Abstract
Climate change has reshaped the socioeconomic, geopolitical, and financial systems of the modern world. Climate finance has become one of the burgeoning fields in contemporary finance literature that resulted from climate concerns in the corporate sector and financial markets. In light of these developments, this thesis comprises three interconnected essays that investigate the idiosyncratic volatility (IdVol) of firms from a climate risk perspective. The findings of this thesis add novel insights into the finance literature mainly from three perspectives: i) examine the impact of carbon disclosure and carbon emissions intensity (CEI) on firms’ IdVol, ii) analyse the long-debated anomalous IdVol puzzle in stock returns using the carbon disclosure decision and CEI of firms, and iii) investigate the role of firm-level exposure to climate change risk (FECCR) in determining the IdVol of firms.
The first essay in Chapter 2 analyses the effects of a firm's decision to disclose carbon emissions and CEI on the IdVol of US S&P 500 firms from 2009 to 2019. I document that the decision to disclose corporate carbon emissions reduces the IdVol of carbon-emissions-disclosing firms by 140bps compared to non-disclosing firms on average. Although firms are being rewarded for disclosing their carbon emissions information, the robust evidence of the first essay shows a significant negative impact of disclosed CEI on firms’ IdVol. The magnitude of the negative effect of CEI increases with the IdVol quantile, implying that the impact of CEI depends on the size of firm-level risk. In light of the managerial opportunism theory’s views, the negative effect of CEI on firms’ IdVol indicates a potential agency conflict over corporate investments to reduce CEI. I also find that firm-level research and development costs explain the negative association between firms’ CEI and IdVol. The results of the first essay further document a significant differential effect of CEI on firms’ IdVol following the Paris Agreement signed in 2015.
The second essay in Chapter 3 examines the anomalous IdVol puzzle in cross-sectional returns from a climate risk perspective. Using a set of US-listed firms from July 2010 to December 2019, the robust portfolio- and stock-level results reveal that the IdVol puzzle exists in both carbon-emissions-disclosing and non-disclosing stocks. Furthermore, I find that investors do not perceive a significant difference in the IdVol puzzle between carbon-emissions-disclosing and non-disclosing stocks, suggesting that the carbon disclosure decision of firms does not affect the IdVol puzzle. However, the results document that the IdVol puzzle is concentrated primarily in high-CEI stocks as far as those carbon-emissions-disclosing stocks are concerned, implying the combined effect of investor attention and ethical screening of stocks.
The third essay in Chapter 4 reveals a statistically and economically significant negative impact of a firm’s exposure to climate change on its IdVol from 2003 to 2020 in the US. The robust results of this chapter suggest that asset prices do not adequately reflect corporate climate change exposures, indicating inefficient pricing of climate risk in the market. I further find that firm-level environmental, social, and governance (ESG) disclosures significantly weaken the negative effect of climate change exposure on firms’ IdVol, highlighting the value-relevance of ESG information. Empirical evidence also documents that firms in polluting and non-high-tech sectors and those operating in highly regulated states are exposed predominantly to the negative impact of climate change exposure on firm-level risk. I find that the information asymmetry and investor confidence serve as channels to explain the negative effect of climate change exposure on firm-level risk.
Overall, the findings of the three interconnected essays of this thesis stand out the importance of climate-related risks in determining the IdVol of firms. More importantly, I document that investing to reduce firms’ exposure to carbon risk is a painstaking corporate decision in the modern business world. Nevertheless, the results further substantiate the specific impact of climate-related risks on asset pricing decisions. In sum, the findings of this thesis suggest that climate change risk implications of firms’ IdVol are worth taking into account in policy-level decision-making by relevant stakeholder groups.