Why the U.S. policy for climate change is flawed

Karin S. Thorburn

16 April 2008



Climate change may prove to be the most severe environmental challenge of this century. Yet, the United States, one of the world’s largest producers of greenhouse gases, has refused to ratify the Kyoto Protocol mandating a reduction of greenhouse gas emissions. Rather than national regulation of greenhouse gas emissions, the Bush administration relies on voluntary measures to combat global warming. The success of U.S. climate change policy therefore ultimately depends on how profitable it is for companies to voluntarily reduce their carbon footprint. In other words, in order to be widely adopted, investments required to reduce greenhouse gas emissions must increase shareholder wealth and thus have a positive net present value.

Porter and van der Linde (1995) and Reinhardt (1999) argue that environmentally responsible investments can improve corporate financial performance. They propose that pollution-reducing investments create “green goodwill,” which differentiates the firm’s products and increases its market share. Such investments may also reduce production costs and the risk of future environmental liabilities, as well as give the firm a competitive advantage if subsequent regulatory actions force industry rivals to follow. In addition, Heinkel, Kraus and Zechner (2001) suggest that if investors refuse to hold the stock of polluting firms, the cost of capital may rise to the point where it is optimal for some firms to undertake environmentally responsible investments.

Do voluntary measures pay?

In joint work with Karen Fisher-Vanden, I examined the positive net present value assumption underlying the U.S. policy for climate change (Fisher-Vanden and Thorburn, 2008). Specifically, we studied the stock market’s reaction when companies joined Climate Leaders, a voluntary government-industry partnership in which firms commit to a long-term reduction of their greenhouse gas emissions. Importantly, when the firms announced to the public that they were joining Climate Leaders their stock prices dropped significantly. Controlling for general market movements, the average abnormal stock return was -0.9% over a three-day window and -1.5% over a five-day window around the announcements. For the 46 sample firms that joined Climate Leaders, the total loss in market value was $16 billion. The stock price decline was smaller for firms in carbon-intensive industries, where regulatory action is more likely (and thus partially anticipated in the stock price), and greater for high-growth firms, suggesting that the green investments crowd out growth-related capital expenditures.

Firms joining Climate Leaders conduct a careful inventory of their greenhouse gas emissions before they subsequently announce a reduction goal. The average firm in our sample set a goal to cut its total emissions of greenhouse gases by 17%. Interestingly, the stock price plummeted even further (on average -1.3%) when the greenhouse gas goal was announced, and the more aggressive the goal, the greater the price decline. The study also included 22 firms joining Ceres, a network addressing sustainability challenges whose principles are adopted by its members as an environmental mission statement. Stock returns were largely unaffected by the Ceres announcements, perhaps reflecting—in contrast with Climate Leaders—the lack of specific environmental investment commitments in Ceres. In addition, we looked at portfolios of industry competitors, but found little movement in stock prices when their rivals joined an environmental program.

Why do firms volunteer?

The negative market reaction for firms joining Climate Leaders reveals that the reduction of greenhouse gases is a negative net present value project for the company. That is, the capital expenditures required to cut the carbon footprint exceed the present value of the expected future benefits from these investments, such as lower energy costs and increased revenue associated with the green goodwill. Some may argue that the decline in stock price is simply evidence that the market is near-sighted and ignores the long-term benefits of the green investments. Notice, however, that the stock market generally values uncertain cash flows in a distant future despite large investments today: earlier work has shown that firms announcing major capital expenditure programs and investments in research and development tend to experience an increase in their stock price. Similarly, the stock market often assigns substantial value to growth companies with negative current earnings, but with potential profits in the future. In fact, only two percent of the publicly traded firms in the United States have joined the Climate Leaders program to date, supporting our observation that initiatives aimed at curbing greenhouse gas emissions largely are value decreasing.

The loss of market value implies that the decision to substantially limit greenhouse gas emissions conflicts with shareholder value maximisation and thus the fiduciary duty of corporate directors in the United States. By comparing the sample firms to their industry rivals, we identified characteristics of the firms that voluntarily joined Climate Leaders and Ceres. We found that the sample firms on average had relatively high environmental ratings and low corporate governance ratings, and were more likely to join in periods when public concerns with global warming were high (measured by the number of U.S. press articles). Overall, the evidence is consistent with the notion that management’s interest in environmentally responsible investments, possibly combined with poor shareholder oversight, drives the decision to commit corporate resources to cut the carbon footprint. This is further supported by the anecdotal evidence that two firms acquired by private investors (Norm Thompson and Polaroid) left the Climate Leaders program shortly after going private.

The need for regulation

So what does this all mean? In a nutshell, it suggests that the federal government’s reliance on voluntary measures to reduce greenhouse gas emissions will likely prove unsuccessful. The success of voluntary programs depends on their ability to achieve meaningful corporate participation. Such participation will ultimately depend on the payoff to shareholders. Our research shows that shareholder value declines when companies join Climate Leaders and pledge large cuts in their carbon footprint. Indeed, greenhouse gas emissions, like most other pollutants, seem to constitute a classic example of an externality, where the overall cost to society is not internalised by the individual corporation. In light of such market failure, federal regulation is a viable way to achieve a broad reduction of greenhouse gas emissions. It is high time for the U.S. federal government to face the facts and take real measures to seriously fight global warming.


Fisher-Vanden, Karen and Karin S. Thorburn, 2008, “Voluntary corporate environmental initiatives and shareholder wealth,” working paper, Tuck School of Business at Dartmouth.
Heinkel, Robert, Alan Kraus and Josef Zechner, 2001, “The effect of green investment on corporate behavior,” Journal of Financial and Quantitative Analysis 36(4), 431-439.
Porter, Michael E. and Claas van der Linde, 1995, “Toward a new conception of the environment-competitiveness relationship,” Journal of Economic Perspectives 9(4), 97-118.
Reinhardt, Forest, 1999, “Bringing the Environment Down to Earth,” Harvard Business Review, July-August 1999, 149-157.



Topics:  Environment

Tags:  climate change, global warming, greenhouse gases, voluntary measures

Associate Professor of Finance and Associate Director, Center for Corporate Governance of the Tuck School of Business, Dartmouth College