Environmental Concerns and the Cost of Equity in the US Energy Sector

This chapter studies how a well-defined environmental concerns factor influences the equity performance of US energy firms and whether or not this influence differs for renewable and non-renewable energy firms. We construct the environmental sentiment factor and seven sub-group environment-related risk factors using the Dynamic Factor Model econometric method. Then, we estimate stock abnormal returns from well-established asset pricing models to measure firm equity performance. We use an unbalanced panel of 448 US energy firms at the monthly frequency from January 2004 to October 2016. First, we find that all US energy companies show negative abnormal returns in the sampled period, that is the actual returns were lower than expected. Renewable energy firms had higher company value, since renewable energy stocks had lower abnormal returns. We also find that the abnormal returns of renewable energy stocks mainly come from environment regulation risks, while the abnormal returns of non-renewable energy stocks are more sensitive to the measure of public environmental concerns and extreme weather conditions. Consequently, we find that holding the level of environmental related risks constant, non-renewable energy stocks command relative lower abnormal returns.