Circular Economy, Stock Volatility, and Resilience to the COVID-19 Shock: Evidence from European Companies

Abstract

Background: By decoupling economic growth from an intensive use of resources, preventing the impairment of natural capital, and enhancing resilience to system-wide shocks, the Circular Economy (CE) is a powerful opportunity to hedge against “linear” risk factors. In fact, it helps shielding against the risk of assets becoming stranded, can generate fresh and non-speculative demand for investments, and can improve investment results at both individual and portfolio levels. Problem: Therefore, equity investors into circular undertakings could benefit from (H1) reduced stock return volatility, as well as (H2) a greater ability to withstand exogenous negative events. Approach: For testing these hypotheses, we constructed a sample of 644 listed companies across EU-15 countries, plus Switzerland, and 17 different industries. We retrieved their market data in 2019–2020, as well as their accounting fundamentals in 2018–2019. By controlling for the latter, we investigated whether equity risk—either in total terms (i.e., the standard deviation of returns) or circumscribed to the systematic component thereof (i.e., the Beta against a European or global market index)—may be explained by a company’s degree of circularity, measured by the Circularity Score (CS). This is a novel indicator originally proposed by Zara and Ramkumar (2022), based on Refinitiv ESG data, the methodology whereof we significantly amended. As a core innovation, in weighting an entity’s performance on a CE framework, we assessed the latter’s “financial materiality” (i.e., relevance to the company’s business) at sub-industry level, applying the SASB Materiality Maps. Via OLS estimation, we tested our hypotheses (i) over the whole-time horizon, in a panel model; (ii) on specific timeframes, in a standard cross-sectional model. The latter was applied to either the entire 2020 or subperiods thereof: namely, with respect to the COVID-19 outbreak, we distinguished between a pre-shock, a shock and a post-shock phase. Our quest was refined to conduct a deeper investigation into the Oil & Gas industry, which is intrinsically the most exposed to linear risks and, also, did experience the widest volatility in 2020. Findings: Both H1 and H2 received widespread confirmation. The CS was found to exert a negative, significant and robust effect on all the three risk measures, over the whole timespan as well as in subperiods (particularly the post-shock phase). Also, amplifying effects were recorded on the Oil & Gas industry. Conclusions: Our results lend remarkable support to the idea that the CE is a powerful enabler of de-risking, also in case of a severe shock, with a view to mitigating the negative consequences and building back better. They call on firms and policymakers to foster the circular transition, thereby accelerating economic recovery in the aftermath of the pandemic crisis.