Carbon Footprint and Productivity: Does the “E” in ESG Capture Efficiency

Volume 16, No. 1, 2018
Gerald T. Garvey, Mohanaraman Iyer and Joanna Nash

This paper analyses the now-popular carbon ratio (emissions relative to sales) as a way to select stocks. We document that reduced carbon ratios are associated with stronger future profitability and positive stock returns in a global universe of stocks. But why? The prevailing view is that lower emissions reduces a firm’s exposure to future greenhouse gas regulations or taxes, and the market is slow to appreciate this. However, we find strong effects in industries such as internet and commercial services where carbon taxes would have little direct effect. We show that there is a more fundamental connection between carbon emissions and overall productive efficiency. Most of a firm’s activities, or inputs, result in some form of carbon emission due to direct energy consumption or indirect
emissions (e.g., travel). We first show evidence that carbon emission works like an input to production along with the more traditional capital and labour. More importantly, firms that produce more than expected given their inputs tend to outperform in the future both in profitability and returns.