Firm-Level Climate Change Exposure

Zacharias Sautner, Laurence van Lent, Grigory Vilkov and Ruishen Zhang contribute to the sustainable investing literature with their June 2021 study, “Firm-level Climate Change Exposure.” They began by noting: “Climate change has started to significantly affect a large number of firms. While some firms face direct costs from change in the physical climate, others are adversely affected by policies and regulations that are implemented to combat global warming. At the same time, climate change does provide opportunities for some firms, those, for example, operating in renewable energy, electric cars, or energy storage. With the consequences of climate change becoming more observable, the debate has intensified over whether capital markets are paying enough attention to the financial impacts of climate change.”

They then noted the challenge that investors face in determining firm-specific exposures to climate change: It remains unclear how the climate will change and whether, how and when policymakers will tighten regulation; the effects of climate change are uneven across firms, even within the same industry (many factors that affect a firm’s ability to adapt to a greener economy exhibit large firm-level components such as managerial skill, innovation or financial constraints); and there is no common practice among academics or practitioners for how to reliably quantify firm-level climate change exposure.

To try to address the problem, the authors used transcripts of 10,158 quarterly earnings conference calls of publicly listed firms from 34 countries to construct time-varying measures of how market participants perceive these firms’ exposures to climate change. Their data sample spanned the period 2002-2019. They used a machine-learning keyword-discovery algorithm to capture exposures related to opportunity, physical and regulatory shocks associated with climate change. They noted that a benefit of using earnings calls is that they are less susceptible to “greenwashing” by management: “Indeed, even if management tries to evade the topic of climate change or to window dress their achievements, analysts could act as a counterpoint by asking probing questions. This is different from other documents such as annual reports or press releases, which exclusively reflect the views of management.” This hypothesis is supported by the evidence from the 2021 study “Cheap Talk and Cherry-Picking: What ClimateBert has to say on Corporate Climate Risk Disclosures,” which found that climate risk disclosure in annual reports is mostly cheap talk, with firms cherry-picking the information they provide.

To benchmark and compare their measures, Sautner, van Lent, Vilkov and Zhang used data (available 2009-2017) on firms’ Scope 1 carbon emissions from CDP. Scope 1 emissions are direct emissions, which come from the combustion of fossil fuels or from releases during manufacturing. They focused on Scope 1 rather than Scope 2 or Scope 3 emissions, as they are directly owned and controlled by firms. They then scaled these emissions by total assets in order to obtain a measure of carbon intensity.

As a second benchmark, they used data on firms’ ISS Carbon Risk Rating from ISS ESG, which constructs data to assess firms’ carbon-related performance. ISS Carbon Risk Rating is available annually and is based on several factors, including the carbon impact of a firm’s products (e.g., the revenue shares of products associated with a positive or negative climate impact) and carbon emission reduction targets and action plans. The ISS sample contained 9,995 firm-year observations from 3,306 firms in all 34 countries covering the period 2015-2019.