Verified carbon emissions and stock returns in the EU Emissions Trading System

We study the stock returns of firms participating at the European Union Exchange Trading System (EU ETS), which are mostly high-greenhouse gas emitters from the energy sector, or very energy-consuming industries. This “cap and trade” scheme implies that high emitters (“brown” firms) must buy allowances for emission from low emitters (“green” firms). Thus, authorities require that CO2-equivalent emissions be verified by independent third-party carbon auditors. As a consequence our data is less prone to a “greenwashing” bias, in contrast with the literature which uses firms-provided, or data vendor-estimated emissions. In this particular framework, we show that green firms returns outperform brown ones, with an excess annual return between 6.6% and 7.9% across different variants, and with a slightly higher risk. Our results thus show that allowances scheme do modify the risk-return profile of stocks, which can provide a financial incentive to consider emissions in investment decisions. To favor ecological transition, policymakers could then generalize emissions trading systems and independent audits of emissions, and increase the cost of allowances.