Carbon Footprint and Productivity: Does the “E” in ESG Capture Efficiency as Well as Environment?

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

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.