Why Companies Aren’t Fighting Climate Change

Consider this example: In 1997, British Petroleum decided to lower its carbon emissions below the 1990 level by 2010. It achieved the goal in 3 years rather than 13 at a cost of $20 million. Oh, and it happened to save $650 million. With that sort of calculus, you’d think that every big corporation would be on the emissions-reduction bandwagon.

While the savings for other companies may not be as dramatic, other analyses have found that investing in energy savings is attractive:

A study by the McKinsey Global Institute (MGI) found that an annual global investment of $170 billion in energy productivity through 2020 could half the global energy demand—an amount equivalent to 64 million barrels of oil per day. This investment would create energy savings with an average internal return rate of 17 percent, or $29 billion. MGI said the most cost-effective method for reducing global greenhouse gas (GHG) emissions is through energy productivity. Additionally, the report says the investment would cut CO2 emissions to about 550 parts per million—the amount needed to stabilize the gas at the safety limit set by the Intergovernmental Panel on Climate Change.

In order to achieve this, MGI said the global industry sectors need to invest about $83 billion per year, residential sectors would need to invest about $40 billion, and the transport and commercial sectors must invest $25 billion and $22 billion per year, respectively. Diana Farrell, director of MGI, said “the vast majority of global executives say fixing global warming problems can boost profits…. We’ve identified huge opportunities to reduce energy demand and carbon emissions through improved efficiency.”

So not only does the math pan out, but in addition, most corporate leaders agree that combatting climate change will improve the bottom line. So why aren’t companies moving ahead aggressively?

An article by Karin S. Thorburn at VoxEU, “Why the U.S. policy for climate change is flawed,” points out an ugly reality: the stock market doesn’t get it. Apparently, investors do not buy the idea that investing in greater energy efficiency in an era of of $115 a barrel oil is compelling (and note that despite all the brouhaha about alternative fuels, using less energy will have a far greater impact).

How could investors be so ill informed? One possibility: socially responsible investing has gotten consistently bad press. It’s generally depicted as a soft-headed way to guarantee inferior investment performance. Thus, being a skinflint about energy use, which like other types of cost-cutting is good for profits, is instead treated as naive do-gooderism and punished.

Aggressive PR might reverse this perception; Thorburn recommends regulation to combat this glaring market inefficiency.

From VoxEU:

US climate change policy relies on corporations voluntarily reducing their greenhouse gas output. But recent research shows that pledging to cut carbon is bad for business, which is why so few firms take such voluntary measures. Reducing carbon emissions will require regulation.

Climate change may prove to be the most severe environmental challenge of this century. Yet, the United States, one of the world’s largest producers of greenhouse gases, has refused to ratify the Kyoto Protocol mandating a reduction of greenhouse gas emissions. Rather than national regulation of greenhouse gas emissions, the Bush administration relies on voluntary measures to combat global warming. The success of U.S. climate change policy therefore ultimately depends on how profitable it is for companies to voluntarily reduce their carbon footprint. In other words, in order to be widely adopted, investments required to reduce greenhouse gas emissions must increase shareholder wealth and thus have a positive net present value.

Porter and van der Linde (1995) and Reinhardt (1999) argue that environmentally responsible investments can improve corporate financial performance. They propose that pollution-reducing investments create “green goodwill,” which differentiates the firm’s products and increases its market share. Such investments may also reduce production costs and the risk of future environmental liabilities, as well as give the firm a competitive advantage if subsequent regulatory actions force industry rivals to follow. In addition, Heinkel, Kraus and Zechner (2001) suggest that if investors refuse to hold the stock of polluting firms, the cost of capital may rise to the point where it is optimal for some firms to undertake environmentally responsible investments.

Do voluntary measures pay?

