Laura T. Starks, Ph.D., is the George Kozmetsky Centennial Distinguished University Chair at the McCombs School of Business, University of Texas at Austin, where she teaches graduate and undergraduate courses on environmental, social and governance investing. Her current research focuses on ESG issues, including climate finance and board diversity, as well as molecular genetics and financial decisions.
The Financial Impact of Poor Corporate Climate Performance
Corporate environmental and climate risks have received more attention from investors and managers and are becoming an important factor in financial decision-making.
In my research, I evaluated whether and how climate and other environmental regulatory risks affect corporate bond credit ratings and prices.
The evidence suggests that uncertainty about future regulatory actions can motivate investors and other bond market participants to respond to firms’ environmental performance, and particularly, changes in firms’ exposures to climate risks. For example, poor environmental performance, including having a more significant carbon footprint, is associated in general with lower credit ratings and higher bond yield spreads, particularly for firms located in states with stricter environmental regulations.
Specifically, the December 2015 Paris Agreement appears to have increased the regulatory risk for firms that are in high emissions industries or have poor environmental performance in general, resulting in negative consequences. More importantly, these effects on bond ratings and yields are observed to be stronger in states that enforce regulation more strictly, suggesting that they are stronger because potential new regulations were expected to be enforced more strictly.
These results have important implications for how firms’ environmental profiles are related to market participants’ assessments of their corporate bonds’ risks and values. The results suggest that credit rating analysts and bond investors are concerned with issuers’ environmental profiles because of potential regulatory costs. Thus, if bond investors expect an issuer to be punished for poor environmental performance, they are more likely to price those costs into the firms’ bonds.