Corporate Responses to Climate Change and Financial Performance: The Impact of Climate Policy on its Relationship

Abstract

Based on unique firm-level time series data, this paper empirically examines the relationship between corporate environmental and stock performance. In contrast to former studies, we consider corporate strategies to address climate change instead of general environmental activities and especially highlight the impact of the underlying environmental and climate policy regime. For this reason, we separately analyze the US and European stock markets for different sub-periods between 2001 and 2006. Methodologically, we compare the risk-adjusted returns of stock portfolios comprising corporations that differ in their responses to climate change. These returns are not only estimated in the common one-factor model based on the Capital Asset Pricing Model (CAPM), but also in the more flexible Carhart four-factor model. Our portfolio analysis first shows a negative relationship between corporate activities to address climate change and financial performance over the entire period from 2001 to 2006, especially for Europe. Furthermore, we especially find that a trading strategy which bought stocks of European corporations with stronger responses to climate change and sold stocks of European corporations with weaker responses to climate change led to negative abnormal returns in the period with less ambitious climate policy from 2001 to 2003, but to positive abnormal returns in the period with a more stringent climate policy regime from 2004 to 2006. In contrast, the US stock market produced negative risk-adjusted returns for the latter period with a rather weak environmental regulation framework.