Less attention to downside of nation’s carbon-neutral goals
ESG investing, which has attracted some $40 trillion thus far and is increasingly focused on the E-for-environment, is essentially a two-sided coin.
One side seeks to avoid owning stock in companies with substantial environmental liabilities or reliance on operations that pollute. This risk-avoidance impulse also gets portrayed as altruistic, wanting to shun perceived bad actors. Think Exxon, the oil and gas giant.
The other side of the coin is the desire to own companies that might profit from the shift to a low-carbon economy. Think First Solar, maker of solar panels.
Which side is of most interest?
In a working paper, UCLA Anderson’s Henry L. Friedman, Chinese University of Hong Kong-Shenzhen’s Kanyuan Huang and Shanghai Lixin University of Accounting and Finance’s Kaiwen Wu leverage a unique feature of the Chinese stock market that provides platforms for investors to lob questions at firms. Not only must management respond to investor questions within a few days, it is typically a high-ranking manager titled “board secretary” — a role often taken by the CFO — who oversees these questions.
The back-and-forth suggests that investors in China are more focused on the upside from climate change — are companies positioned to profit? — and less on the downside.
The word clouds below gleaned from both investor questions and management answers have a forward-looking emphasis on where firms are headed, and less emphasis on where they are at today in terms of exposure. (You’ll need to look a bit to find “emission” while “development” and “technology” loom large.
A big shift in China’s carbon-emissions policy announced in March 2021 provided the researchers with a real-time event to track the extent to which a full-throated government commitment to carbon neutrality played out in the volume and nature of carbon-related questions.
Chinese President Xi Jinping had previously pledged in the fall of 2020 that the country would reach peak carbon emissions in 2030, and from there it would be transitioning to net carbon neutrality by 2060. But given the venue of that pronouncement — the United Nations — it was received as more diplomatic talk than policy. That changed in March 2021 when the Chinese government announced in a high-level governmental meeting that the 2030/2060 goals were enshrined as national economic policy.
The researchers document that around and following the government announcement, investors submitted a large increase in carbon-related questions.
Hand-wringing over potential downside? Not so much. Rather, investors were mostly interested in data related to whether a firm was positioned to benefit from the government’s explicit goals for a green transition within 40 years.
The researchers also teased out signals that the increase in carbon-related questions was not because investors internalized the government’s policy as a reason to become more socially responsible. The researchers found evidence that suggests investor questions were more rooted in wanting to figure out where there was profit to be made, not just doing good.
Eyeing the Upside to Carbon Neutrality
The researchers created a database of all questions submitted to companies via two platforms between January 2020 to November 2021. That gave them a window into both the before and after of the March 2021 carbon neutrality policy announcement by the government. They focused on Chinese A shares, which are held mainly by Chinese investors.
Of the 1 million questions submitted in that time span, they found that around 9,000 were carbon-related, with the majority landing after the government’s announcement. Less than 700 carbon-related questions came in the 14-months before the government announced its carbon neutrality goals. (Interestingly, there was no increase in questions in September 2020, when Xi announced the goal of carbon neutrality at the U.N.)
When the specific carbon goals became domestic economic policy in March 2021, the researchers report that there were about 3,000 carbon-related questions that month, and more than 1 in 4 of the nearly 4,000 firms in the database received at least one carbon-related question.
Opportunity was the subtext, as 70% of carbon-related questions were about “whether the company has current business or future business plans to help reach the carbon neutrality goal.”
Not Just Greenwashing?
A strain of ESG research (and criticism) is that the huge growth in assets dedicated to the strategy is a function of capturing the wallets of do-gooders who are more focused on social good than cash flow outlooks. Talk the talk being sufficient to attract investors.
Friedman, Huang and Wu surmised that if “warm glow” investing was the only factor in play, there would be no difference in a stock price’s reaction to new info in earnings announcements among firms that were the focus of carbon related questions, and those that weren’t on investors’ carbon radar. That is, news doesn’t matter, just investing in the ESG-conscious firm is enough.
The team found that the metric used to capture this price reaction to new news (earnings response coefficient, ERC) was similar in the pre-announcement period among firms with and without carbon-related questions: .052 vs. .039. After March 2021, there was a significant shift, as the ERC for firms asked a carbon question rose to 0.182, while the ERC for the nonquestioned had a far less dramatic uptick, to 0.54.
The investing opportunity angle to investor questions was mirrored in analyst estimates. The researchers report earnings estimates for firms that received carbon-related questions increased by 7.1% after the government laid down its specific goals. Among companies that didn’t attract carbon-related questions, analyst estimates declined by an average of 2.5%.
Moreover, they found that in the month after the government’s announcement, companies that were targeted with carbon-related questions posted returns that were 3.1% higher than firms that did not get carbon-related questions. And that boost wasn’t some one-time reaction; the researchers found there was no countervailing correction three months later.
“Critics of ESG often argue that sustainable investing is a marketing tactic that does not bear material consequences,” the authors write. “Our results suggest that public support for ESG activities provides a reasonable channel through which ESG activities and information about them become material.”
Henry L. Friedman
Associate Professor of Accounting
About the Research
Friedman, H.L., Huang, K. & Wu, K. (2022). ESG Attention in Capital Markets: Evidence from China’s Carbon Neutrality Pledge Announcement.