Week 2

Question 1

Why is it important to look at emissions within industry?

Answer 1

Important to understand the difference in how different industries pollute to understand how scale impacts pollution- idea that large market cap doesn’t always equate to high emissions eg. JP Morgan

The observation that once you control for industry-specific variation - companies that are larger tend to pollute more - economically, it is expected that there should be some kind of relationships like that

Question 2

What is the book to market ratio?

Answer 2

ratio of book value assets/equity of the company relative to the market capitalisation of the company

book value of assets the value of the assets

market capitalisation is price x shares outstanding/book value

Question 3

Why is it important to look at the book value?

Answer 3

It is the valuation of the company in two forms the assets in place and future growth opportunities

both have to be factored in for forward-looking investors

value created in the future impacts the discount rates or financing in relation to that

Question 4

What does a high book to market ratio mean?

Answer 4

low growth companies - book value dominates the growth opportunities eg. Steel companies about existing infrastructure

Low book to market ratio means market cap values something not reflected in book - must be a growth opp eg. tech companies that derive value from future projects

Question 5

What is the relationship between B2M and emissions? and what are some explanations for this?

Answer 5

Companies that have a high B2M (low growth companies) have a positive relationship with emissions (high emissions)

makes sense as emissions come from something ie. production

1. the more you are relying on the current assets the more you are thinking about the assets and emissions already in the production scheme - why it may be related to higher emissions
2. old vs new technology - growth is new tech and thus going to be more carbon efficient thus less emissions.

Question 6

what is the point in looking at firm characteristics and emissions?

Answer 6

if we know how companies relate to these characteristics we can predict how responses will change to characteristic changes later on

Question 7

What is ROE?

Answer 7

Return on equity - it is the profitability margin or idea of how much profit you can generate from your own equity

Question 8

What is the relationship between ROE and emissions? and what are some explanations for this?

Answer 8

there is a strong positive relationship between profitability and the level of emissions

1. if you generate more profit you are going to translate that into more production - cyclical effect

Question 9

What is leverage?

Answer 9

reliance on debt financing. how much companies are using external debt to finance their operations

Cost of capital is lower, require captial to finance debt, run out of resources and turn to external as can no longer rely on my own assets

Question 10

What is the relationship between leverage and emissions?

Answer 10

More leverage = more emissions due to a potential expansion of production capacity

Question 11

What does investment mean in the context of the regression analysis?

Answer 11

capital expenditure - spend their money on capital that they have

Question 12

What is the relationship between investment and emissions? What are some possible explanations to this?

Answer 12

There is a negative correlation, as investment increases emissions go down when scaled by assets

1. difference between investment and output - sometimes time lag between investment and output - output will be reflected in future emissions not current emissions
2. idea of the lifecycle of emissions

Question 13

What does HHI mean and what does it tell us?

Answer 13

HHI= Herfindahl-Hirschman Index

measures the competition within the industry by looking at the share of each company relative to each industry - tells you about the relative importance of each company in the industry

if HHI=1 = then it the company has 100% share of the industry

Question 14

What kind of company produces more emissions and why? - conglomerates in multiple industries vs single business

Answer 14

companies in one business on average have lower emissions

Finance and tech - tend to pollute less and have lower emissions
Could argue that companies like Exxon mobile converting from brown to hybrid/green could have lower emissions due to diversification but this mechanism doesn’t dominate over the first.

Question 15

What does PPE stand for and what does it mean?

Answer 15

Property, plants and equipment

the tangible capital - something that is demonstrated by the physical capital that is observed

Question 16

What is the relationship between PPE and emissions? What are the possible explanations?

Answer 16

This variable is very signficiant and positive

more tangible capital the more likely you are to emit high
Human capital and patents do not produce emissions as much as physical capital does

Question 17

What does the MSCI variable measure?

Answer 17

are you part of the global index or not - companies ie either affiliated or not

Question 18

What is the relationship between MSCI and emissions?

Answer 18

the index is usually for larger scales of operations

there is a positive relationship between emissions and MSCI rating

Question 19

How would inclusion of transition risk in company valuation be reflected in company valuations?

Answer 19

there would be a higher expected return or higher cost of equity
or
they are discounted today and therefore have a lower price today

Question 20

What is a carbon premium? and how is it measured?

Answer 20

the compensation for the extra compensation required for a particular risk

coefficient of carbon emissions measures identified average carbon premium
- Daniel and Titman 1997
- monthly stock returns, lagged carbon emissions on an annual basis, various firm-level characteristics as controls - fix time and space and provide standard error

Question 21

Why and what does the levels of emissions tell you something about the transition risk?

Answer 21

Emissions today are an indication of how much you need to do to get to net neutrality

this is the long term risk

Question 22

What are some the messages from the carbon premia in terms of levels of emissions?

Answer 22

1. There is a positive relationship between tr and expected return - the higher the transition risk and the higher the expected return –> especially when industry effects are fixed
2. The industry is an important factor as they can condition different risks types - there can be v specific idiosyncratic risks specific to a certain industry

Question 23

How big is the effect of emissions in terms of economics - what are the two ways of thinking about it?