In joint work with Karen Fisher-Vanden, I examined the positive net present value assumption underlying the U.S. policy for climate change (Fisher-Vanden and Thorburn, 2008). Specifically, we studied the stock market’s reaction when companies joined Climate Leaders, a voluntary government-industry partnership in which firms commit to a long-term reduction of their greenhouse gas emissions. Importantly, when the firms announced to the public that they were joining Climate Leaders their stock prices dropped significantly. Controlling for general market movements, the average abnormal stock return was -0.9% over a three-day window and -1.5% over a five-day window around the announcements. For the 46 sample firms that joined Climate Leaders, the total loss in market value was $16 billion. The stock price decline was smaller for firms in carbon-intensive industries, where regulatory action is more likely (and thus partially anticipated in the stock price), and greater for high-growth firms, suggesting that the green investments crowd out growth-related capital expenditures.

Firms joining Climate Leaders conduct a careful inventory of their greenhouse gas emissions before they subsequently announce a reduction goal. The average firm in our sample set a goal to cut its total emissions of greenhouse gases by 17%. Interestingly, the stock price plummeted even further (on average -1.3%) when the greenhouse gas goal was announced, and the more aggressive the goal, the greater the price decline. The study also included 22 firms joining Ceres, a network addressing sustainability challenges whose principles are adopted by its members as an environmental mission statement. Stock returns were largely unaffected by the Ceres announcements, perhaps reflecting—in contrast with Climate Leaders—the lack of specific environmental investment commitments in Ceres. In addition, we looked at portfolios of industry competitors, but found little movement in stock prices when their rivals joined an environmental program.

Why do firms volunteer?

The negative market reaction for firms joining Climate Leaders reveals that the reduction of greenhouse gases is a negative net present value project for the company. That is, the capital expenditures required to cut the carbon footprint exceed the present value of the expected future benefits from these investments, such as lower energy costs and increased revenue associated with the green goodwill. Some may argue that the decline in stock price is simply evidence that the market is near-sighted and ignores the long-term benefits of the green investments. Notice, however, that the stock market generally values uncertain cash flows in a distant future despite large investments today: earlier work has shown that firms announcing major capital expenditure programs and investments in research and development tend to experience an increase in their stock price. Similarly, the stock market often assigns substantial value to growth companies with negative current earnings, but with potential profits in the future. In fact, only two percent of the publicly traded firms in the United States have joined the Climate Leaders program to date, supporting our observation that initiatives aimed at curbing greenhouse gas emissions largely are value decreasing.

The loss of market value implies that the decision to substantially limit greenhouse gas emissions conflicts with shareholder value maximisation and thus the fiduciary duty of corporate directors in the United States. By comparing the sample firms to their industry rivals, we identified characteristics of the firms that voluntarily joined Climate Leaders and Ceres. We found that the sample firms on average had relatively high environmental ratings and low corporate governance ratings, and were more likely to join in periods when public concerns with global warming were high (measured by the number of U.S. press articles). Overall, the evidence is consistent with the notion that management’s interest in environmentally responsible investments, possibly combined with poor shareholder oversight, drives the decision to commit corporate resources to cut the carbon footprint. This is further supported by the anecdotal evidence that two firms acquired by private investors (Norm Thompson and Polaroid) left the Climate Leaders program shortly after going private.

The need for regulation

So what does this all mean? In a nutshell, it suggests that the federal government’s reliance on voluntary measures to reduce greenhouse gas emissions will likely prove unsuccessful. The success of voluntary programs depends on their ability to achieve meaningful corporate participation. Such participation will ultimately depend on the payoff to shareholders. Our research shows that shareholder value declines when companies join Climate Leaders and pledge large cuts in their carbon footprint. Indeed, greenhouse gas emissions, like most other pollutants, seem to constitute a classic example of an externality, where the overall cost to society is not internalised by the individual corporation. In light of such market failure, federal regulation is a viable way to achieve a broad reduction of greenhouse gas emissions. It is high time for the U.S. federal government to face the facts and take real measures to seriously fight global warming.

