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Climate Change and Firm Valuation: Evidence from a Quasi-Natural Experiment Philipp Krüger University of Geneva & Swiss Finance Institute 1 What is my paper about? • Mandatory corporate climate change disclosure • Research question: Does the introduction of mandatory corporate greenhouse gas emissions disclosure affect firm value? … and if so, how and why? 2 Mandatory GHG disclosure regulation • GHG emissions disclosure regulation is a “hybrid” type of regulation – Disclosure regulation – Environmental regulation • What does economic theory tell us about the potential firm-level valuation effects of disclosure and environmental regulation? 3 Predictions from economic theory 1. Information economics a. Asymmetric information hypothesis 2. Environmental economics a. Traditional view b. Porter hypothesis 4 1. Information economics a. Asymmetric information hypothesis: Mandatory GHG disclosure reduces information asymmetries among investors – reduces adverse selection problem – uninformed investors become more inclined to trade ⇒ Net effect on firm value: positive 5 2. Environmental economics a. Traditional view: Environmental regulation is costly to firms – Firms need to allocate costly production inputs (e.g., labor or capital) to comply with the regulation. ⇒ Net effect on firm value: negative 6 2. Environmental economics (contd.) b. Porter hypothesis: Environmental regulation is not necessarily costly – Raise corporate awareness for material issues – Signal about resource inefficiencies and potential technological improvements – Trigger innovation (which offset compliance costs) – Reduce uncertainty that environmentally oriented investments will be valuable ⇒Net effect on firm value: positive 7 Conflicting predictions from economic theory regarding impact • Information economics suggests positive impact • Environmental economics suggests negative or positive impact ⇒To figure out the impact of the disclosure regulation on valuation, need to look at data. 8 Empirical strategy: Examine a recent regulatory change in the UK • The Companies Act 2006 - Regulations 2013 mandates publicly listed UK companies to report their GHG emissions “[…] in the UK, from the start of next financial year, all firms listed on the London Stock Exchange will have to report the levels of greenhouse gases they emit.” (Former Deputy Prime Minister of the UK Nick Clegg writing in The Guardian on June 19th, 2012) 9 Which firms are concerned? • UK quoted companies – UK incorporated – Listed on the Main Market of the London Stock Exchange • Small firms are exempt (assets, sales, and employees threshold) 10 What needs to be reported? • Absolute quantity of emissions in metric tons of CO2e • Emission intensity – A ratio which expresses absolute emissions in relation to a quantifiable factor associated with the company’s activities (e.g. sales, assets, etc.) 11 Where will the information be published? • Directors’ report: – A document prepared annually by the directors under the requirements of UK company law – Similar to SEC’s Form 10-K 12 Empirical strategy: Try to emulate a clinical trial • Assign firms to – Treatment: Firms affected by the regulation – Control: Firms not or less affected by the regulation • Compare how firm value of the two groups changes after the regulation • Main challenge: Finding appropriate control group(s) 13 Two different control groups • Control group 1 (not-affected): Size and industry matched firms from other European countries – for each UK firm, select most similar non-UK European firm • Control group 2 (less-affected): UK based control group of firms that were already compliant with the regulation beforehand 14 Empirical strategy 1 • Treatment: All UK quoted companies • Control: Size and industry matched firms from other European countries • Idea: – Legislation does not extend to other European countries – Compare how average firm value of UK firms and matched EU firms change after the regulation 15 Main result • Firms subject to mandatory reporting (UK, treatment) increase more in value than unaffected firms (European, control) – Implication: Investors value GHG transparency positively • Evidence is – consistent with Porter and Information Asymmetry view – inconsistent with Traditional view on environmental regulation (opposite sign) 16 Empirical strategy 2 • Separate UK firms into two homogeneous groups based on exante compliance: –Treatment group: Firms that did not report before introduction. (not—compliant) –Control group: Firms that already reported before introduction. (quasi—compliant) 17 Empirical strategy 2 (contd.) • Treatment group: Not-compliant with new reporting requirements more strongly affected • Control group: quasi-compliant with requirements less or not affected • If firm value of the treatment group increases more than that of the control group, corroborating evidence that providing GHG emissions data affects value positively. 18 How do I measure ex-ante compliance? • Use data from CDP (Carbon Disclosure Project) • Firms mark response to CDP as either ``Public'' or ``Private.'' i. ``Public’’ = available to the general public ii. ``Private’’ = response available to CDP and the investors backing CDP iii. ``NA’’ = did not answer CDP questionnaire • CDP Response allows to separate UK firms into non– and quasi—compliant groups. 19 Result 2 • Firms less compliant with the new reporting requirements before the introduction (not reporting to CDP publicly) experience stronger value increases afterwards • Confirms that investors value mandatory GHG emissions disclosure positively 20 Valuation effects stronger for large firms 1. GHG emissions tend to increase with the scale of a firm's operations 2. Larger firms more likely to be adversely affected by climate change because more assets are exposed ⇒ Evidence suggests stronger effect for large firms 21 Does the magnitude of the effect depend on the industry? • Strongest effect in carbon intensive sectors 22 Why does firm value increase? • Evidence consistent with – Porter view: increase in efficiency, technological improvements, etc. – Information asymmetry view: reduction in adverse selection • Is the increase in value due to a Porter or due to an Information asymmetry effect? 23 Why does firm value increase? (contd.) • Porter view implies “real effects” (change in corporate behavior): – e.g., higher capital expenditures, research & development spending; higher return on assets • Information asymmetry view implies “capital market effects”: – e.g., lower Bid-ask spreads, higher trading volume, etc. 24 Why does firm value increase? (contd.) • Value increase appear to be due to “capital market effects”: – Higher liquidity – Lower bid-ask spreads • Value increase not due to “real effects” – No changes in ROA, R&D, or Capex (maybe there will be in the longer term, to be seen) • Evidence more consistent with information asymmetry view 25 Conclusion • Mandatory disclosure with respect to corporrate GHG emissions is valued positively by investors – Effect strongest for large firms and firms in climate sensitive sectors • Valuation increases appear to be driven by capital market effects (higher liquidity) • Important implications for corporate climate change disclosure regulation in other jurisdictions (e.g., United States) 26 Thank you for your attention! 27