Market Reaction to Corporate ESG News

Photo by Adeolu Eletu on Unsplash

A recent paper by George Serafeim and Aaron Yoon explores the market reaction to different ESG news. They analyze the market reaction to ESG news for 3,109 companies. They find that prices react only to financially material ESG news, and the reaction is larger for news that is positive, receives more news coverage, and is related to social capital issues. They conclude that investors are motivated by financial rather than nonpecuniary motives as they differentiate in their reactions based on whether the news is likely to affect fundamentals.

This paper has important implications:

  1. ESG news contains value-relevant information.
  2. Portfolio managers who integrate ESG ratings into their investment decisions will likely generate better returns.
  3. Investors need to understand that the market does not react to all types of ESG news equally; hence, specific types of news become important in generating returns.
  4. Given that price reaction is larger for positive ESG news, which receives more news coverage, and relates to social capital issues relative to natural or human capital issues, a market participant can focus on these news types in their capital allocation decisions.

Paper by Serafeim and Yoon: https://www.hbs.edu/ris/Publication%20Files/WP21-115_397685a0-a044-4f86-8e6a-e4b9a0769cc7.pdf

The Net Zero Emissions Bill 2022

The Net Zero Emissions Bill 2022 was introduced in Rajya Sabha on December 9, 2022. It hasn’t received the attention that it deserves. The Bill creates a structure that will enable India to achieve the net zero target set out at the Glasgow Summit and incorporated in India’s NDCs (Nationally Determined Contributions). To achieve the 2070 target, Interim emission targets are set out:

(a) reduce by the year 2030 emissions intensity by forty-five per cent. from 2005 levels;
(b) achieve about fifty per cent cumulative electric power installed capacity from non-fossil fuel-based energy resources by the year 2030, with the help of transfer of technology and low-cost international finance including from Green Climate Fund;
(c) create an additional carbon sink of two and a half to three billion tonnes of carbon dioxide equivalent through additional forest and tree cover by the year 2030.

The Interim Emission Target shall be considered to have been achieved if emissions reductions meet or exceed those required by the target as per the 2005 levels.

The Bill envisages setting up the Net Zero Emission Commission of India. Similarly, State Net Zero Emission Councils and District Net Zero Emission Councils will be set up.

The Bill also provides for the protection of vulnerable communities. The State Councils and District Councils shall respectively maintain a localized climate-vulnerable community population registry. This classification will be based on the following:

(a)  exposure to regional drastic climate variability;
(b) (historical susceptibility to drastic climatic events according to available sources of climate information;
(c)  frequency of economic and non-economic loss suffered due to drastic climate events;
(d) access to technology and risk perceptions systems and their awareness;
(e)  loss of livelihood and customary and cultural practices of communities;
(f)   specialized impact of climate change unique to a person or community

The Bill also provides for a National Risk Assessment. though
(a) assessment of the risks to India’s economy, society, environment and ecology from the current and future effects of climate change; and
(b) identification of the most significant risks to India based on the nature of the risks, their severity and the need for coordinated steps to respond to those risks in the next six-year period.

The Bill envisages the constitution of the National Emission Reduction Fund that shall be utilized for greenhouse gas emission reduction activities. Both the State and Central governments will fund this by a grant of loans.

All disputes will lie with the National Green Tribunal.

Inflation, Sustainability and Consumer Behaviour

High inflation rates have persisted for quite some time now. As a result, inflation affects both (a) how businesses operate in a high inflation environment and (b) how consumers respond with their purchase decisions.

Rising prices
Photo by Monstera: https://www.pexels.com/photo/graph-with-increasing-euro-profitable-investment-6289026/

In an inflationary environment, businesses face higher costs due to increased input prices. Staff costs rise too as the company needs to compensate people for a higher cost of living. Nominal interest rates raise the cost of borrowing. While all costs are rising, businesses have limited capacity to pass on the cost increases. While the worker (who is also a consumer) receives higher wages, she does not get fully compensated for inflation. Thus, the worker or the consumer sees an effective reduction in her purchasing power. With tight demand, higher prices will only drive away the consumers. Add to this chaos consumer preference for sustainable products. 

A study by GfK indicates that about 80% of consumers globally say that sustainability remains important to them. At the same time, about 30% of Europeans, 40% of people living in the US and 50% from developing Asia indicate that they will put their own economic security and wellbeing before environmental problems.

This makes reading the situation confusing. So what’s a company to do?

Finetune your messaging: Undertaking sustainable actions is not enough. These actions need to be communicated credibly too. Communication without action is easily caught out and can cause irreparable harm. For instance, if you are an appliance manufacturer, help the customer understand your repair and refurbish programme and make it easy for them to avail of it. Or, prevent food waste by providing discounts near expiry dates. Provide net zero labels that are easily visible or communicate net zero credentials powerfully on other mediums. 

Build core sustainability capabilities: The customer’s view on sustainability has shifted from “cleaning up” to “saving the planet” – given the magnitude of the problem and increased awareness of sustainability issues. Thus, companies will need to continue to build a strategic focus on sustainability. Then, when inflation ebbs, the company will be ready to cater to customers opening up their wallets.

The opportunity for sustainable products is immense. Increase their perceived value, ensure its effective use and create compelling communication to build trust with the consumer.

Stranded Assets and Finance

The shift to net-zero requires moving away from fossil fuels (coal, oil, and gas) and decarbonizing production processes and supply chains. Thus, new equipment or new methods may be required. This results in stranded assets. In this article published in Artha (journal of IIM Calcutta) I explore stranded assets and their implications and focus on environment-related stranded assets.

The August issue is available at https://www.iimcal.ac.in/FinLab/email-template4/

stranded-assets-and-finance-arthaDownload

A Just transition

Faced with the climate crisis, companies are rapidly transitioning to a green economy. However, this transition is often painful, disrupting people’s lives and livelihoods. Businesses have often gone about the transition as if “transition is assured, justice is not.” Trade unions questioned this mindset in the US in the 1990s. The concept of just transition emerged from these struggles. 

Source:  LOGAN WEAVER | @LGNWVR / Unsplash

While the term still refers to the support for workers who lose their jobs due to environmental protection policies, it is now seen more widely to include support for racial justice and social equity in environmental and climate policy and includes impacted communities. 

The importance of a just transition is underscored by The Paris Agreement of 2015, stating, “Taking into account the imperatives of a just transition of the workforce and the creation of decent work and quality jobs in accordance with nationally defined development priorities.”

A just transition model must include the following:

  • Income support for workers during the entire duration of the transition
  • Local economic development tools for affected communities
  • Realistic training/retraining programs that lead to decent work
  • Knowledge sharing — the adoption of best practices from other jurisdictions
  • A framework to support labour standards and collective bargaining
  • A sectoral approach customized to regions and work processes
  • Research and development to provide support for technological adjustment
  • An equity lens to understand the impacts on racialized and indigenous communities

Companies are increasingly talking about stakeholder values. They must demonstrate their commitment to stakeholder value by ensuring that their sustainability commitments include a just transition. A just transition must be woven into the design for transition. Becoming net-zero needs to be backed up by a just and fair process. A just transition brings together the Environmental and Social pillars in ESG and Governance pillar provides the glue that keeps them together.