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  1. Richard Kline

    Another reason why equity investors don’t get energy productivity is that their own heads are a lagging indicator. Investors are, well, not young; they have lived most of their lives with oil at or under $30 a barrel, and so they still see the $60 a barrel oil of a few years as ‘the new norm’ and $115 a barrel oil as an abberation rather than the reverse. Further, investors are completely bought in, pun intended and otherwise, to the idea of ‘externalities,’ that is that the impacts of their companies are NOT THEIR PROBLEM so long as the companies aren’t directly liable. Mentally, economically they’re safe and in the money goes the perception, so it is hard to care, and harder to spend money upfront to solve ‘someone else’s problem.’ This is part of how we have built capitalism stupid, but letting wealth creators walk away from the costs of their actions.

    In industrialized countries, most especially the US, we waste such colossal amounts of energy it’s mindbending. We aren’t the only society in human history to ‘not get it;’ consider the consequences of over-grazing through ten millennia of experience, for example. The point is that even with existing technologies we could vastly change our energy usage. This is where I’d love to see US engineering sharpen up it’s pencils and competitive juice and buckle down. The problem, though, is legacy technology: we, as a society, have invested in crap energy infrastructure. And replacing it all, now, fast, will be, ah, expensive. But we need to GET ON WITH IT, yes.

    Speaking of ‘acting locally,’ one of the best things individuals and local cities could do is to work as hard as possible to ‘get off the grid’ for their energy planning.

  2. Francois

    I agree with Richard Kline: Investors do not think globally with a long-term horizon. Thinking that global warming is “someone else problem” makes one wonder on which planet do they think they’re living.

    In any case, this is the kind of attitude that scream “Please, regulate me more!”

  3. Anonymous

    I love your blog, and read it daily. Greater efficiency and conservation are clearly the lowest cost solution to higher energy prices and in many cases (such as increased housing insulation) have a net positive payoff- the cost of insulation is less than the savings from decreased energy usage over a very short time frame. However increased regulation is a second-best solution; we’d be better off having Pigovian pollution taxes on all energy sources and removing all the subsidies and tax-breaks that currently distort production decisions. Comprehensive mileage-based vehicle user fees for insurance, pollution, roadways, parking and congestion -as proposed by Todd Litman at Victoria Transport Policy Institute- would reduce VMT by roughly half. A policy of gradually reducing vehicle weight and mandating engineering changes to assure vehicle occupant safety would permit the development of 100 mile/gal cars within a decade. None of these proposals requires the development of new technology, just the optimization of what we currently have.

    Green Marketeer

  4. Anonymous

    What an inane analysis! What vain imaginations? Every company I am aware of is out there trying to reduce energy costs and eliminate environmental liabilities.

    Meanwhile, what does regulation do? It does things like the ethanol nightmare. For what? It costs more than gasoline, it causes global food prices to skyrocket, and it increases greenhouse gases. The US and EU are much better off just dropping the nightmare policy, and buying sugar cane ethanol from Brazil–but no, we have to have bennies for political friends and complicated regulations instead of market incentives.

  5. LY

    What’s required to save those costs and decrease energy consumption? Technical experts, long term planning and capital expenditures. Neither of which seem to be favored by corporate America.

  6. S

    The data on climate change long cycle is inconclusive at best. I’d be happy with a good weekend report.

  7. Anonymous

    Hmm, nice with more data showing that markets are not quite as rational and good at allocating resources as some people like to preach.

  8. Anonymous

    The writer is an idiot. Of course Wall Street gets it, 17% ROE works all day long! Only recently has the cost of energy gotten to the point where 17% returns were possible from some conservation measures. By the way, Solar DOES NOT generate 17% returns and is completely uneconomical without subsidies. I know the solar advocates say we are getting close to competive w/ conventional energy, as they have been saying that for 30 YEARS.

  9. Yves Smith

    Anon of 8:14 PM,

    I have to beg to differ. First, McKinsey Global Institute found that despite the fact that most “global executives” (what a lousy turn of phrase) agreed they could save money by investing in energy savings, they weren’t doing it.