Answer 23

1. If you looks at the value of companies with 1sd more emissions relative to you - the debt effect is 2-3% per yr
2. decarbonise - how much do you get if you decarbonise? cost-benfit?
   could be a .5-1% valuation different which can be pretty meaningful

Question 24

Are the scopes of emissions correlated?

Answer 24

S1 and 3 is correlated but independent.

Question 25

What are the main takeaways from results for level and changes in carbon emissions?

Answer 25

LEVEL - a postive and mostly statistically significant effect of total emissions on future individual stock returns consistent with the idea that high-emission firms are riskier CHANGES - a positive and highly significant effect on future individual stock returns

Question 26

Why is timing important?

Answer 26

the lags between end of year disclsure of emissions and the month when returns are realised is important investors have limited attention and cannot immediately absorb all the new info about carbon emissions emissions numbers become stale after while and they are subsumed by new numbers - signal (of emissions) is useful but at some point it looses its value LEVELS premium remains large and significant for all the different lags CHANGES positive and significant for up to 6 months and becomes insignificant after 12 months, when the new yr on yr emissions changes are reported

Question 27

How do you work out the carbon intensity?

Answer 27

total emissions relative to scope of opp/reve of a company = how much carbon you produce per unit of revenue

Question 28

What is the relationship between carbon intensity and future returns? What are the possible explanations?

Answer 28

there is no statistically significant relationship between carbon intensity and stock returns = investors don't think of this as being a meaningful metric of transition risk 1. A reduction in emissions intensity does not mean a reduction in total emissions - could mean increase in emissions and grow faster - form of greenwashing (regulators heating up on this SEC and EC) 2. dividing emissions by sales revenue introduced noise: when emissions intensity changes it could be because of a change in sales revenue or a change in the level of emissions - with noise results are expected to be less significant

Question 29

How do we know that short term and long term risks are not the same?

Answer 29

if they were the same thing they would substitute each other but they produce different results therefore there must be independent variation between them they are both significant and positive but they are independent of each other both matter 50/50 to investors so it is not like one is more important than the other

Question 30

What is another way of thinking about how risk is priced other than COE or ER? tell me more about it

Answer 30

the valuation of a company today = if it is riskier, investors are going to be less likely to invest unless they are compensated We are asking whether companies with higher transition risk have different price multiples compared with companies with lower transition risks - what we would expect is that is this is true, companies with a high transition risk would have lower prices and a higher B2M ratio

Question 31

How do book to market ratio interact with short and long term risk? Some possible explanations to this?

Answer 31

LEVELS positive strong relationship CHANGES positive strong but relatively less strong relationship DCF model tells us to take expected cash flows and discount them to today - in value calculations there is cash flow and discount rate if we focus more on discount rate this may be more directly related to risks

Question 32

What happens when you control for cash flow effects?

Answer 32

The focus is purely on discount rate and effect Results were stronger for the short term risks relative to their valuation LT risk discount rate matters and for short term the cash flows matter more in LR looking at how easy it is to access capital and what the discount rate is in ST ability to generate cash flows is important cash flow is sales and long term growth

Question 33

How do we interpret B2M and emissions

Answer 33

companies with high emissions have higher B2m ratios the coefficient LOGS1TOT is statistically significant in the model without industry fixed effects the link between emissions and B2M is stronger when we add industry fixed effects Results for scope 1,2 and 3 are comparable in magnitude. coefficients S1Ch and S3Ch are insignificant in industry fixed effects why? - yr to yr changes are not persistent, changes in any given year are averaged out in a discounted cash-flow analysis

Question 34

Why is the focus mainly on Co2 and not the other greenhouse gases?

Answer 34

Scientific perspective Co2 is more important to look at Other ghgs are harder to measure - but they are getting increasing attention in terms of regulation there is some evidence of a transition risk for methane and HFC but the economic discount is significantly smaller than CO2 why? - early stage or less of a problem than Co2 CO2 has a longer longevity in the atmosphere than methane look at price to earnings rather than B2M for non-Co2 - we expect that if the risks are important there would be a negative relationship - companies with high emissions have low price to earnings - mostly found

Question 35

what are the two possible explanations for the pricing effects of transition risk

Answer 35

Divestment is a potential channel behind pricing effects investors with exclusionary preferences drive up the risk premia of the holders alternative - investors do not screen on carbon emissions but simply reprice the risk due to the transition

Question 36

Does geographic location matter for transition risk?

Answer 36

The ST and LT premium is present in most geographic locations globally - some cross sectional variation in magnitudes --> carbon premium is generally larger in northern America, Europe, Asia than in the souther hemisphere group of countries all premia especially those that absorb industry-fixed effects are positive and statistically significant for CHANGE in emissions the coefficients for Europe are smaller than those in northern America and Asia but still positive and significant - weaker results for countries from Africa and the Southern Hemisphere - eg. Argentina, Australia, Brazil, Chile, Nigeria and South Africa --> coefficient os S1CHG is insignificant when we add industry fixed effects - these countries are least aligned with carbon neutrality

Question 37

Does the degree of a country's development matter? is carbon transition risk mainly a developed country issue?

