Climate change disclosure ranks among the priorities of Gary Gensler, the new chair of the Securities and Exchange Commission. With the rapid reallocation of capital to green investments – characterized as a “tectonic shift” by BlackRock[1] and a “frenzy” by the Wall Street Journal[2] – concerns have arisen about whether disclosures accurately portray firms’ commitment to protecting the environment or simply represent “greenwashing.” Intensifying climate change and commensurate increases in political and financial support for positive environmental actions reinforces how climate change disclosures have become a priority.

As regulators try to determine what types and amount of disclosure to require, an important consideration is how investors use such information. Do they care about detailed environmental information, or is it enough that an investment or industry simply be categorized as “green?” Clearly, detailed information is necessary for an analysis that goes beyond investment-by-categorization, including incorporating “green-ness” into the classic equity valuation process, for example, by adjusting the cash flows and discount rates in analysts’ discounted cash flow models. (Detailed information might also be useful to those aiming to invest in environmental causes while also complying with the 2020 Department of Labor (DOL) mandate. That mandate is  to consider only pecuniary factors in decision-making and to select investments “based solely on financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action.”[3] [4]) In contrast, investment decisions made solely on industry membership or based simply on claims of environmental friendliness require little or no detailed environmental information.

In a new paper, we address the demand for environmental information by examining the extent to which the topic is addressed in conference calls. The purpose of the calls is for firms to discuss their periodic performance. Conference call content signifies topics of mutual importance to firms and their financial analysts. Using textual analysis of over 147,000 conference call transcripts, we document an overall increase since 2006 in the amount of environmental discourse in conference calls, including a spike in the amount since 2018. Discussion of environmental issues on conference calls has also become more pervasive. Only 23 percent of firms’ conference calls included any mention of environmental topics in 2006, compared with more than 45 percent of calls in 2020. The increase in amount and pervasiveness has not been linear, with a spike in both in 2010 and 2011, possibly attributable to the SEC’s 2010 interpretative guidance on disclosures related to business or legal developments regarding climate change.[5]

How environmental discourse in conference calls relates to firm valuation is an empirical question. Prior research on environmental disclosures is not directly applicable because the nature of environmental discourse in conference calls differs from disclosures in firm-authored reports. Conference calls are real-time, two-way communications between managers and analysts, and therefore the self-serving biases observed in narrative disclosure,[6] for example, may differ in the conference call setting.

Assuming a relation exists between the amount of discourse and firm valuation, how does the amount of environmental discourse relate to firm valuation? A positive relation could be expected if more discourse signifies effective green signaling or indirect, potentially long-horizon financial returns to environmental investment. Yet a negative relation is also a reasonable expectation to the extent that greater amounts of environmental discourse might signify concerns, uncertainty, or increases in negative net present value projects. Our analysis indicates that a greater amount of environmental discourse is associated with higher cost of capital and lower share price, suggesting that more attention to environmental matters in conference calls increases uncertainty regarding financial payoffs. In short, we find a negative relation between the amount of environmental discourse and firm valuation.

It has been claimed that “green” investments, in addition to being ethically responsible, yield superior market returns, which seems somewhat contradictory to our findings. To explore this apparent contradiction, we first compare returns on two hypothetical portfolios created according to the amount of environmentally related discussion in conference calls and find that the portfolio of more-discussion firms yields lower returns than the less-discussion portfolio. In contrast, when portfolios are created based on actual environmental metrics (namely, intra-industry ranked toxic emissions data from the EPA), the portfolio of measurably greener firms yields higher returns. This additional analysis suggests that the market rewards “good,” i.e., environmentally friendly, actions but not environmental discussions alone.

Our study shows that the amount and pervasiveness of environmental discourse in conference calls has increased substantially in the last 15 years and especially in the most recent years. Our evidence also indicates that greater amounts of discussion have been negatively associated with firm valuation, and an investment strategy based on greater amounts of discussion would have yielded inferior market returns. In contrast, an investment strategy based on quantifiable evidence of environmentally responsible actions would have yielded superior market returns.

Discourse evolves, and any investment strategy is ultimately subject to arbitrage. Current and future demand for green investments may drive their prices to a level in excess of their intrinsic value, in which case subsequent positive returns would not be realized. But a climate change disclosure regime including quantifiable measures of firms’ pro-environment actions could be an important component of fundamental equity valuation and thus contribute to sound decision making by environmentally focused capital providers.

ENDNOTES

[1] Refer to: https://www.blackrock.com/ca/institutional/en/insights/investment-actions/sustainable-investing-shift.

[2] Justin Scheck, Eliot Brown & Ben Foldy. Environmental Investing Frenzy Stretches Meaning of ‘Green’ by Wall Street Journal, June 24, 2021. https://www.wsj.com/articles/environmental-investing-frenzy-stretches-meaning-of-green-11624554045.

[3] U.S. Department of Labor. DOL. (2020). U.S. Department of Labor Announces Final Rule to Protect Americans’ Retirement Investments. https://www.dol.gov/newsroom/releases/ebsa/ebsa20201030.

[4] A blurring of the dichotomy between pecuniary-focused investment and purpose-focused investment is evidenced by an activist hedge fund’s rationale for recent actions against Exxon which were based on economic rather than moral arguments. The argument was: “that Exxon has been so slow to recognise the need for a transition away from fossil fuel that its revenues will crumble, destroying investor capital” (Financial Times May 27, 2021).

[5] Securities and Exchange Commission. SEC. (2010). SEC Issues Interpretive Guidance on Disclosure Related to Business or Legal Developments Regarding Climate Change. Retrieved from: https://www.sec.gov/news/press/2010/2010-15.htm.

[6] See Cho, C.H., Roberts, R.W. and Patten, D.M. (2010). The language of US corporate environmental disclosure. Accounting, Organizations and Society, 35(4), pp.431-443.

This post comes to us from Professor Elaine Henry, PhD candidate Xi Jiang, and Professor Andrea Rozario at the Stevens Institute of Technology. It is based on their recent article, “The Evolution of Environmental Discourse: Evidence from Conference Calls,” available here.