IMF working paper on stock market channels incentivizing firms to decarbonize

December 01, 2022

In November 2022, JVI economists Laurent Millischer and Tatiana Evdokimova and JVI research assistant Oscar Fernandez have published an IMF working paper entitled “The Carrot and the Stock: In Search of Stock-Market Incentives for Decarbonization”. The paper aims to establish a link between carbon price changes and stock returns and to explore whether the relationship depends on a company’s carbon intensity. It contributes to the existing research on the topic, most of which does not cover the period since 2017, which saw a significant carbon price increase.

The project started a year ago and was inspired by the team’s work on the JVI course on Climate Change Economics. Laurent and Tatiana developed the workshops on carbon pricing and green finance and were interested in uncovering the synergies between carbon pricing and ESG data disclosure to foster green transition via financial market channels. The companies covered by the EU Emissions Trading System (ETS) - and thus involved in emission permits trading and obligatory emissions data disclosure already for a long time - seemed to be a very relevant sample for the analysis.

The first phase of the research project focused on the data collection. The team compiled a novel dataset on stock prices and carbon intensities of the European publicly traded companies covered by the EU ETS for the period between 2013 and 2021. The authors used the information about the corporate ownership structure to aggregate open access  ETS data at the level of publicly traded companies. The final sample consisted of 338 companies from 24 European countries and 23 industries. This is one of the largest samples used to date in the academic research to analyze the relationship between the carbon price and stock performance.

The initial data analysis showed that despite a sharp increase in the price of carbon since 2017, firms’ carbon-related costs remain relatively low. Most firms still spend less than 0.5% of their turnover  to buy emissions allowances. The electricity-generating companies, whose respective costs are on average around 3%, represent the main exception since, unlike companies from other sectors, they receive almost no allowances for free. 

The econometric analysis showed that the level of carbon costs (or a firm’s carbon intensity) affects the relationship between carbon price changes and stock returns. The stock market was found to discriminate against highly emissive firms in a context of increasingly stringent environmental regulations and rising carbon price.  In particular, the estimates showed that an increase in the carbon price is associated with a stock price decline for companies with carbon intensity above 1.8%. In other words, a 1% carbon price rise was found to drive a wedge of 0.14% between the stock of the dirtiest company from the sample (carbon intensity of 25%) and a zero-carbon intensity one. The established effect was particularly strong in the subsamples with high carbon intensity: concretely, in the electricity sector, during the recent period of a rapid carbon price increase, and in the countries with the highest carbon costs. 

Crucially, the results suggest that the markets price in the costs of purchased emissions allowances, while emissions covered by the allowances allocated to the firms for free do not affect the relationship between carbon prices and stock returns. In other words, stock markets do not seem to care about the overall level of firms’ emissions but only about their fraction that has a direct impact on firms’ profitability. These results suggest that simple ESG-related data disclosure is hardly enough to improve markets’ ability to channel funds towards more sustainable projects. 

The paper concludes with recommendations in favor of more ambitious carbon pricing policies, as they would strengthen the stock-market incentive channel for firms to decarbonize. Specifically, the authors argue for a continued gradual phasing out of free emissions allowances and a broadening of the EU ETS scope to other sectors. The modest magnitude of the carbon-price impact on stock prices suggests that the aggregate financial stability risk for stocks from higher carbon prices is limited at this stage.

Are you working on carbon pricing and its impacts on financial markets? Do reach out, Laurent ( and Tatiana ( would be happy to discuss.

Tatiana Evdokimova and Laurent Millischer, Economists, JVI

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