Firm Carbon Dioxide Emissions and Future Earnings/Stock Returns

Prior research indicates that stocks of firms with high direct and indirect carbon dioxide emissions tend to beat the market (offer a carbon premium). Does high-emissions stock outperformance derive from surprisingly high earnings? In their September 2023 paper entitled "Does the Carbon Premium Reflect Risk or Mispricing?", Yigit Atilgan, Ozgur Demirtas, Alex Edmans and Doruk Gunaydin examine relationships between firm carbon dioxide emissions and future earnings surprises. They consider three levels of emissions from S&P Global Trucost: Scope 1 directly from firm operations; Scope 2 from firm consumption of purchased heat/electricity/steam; and, Scope 3 from upstream supply chain operations. They consider level of emissions (natural logarithm of emissions measured in tons) and annual change in level of emissions, with the latter winsorized at the 2.5% level. They consider several measures of earnings surprises, all comparing analyst forecasts to actual earnings. They calculate market reactions to earnings announcements as 3-day cumulative abnormal returns (CAR) relative to a 3-factor (market, size, book-to-market) model the day before through the day after earnings announcements. Using carbon dioxide emissions data, stock returns, market valuations, book values and analyst earnings forecasts for a broad sample of U.S. stocks during 2002 through 2021, they find that: