon intensity/climate responsibility and controls

Data

• Climate data: MSCI KLD and Vigeo Eiris

• Sample: all Russell 3000 firms with available climate-related and control variables on election days

• Compustat: Accounting data

• CRSP: Stock returns

• Kenneth French’s data library: Fama-French factors and risk-free rates

• The sample periods include dates around the 2016 and 2020 presidential elections

Findings

• Carbon intensity and Climate responsibility are only weakly correlated.

• Investors reacted to the 2016 election by rewarding carbon-intensive firms.

• After both the 2016 election and the Pruitt appointment, investors also rewarded companies demonstrating more responsible climate strategies.

  • Financial analysts indeed increased their expectations of earnings per share of carbon-intensive firms for the near term (for FY2017 and FY2018). However, analysts---who only make projections for a few years forward---did not change their forecasts for climate-responsible firms for the 4 years of the Trump presidency.

  • Different investors are likely to have been responsible for pricing assets over different horizons. Among institutional investors, short-term holders would tilt toward carbon-intensive firms, long-term holders toward climate-responsible ones. Specifically, in stocks heavily held by short-term investors, carbon intensity played a bigger role for stock-price reactions; in stocks heavily held by long-term investors, climate responsibility was a key driver.

• The financial market's reactions to the 2018 midterm election and the 2020 presidential election provide evidence confirming implications from the 2016 election.

• Long-term investors’ preference for climate responsibility is likely to pay off in the long term, given climate-responsible firms’ ability to better cope with future tightening in climate regulation.

• Investor rewards to climate-responsible firms strongly depend on expectations about the long-run regulatory environment for climate change.