By Inhwan Ko &
August 11, 2024
Source: Nature
Photo / Image Source: Unsplash,
Introduction
Climate change results from the overuse of the atmosphere as a sink for greenhouse gases. To limit the overuse of this global common pool resource1, a market failure, countries have announced net-zero emission targets2. To achieve this target, they have adopted a variety of policy instruments, including carbon pricing3,4. However, climate groups are frustrated by the failure of governments to accelerate decarbonization. They are suing governments in local, national, and international venues5, and embarking on radical actions such as museum protests to pressure governments for more vigorous steps to combat climate change6.
The twin failures of markets and governments7 to address the climate crisis have created the policy space for firm-led voluntary climate action in the form of corporate emission pledges8. For instance, in 2019, Amazon pledged to reach net-zero emission status by 2040. Furthermore, when announcing its Climate Pledge, Amazon invited other firms to join this effort. As of July 2024, 503 companies from 45 countries have pledged to achieve net-zero emissions by 20409.
The popularity of corporate emission pledges raises an important question: why should profit-seeking firms voluntarily incur private costs to create the global public good of climate mitigation via emission reductions? To address this issue, we draw on the literature on voluntary environmental programs (VEPs), which could be viewed as institutions that encourage participating firms to voluntarily produce environmental public goods (climate mitigation in our context) beyond the requirements of the law10,11,12,13,14. In return, participating firms secure reputational benefits with club good features in that they are nonrival (enjoyed by all VEP member firms) and excludable (limited to VEP members only).
Reputational benefits can take many forms, including higher stock prices, regulatory relief from government agencies, and stakeholder goodwill. The logic is that the promise of excludable benefits (which can be enjoyed by VEP members only) motivates firms to voluntarily incur private costs to reduce emissions.
Yet, scholars question the effectiveness of voluntary measures in motivating environmental improvements and view them as greenwashes, namely “the practice of falsely promising an organization’s environmental efforts or spending more resources to promote the organization as green than are spent to actually engage in environmentally sound practices.”15,16 Scholars note that for VEPs to be effective in producing environmental public goods, they must monitor their members’ compliance through external third-party audits and verification.
However, monitoring and verification impose costs on participating firms. The implication is that firms might be more willing to incur the costs of joining VEPs with credible monitoring mechanisms if they have a reasonable assurance that they will be able to secure the payoffs from VEP membership. Stock market rewards might be an important component of this excludable benefit.
In this article, we focus on the stock market response to a leading climate-focused VEP: Science-Based Targets Initiative (SBTi). As a VEP, SBTi offers an institutional platform for firms to secure an external review and verification of their emission reduction pledges.
Established in 2015, SBTi was born from the partnership between the United Nations Global Compact, the World Resources Institute, and the World Wildlife Fund for Nature. In 2022, CDP (formerly the Carbon Disclosure Project) also joined the partnership. Thus, SBTi is a coalition of technically competent non-profit organizations and an UN-affiliated body with expertise in climate policy and corporate social responsibility. Around 4000 firms worldwide have submitted their emission pledges for SBTi verification.
Joining SBTi requires firms to incur non-trivial costs. Unlike national net-zero emission pledges that allow countries to interpret their climate obligations in different ways and provide them loopholes to evade emission reductions2, SBTi has clear guidelines for firms to set up emission pledges17. Firms must establish near-term emission reduction targets (predominantly scope 1 and 2 emissions) that cover 5–10 years from the submission date. Unlike long-term targets which could span over 20 years (e.g., by 2045 or 2050), near-term targets impose costs on firms immediately.
The number of firms with SBTi-approved pledges has increased from 133 in 2018 to 2097 in 2022, covering about 34% of the global economy by market capitalization. Given the substantial costs firms incur to document emissions and meet the pledged reductions, what explains SBTI’s attractiveness?
This is where the role of VEPs’ reputational benefits with club-like features comes in. Firms invest vast resources to build corporate reputation because it has a payoff: by some measures, brand equity, a reputational attribute, accounts for about 20% of firms’ market capitalization18. Reputations allow stakeholders to evaluate different aspects of firm performance. Viewed this way, corporate reputations could improve firms’ relationship with regulators, cushion the negative impact of unfavorable events such as industrial accidents, lower the cost of capital, and attract and retain employees19.
We suggest that the stock market is the primary venue where reputational benefits translate into tangible rewards. Firms with higher reputations enjoy more positive evaluations of their performances20, which is reflected in their stock prices21. Pro-climate business leaders such as Larry Fink, the CEO of BlackRock, the world’s largest investing firm, claim that firms investing in climate actions will be rewarded with superior benefits22. Broadly, in recent years, stock markets have become vigilant about corporate climate actions. Credit rating agencies have started to incorporate firm-level climate-related indicators into their metrics. S&P published a report assessing the impact of transitional climate risk23, defined as a regulatory risk firms face when adjusting to climate regulations, on firms’ fiscal health24. Moody’s has announced that it plans to incorporate climate risk data into the rating of US commercial securities.
A recent study finds that SBTi verification helps firms improve the quality of their emission inventory reporting25. However, it is less clear if superior reporting also creates financial benefits (a payoff for joining this VEP) for firms. For instance, Republican Attorney Generals of several U.S. states have sued financial companies that employ ESG (environmental, social, and governance)—emission reductions being a critical element of the ESG approach.
The U.S. House of Representatives Judiciary Committee is investigating collusion among financial companies to promote ESG. Thus, given the political controversy, financial investors may be less likely to reward firms that have joined SBTi and pledged to reduce emissions. Therefore, it is an empirical question whether stock markets reward firms joining SBTi.
To address this issue, we examine quarterly stock prices from 2010 to 2023 of S&P 500 firms that vary by their SBTi verification status. As of February 2024, 5 firms had their targets verified at the 2 °C level, 25 at well below the 2 °C level, and 102 at the 1.5 °C level. Also, 56 firms had committed to target verification in the future. The logic of the tiered VEP structure is that firms that have pledged a more aggressive emission reduction target should receive greater recognition from external stakeholders.
Using multiple empirical approaches (event study, matching, and weighted two-way fixed effect model), we find little evidence that SBTi membership (in any tier) increases stock prices. The implication is that if stock markets are not incentivizing firms to pledge climate actions voluntarily, policymakers and climate advocates need to focus on providing nonfinancial rewards to encourage firms to invest in emission reductions.
Ko, I., Prakash, A. Stock markets, corporate climate pledges, and the Science-Based Target Initiative. npj Clim. Action 3, 69 (2024). https://doi.org/10.1038/s44168-024-00148-8
Received05 April 2024
Accepted24 July 2024
Published11 August 2024
DOIhttps://doi.org/10.1038/s44168-024-00148-8
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