Answer 37

LEVELS The level of a country's developement DOES NOT differentially affect long term transition risk Insignficant for the interaction between GDP and LEVEl, share of manufacturing and LEVEL (emerging markets tend to have a larger share of manufacturing sectors) and per capita health expenditures and the level of emissions - advanced economies have a larger share of health expenditure difference in development do not appear to explain much of the variation in LR carbon premia across countries CHANGES firms location in more developed countries are exposed to SMALLER short term transition risks interaction changes with emissions - they are significant for firms located in countries with higher GDP per capita and larger health expenditures have statistically smaller stock returns

Question 38

What aspect of transition risk matter for asset price and in St or Lt?

Answer 38

- technology (energy mix changes) - production mix matters for ST risk - policy environment - matters for ST risk - Climate-related policy tightness - domestic policy matters for LT risks - Investor awareness - matters for LT risks

Question 39

How does the energy structure interact with emissions

Answer 39

countries with higher relience on renewables are more developed and further along the carbon transition short term tr are priced lower in these countries - interaction with S1CH is negative international with energy use ENINT is positive

Question 40

How do carbon premia and social norms interact?

Answer 40

Socio-political factors only appear to matter for investors carbon transition risk perception in the ST - rule of law and CHANGEs and voice and CHANGES are highly significant and negative the carbon premia is lower in countries with better rule of law, more democratic political institutions and more economic equality why - greater social harmony induces less climate policy uncertainty - effects are for short turn risk, socio-economic environment can evolve, and current conditions are seen s having a transitory impact on policy uncertainty by investors

Question 41

What is the relationship between policy risk and carbon premia

Answer 41

Domestic climate policy - LT risk - interaction term for LEVEL is statistically significant for s3 emissions but insignificant for changes carbon policies are seen by investors as permanent shocks to carbon-transition risks - investors believe that climate policies are already in place and are largely irreversible domestic policies have a bigger effect on the carbon premium than international agreements that are seen as less binding - unless implemented through domestic policy changes

Question 42

What about reputational risk and carbon premia?

Answer 42

results are v similar when salient industries are excluded - transport, energy, utilities no special reputational risk for companies operating in these salient industries

Question 43

KSS survey in what order to prof investors rank: regulatory, physical and technological risks?

Answer 43

Regualtory physical technological

Question 44

How do you measure investor awareness and carbon premia

Answer 44

use COP 21/ Paris Agreement as a shock to awarenes 2014-2015 pre period 2016-2017 - post period

Question 45

What is the relationship between investors awarenes and carbon premia?

Answer 45

there is NO signficant premium associated with the level of scope 1 emissions before Paris there is a significantly large positive premium after Paris significant increase in the premium for the level of scope 3 changes in emissions are significant pre and post Paris investors updated their awairness about long term transitions risks after Paris the pairs agreement has been particularly important in reshaping investor awareness about forthcoming climate-related policies

Question 46

What is the long term premium unrelated to

Answer 46

economic development energy mix social environment more related to domestic policy implementation

Question 47

What is the short term premium associated with?

Answer 47

technology risk and social environment - less so to policy implementation importance of changing investor awareness especially post Paris

Question 48

Why do we look at insitutional investors?

Answer 48

- Magnitude they hold most of the ownership - 82-85% of all equitities - they are information savvy and react in a real way - they have a fiduciary duty. institutions are different in the context of ESG - they have some pre-specific mandate or a delegaotr of some ideas that their shareholders emulate - Ii cannot hide

Question 49

What is the hypothesis if ii are divesting? What does the data say about it what are some potential explanations for this?

Answer 49

companies with higher levels of transition risks should be held less by institutional owners - if they are divesting based on transition risk you should expect that the institutional owernshhip should be lower the relationship between investment and levelof emissions is positive so this is hypothesis is not correct, on average they hold more of the companies with high emissions - could be that high emitters have higher returns - might have a preference for high returns and thus hold these stocks

Question 50

What is the hypothesis if ii are divesting? What does the data say about it what are some potential explanations for this?

Answer 50

companies with higher levels of transition risks should be held less by institutional owners - if they are divesting based on transition risk you should expect that the institutional owernshhip should be lower the relationship between investment and levelof emissions is positive so this is hypothesis is not correct, on average they hold more of the companies with high emissions - could be that high emitters have higher returns - might have a preference for high returns and thus hold these stocks - could be that investors are divesting more in smaller companies - little to do with the emissions but the institutions themselves

Question 51

What is the idea behind home bias?

Answer 51

local investors would prefer to invest in local over global companies - know more about the economy, easier to exploit information advantage rather than somewhere else - patriotic - US investors have a strong preference for US companies

Question 52

What is the relationship between long term transition risk and global variation?

Answer 52

long term transition risk is priced all over the world - investors are global investors and they think it to be important to recognise the risks in the global markets and not just the local markets

Question 53

how does scope 3 interact with policy?

Answer 53

for domestic polich there is a positive effect for scope 3 - long term - stricter legisiltion you have a higher transition risk therefore this has to be priced