    Second, the extreme short-sightedness, which results froma fixation with meeting quarterly targets, isn’t limited to reducing carbon emissions. One McKinsey director (this is the most senior level at that firm) told me about a major corporation whose most profitable service was an add-on to its basic service. The payback on an ad campaign to promote said service was 11 months (and customers don’t generally turn it off once they’ve signed up, so the returns are very juicy), The company nevertheless nixed the campaign because it wanted to show better results in the intervening quarters. Note I heard this about a year ago, which means the incident took place earlier, meaning when the economy was considered to be strong. And the director was clearly using this as an illustration; he had more examples like that.

  10. Richard Kline

    To Green Marketeer: I agree completely that subsidies are a ‘wrong sizing’ approach, and at best inefficient. Subsidies not ‘regulation’ are what got us ethanol from corn; this will be the classic example for many years to come. I completely favor a tax-and-bind approach to bad/dirty technologies—as a first step. But one still gets the dirt, especially with legacy physical capital which can’t be turned off fast, it just makes that source more expensive with the costs passed on to the end user. Regulatory clamp-downs on dirty-source output help.

    However, the market always goes for the cheapest new thing, not the best new thing. Just leaving it up to the market doesn’t mean that the outcome is ‘good.’ This means that one needs an integrated policy, and that new sources also receive incentives and disincentives. For example, as you say lower weight vehicles may have to be mandated by regulation; the market won’t ‘choose’ that option if another one is cheaper.

    Our single biggest problem with energy is that the highest utility and most widely available form of mid-term and long-term energy _storage_ is a five gallon can of gasoline. We really need a way to store produced energy for 24-1000 hours. The engineer and the country which gets that prize will literally change the world. Maybe it’s in India, maybe in China, maybe here. Listening, bright guys?

    To S: The long cycle climatic changes pertaining to the global warming hypothesis aren’t ‘proved,’ no: by the time they are, it will be much too late to do anything to affect the outcome. The fundamental science behind the hypothesis is sound beyond doubt; what is in question is the scale and the time frame of impacts, and whether such related features such as carbon expression from permafrost or absorbtion by the oceans will mitigate or exacerbate the outcome. If we wait, we get what’s coming; if we act, we choose what’s coming, and perhaps what’s not. The argument that the science ‘isn’t proved’ is advanced by the ‘do nothing and wait’ crowd. If they are the dodos, they’ll be the last to know; most of us don’t want to wait and find out.

    To Anon 8:14: The market chooses what it cheapest for the choser, not what is best for the users. This is a fundmental error for capitalism. Fossil fuel carbon will still be cheaper than solar for long to come—so long as we permit choosers to exclude ‘externalities’ such as pollution and climatic impact from _their_ costs. If we factor those costs into the ledger, solar is the cheaper choice ‘for society.’ Even if solar is more expensive, it’s the better choice for society, so we should be taxing the hell out of carbon-side choices to level the playing field. Cost to the chooser is not the acceptable standard for something that has group concequences, which carbon use does. This is a mental breakthrough which some societies, ours notably, find very difficult to make. It ‘dosen’t make sense’ in the dominant frame of reference, which only makes cents. We could all afford to go solar tomorrow if this is where we, as a society, decided to spend some of our surplus value added, the difference between solar and ‘other’ isn’t an order of magnitude. Not that I necessarily think solar is the only way to go.

    Fundamentally, I don’t personally _care_ if it is more expensive for companies and end users to get clean(er) energy sources. It is more expensive to go to the doctor regularly than to stay home uninsured; the outcome is seldom better from that strategy, as in this instance also.

  11. burnside


    Nicely formulated response.

    I note that discussion of long cycle climate change can neglect effects other than global warming, viz, CO2 concentrations affect oceanic acidity in ways we are sure to find disagreeable.

  12. Richard Kline

    To burnside, d’accord, there are other undesirable effects from increasing atmospheric carbon. BTW, it might be better to ‘reply’ me when and as you choose to do so as ‘Richard Kline’ since there is another poster here who is _not_ me going by the tag RK. Regards.

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