CLIMATECHANGEANDCLIMATEFINANCECURRENTEXPERIENCEANDFUTUREDIRECTIONSEditedbyFariborzMoshirianandCyn-YoungParkSEPTEMBER2023ASIANDEVELOPMENTBANKASIANDEVELOPMENTBANKCLIMATECHANGEANDCLIMATEFINANCECURRENTEXPERIENCEANDFUTUREDIRECTIONSEditedbyFariborzMoshirianandCyn-YoungParkSEPTEMBER2023CreativeCommonsAttribution3.0IGOlicense(CCBY3.0IGO)©2023AsianDevelopmentBank6ADBAvenue,MandaluyongCity,1550MetroManila,PhilippinesTel+63286324444;Fax+63286362444www.adb.orgSomerightsreserved.Publishedin2023.ISBN978-92-9270-308-0(print);978-92-9270-309-7(electronic);978-92-9270-310-3(ebook)PublicationStockNo.TCS230333-2DOI:http://dx.doi.org/10.22617/TCS230333-2TheviewsexpressedinthispublicationarethoseoftheauthorsanddonotnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank(ADB)oritsBoardofGovernorsorthegovernmentstheyrepresent.ADBdoesnotguaranteetheaccuracyofthedataincludedinthispublicationandacceptsnoresponsibilityforanyconsequenceoftheiruse.ThementionofspecificcompaniesorproductsofmanufacturersdoesnotimplythattheyareendorsedorrecommendedbyADBinpreferencetoothersofasimilarnaturethatarenotmentioned.Bymakinganydesignationoforreferencetoaparticularterritoryorgeographicarea,orbyusingtheterm“country”inthispublication,ADBdoesnotintendtomakeanyjudgmentsastothelegalorotherstatusofanyterritoryorarea.ThispublicationisavailableundertheCreativeCommonsAttribution3.0IGOlicense(CCBY3.0IGO)https://creativecommons.org/licenses/by/3.0/igo/.Byusingthecontentofthispublication,youagreetobeboundbythetermsofthislicense.Forattribution,translations,adaptations,andpermissions,pleasereadtheprovisionsandtermsofuseathttps://www.adb.org/terms-use#openaccess.ThisCClicensedoesnotapplytonon-ADBcopyrightmaterialsinthispublication.Ifthematerialisattributedtoanothersource,pleasecontactthecopyrightownerorpublisherofthatsourceforpermissiontoreproduceit.ADBcannotbeheldliableforanyclaimsthatariseasaresultofyouruseofthematerial.Pleasecontactpubsmarketing@adb.orgifyouhavequestionsorcommentswithrespecttocontent,orifyouwishtoobtaincopyrightpermissionforyourintendedusethatdoesnotfallwithintheseterms,orforpermissiontousetheADBlogo.CorrigendatoADBpublicationsmaybefoundathttp://www.adb.org/publications/corrigenda.Notes:Inthispublication,“$”referstoUnitedStatesdollars.ADBrecognizes“America”astheUnitedStates;“China”asthePeople’sRepublicofChina;and“Hongkong”and“HongKong”asHongKong,China.CoverdesignbyFrancisManio.Onthecover:AwomaninstallingsolarpanelsontheroofinBhutan,AstanabridgeovertheIshimRiver,andKhandkewindpowerprojectphotosfromADB’sFlickraccount;mangroveseedlingsandShatinurbandevelopment(housing)projectphotosbyArielJavellana;andahandshakephotobyMarkFloro.PrintedonrecycledpaperTablesandFiguresviiForewordixAcknowledgmentsxiEditorsxiiiAuthorsxvAbbreviationsxviiiChapter1Introduction1FariborzMoshirianandCyn-YoungParkChapter2ClimateJustice7BethanyRodgers2.1Introduction72.2TheClimateJusticeConcept92.3Conclusion22Chapter3DoDirectorsHaveaDutytoConsiderSocialand27EnvironmentalImpact?MarkHumphery-Jenner3.1Introduction273.2“Best-Interests”DutyandSocialandEnvironmentalImpact293.3ImproperUseofPosition333.4WhatabouttheDutyofCare?343.5GreenwashingandMisleadingStatements363.6WhatabouttheBusinessJudgmentRule?383.7Conclusion40ContentsChapter4GreenorGreenImage?SelectiveDisclosure44ofCorporateSuppliersYilinShi,JingWu,andYuZhang4.1ExaminingCorporateSocialResponsibilityinSupplyChains444.2SelectiveDisclosureofGreenSuppliers484.3FactorsDrivingtheSelectiveDisclosureofGreenSuppliers514.4Conclusion55Chapter5TheEconomicConsequencesofCorporateSocial60IrresponsibilityandPolicyImplicationsGuanmingHe,ZhichaoLi,andRichardSlack5.1Introduction605.2CoexistenceofCorporateSocialResponsibilityand61CorporateSocialIrresponsibility5.3EconomicConsequencesofCorporateSocialResponsibility62andCorporateSocialIrresponsibility5.4CharacteristicsThatAffecttheBenefits67versustheCostsofCorporateSocialResponsibilityandCorporateSocialIrresponsibility5.5RegulationsandLegislationofCorporateSocialResponsibility70andCorporateSocialIrresponsibilityandItsPolicyImplications5.6Conclusion73Chapter6ClimateChange:Policy,Innovation,andProposals87GregTindall,RebelCole,andDavidJavakhadze6.1Introduction876.2ClimateChangeas“ProperSubjectforAction”936.3TheInstigationandLessonsfrom2008956.4SubstantialImplementation976.5SupportThresholds996.6ConclusionandPolicyRecommendations101Chapter7ManagingClimateChangeRisks:SeaLevelRise106andMergersandAcquisitionsJohn(Jianqiu)Bai,YongqiangChu,ChenShen,andChiWan7.1Introduction1067.2LiteratureandHypothesis109Contentsiv7.3EmpiricalMethodology1107.4SummaryofFindings1117.5Conclusion118Chapter8Environmental,Social,andGovernancePerformance123andDownsideandUpsideRisksVinaJavedKhan,SearatAli,andMillicentChang8.1Introduction1238.2GapsintheAcademicLiterature1268.3ResearchMethod1268.4EmpiricalResultsandDiscussion1318.5ConclusionandPolicyImplications134Chapter9WhatShouldInvestorsDoaboutEnvironmental,142Social,andGovernance?MarkHumphery-Jenner,SumanBanerjee,andVikramNanda9.1Introduction1429.2HowDoEnvironmental,Social,andGovernanceFactors143FitintoaPortfolio?9.3WhatMustOfficersandDirectorsConsider?1499.4HowMightEnvironmentalFactorsImpactBusiness?1539.5WhatShouldInvestorsDoaboutEnvironmental,159Social,andGovernance?Chapter10SustainablePrivateCapitalMarkets165JongsubLee,SehoonKim,NitishKumar,andJunhoOh10.1Introduction:TheRiseofEnvironmental,Social,165andGovernanceandPrivateMarkets10.2SustainableInvesting:TheCaseofPrivateEquity16710.3TransparencyandDisclosureofSustainability169inPrivateMarkets10.4TransparencyandDisclosure:TheCase170ofSustainability-LinkedLoans10.5ConclusionandPolicyGuidelines174ContentsvChapter11Climate-RelatedRiskstoFinancialStability180andGreeningPoliciesbyCentralBanksRamkishenS.RajanandCyn-YoungPark11.1Introduction18011.2ImpactofClimateChangeonFinancialStability18211.3RoleofCentralBanksandGreenPrudentialPolicies18411.4Empirics18911.5Conclusion195Annex197Chapter12CentralBanksandClimateChange204JonathanKearns,AnnaPark,andSerenaAlim12.1Introduction20412.2CentralBankActionsRelatedtoClimateObjectives211Chapter13ClimateRiskDisclosureandGreenTechnology218Innovation—ASurveyZijunZhao13.1Introduction21813.2ClimateRiskDisclosure22013.3GreenTechnologyInnovation22413.4Conclusions228ContentsviTables4.1MainResults504.2Moderator—CustomerFirmCharacteristics514.3Moderator—PublicAwarenessandRegulation547.1SeaLevelRiseandLikelihoodofBecominganAcquirer1137.2SeaLevelRiseandLikelihoodofBecomingaTarget1147.3SeaLevelRiseandMergerPair1157.4MarketReaction—Acquirers’AnnouncementPeriodReturns1178.1Environmental,Social,andGovernanceScoresbyYear1288.2VariableDefinitions1308.3DescriptiveStatistics1318.4Environmental,Social,andGovernanceandFirmRisk1328.5MarginalEffectsofEnvironmentandSocialonFirmRisk13411.1ScenariosofInterconnectedPhysicalandTransitionRisks184BasedonDegreeandTimingofCorrectiveResponses11.2Variables,DataSources,andDirectionofImpact19211.3ClimateRisksandGreenPrudentialPolicies—ProbitModel19311.4InteractionEffectsofClimateRiskswithOverallCapacity19512.1ExamplesofCentralBankClimate-orSustainability-Related207Objectives12.2ExamplesofChangestoMonetaryPolicyOperations213A.1FourClimateRiskSubindexesfromtheHSBCFragilePlanet197Report2018TablesandFiguresFigures2.1MajorAnthropogenicGreenhouseGasEmissionsContinue8toRiseGlobally2.2CumulativeNetAnthropogenicCarbonDioxideEmissions11perRegionfrom1850to20192.3CumulativeNetAnthropogenicGreenhouseGasEmissions12perCapitaandforTotalPopulation,perRegion,20196.1ShareholderProposalFeedbackLoop886.2ProposalsbySponsor916.3AverageandRangeofClimateProposalSupportbyYear1008.1SustainableInvestingintheUnitedStates,1995–20201248.2Environmental,Social,andGovernancePerformanceand125DownsideandUpsideRisks8.3RefinitivEnvironmental,Social,andGovernanceScore12710.1Sustainability-LinkedLoanIssuance17110.2BorrowerEnvironmental,Social,andGovernancePerformance173aroundSustainability-LinkedLoanIssuanceTablesandFiguresviiiForewordReachingambitiousglobalclimategoalsdemandsacceleratedclimateactionthroughstrongcommitmentandcoordinatedeffortfromthepublicandprivatesectorsthatwillproduceaclearerandmorecrediblepathforward.Assuch,globalclimateleadersarenowurgingrealworldsolutionstoguideeconomiestoanetzerofuture.Thisisobviouslyatallorderthatrequiresdeepanalysis,stakeholderdialogue,anddetailedplanningatalllevelsofsociety—especiallywithpolicymakers,businessleaders,andinvestors.Thisvolumescrutinizesissuesrelatedtothecorporatesector’sgreeninvestmentthatcontributestotheknowledgebasethatenablesustomaximizeprivatesectorengagementtomobilizeresources,harnessskillsandtechnology,anddeliverinnovativeclimatesolutions.Todoso,businessesmustconsiderenvironmental,social,andgovernance(ESG)impacttobeanimportantfactorthatmightinfluencecorporatevalue.Despitethecatalyticrolethatbusinessescanplayforthechangeweneed,currentcorporateandmarketincentivesmaynotbefullyalignedwithacorporatesectortransformationacrossfinance,industry,andtechnologyforclimatechangemitigationandadaptation.Withoutsignificanttop–downpressurefromcorporateleadersandinvestors,itmaybedifficulttoscaleupinvestmentandinnovativesolutions.ProliferatingESGinvestment,forexample,mayhaveraisedtheprofileofclimatechangeobjectivesinthecorporateworldandcanacceleratetheenergytransition.Butcloserscrutinymayrevealunclearbenefitstoshareholdersandraiseallegationsof“greenwashing”duetoalackofconsistencyandreliability.ForewordxYetadroithandlingofclimatechangeissues—underthecorporatesocialresponsibilitybanner—canhelpexpandshareholdervalueandensurethatcompanyshareholdersareonboard.Theyinturncanhelpsteercorporateactionsmoreeffectivelyandensurecorporatedecisionsareinfactsociallyresponsibleandnotmerevirtuesignaling,orworse,sociallyirresponsible.Theevidencesuggeststhatshareholder“voice”isimportantinshapingeffectivefirmresponsetoclimatechangeissues.Thebookexploreseachoftheseissues—corporateresponsibility,shareholderrightsandvalues,greenwashing,andsustainablecapitalmarkets—throughseveraldetailedandinformativechapters.Meanwhile,thefar-reachingeconomicimpactsofclimatechangeandenvironmentaldegradationhavesignificantimplicationsforfinancialstabilityandsustainablegrowth.Thefinalchaptersofthevolumethuslookattheimportantrolethatcentralbanks,standardsetters,policymakers,andregulatorsmustplayinsafeguardingfinancialstabilityagainstclimaterisksandsupportinggreeninvestment.Iamconfidentthatthisbook—drawnfromtheinsightsandevidenceofanimpressiverosterofexpertsfromdifferentfields—willshedimportantlightontheissuesthatallbusinessleaders,investors,andpolicymakersneedtoconsiderifwearetowalkthetalkandbringsubstancetoouraspirationsforastableclimateandsustainableeconomies.AlbertParkChiefEconomistandDirectorGeneralEconomicResearchandDevelopmentImpactDepartmentAsianDevelopmentBankAcknowledgmentsThisbookwaspreparedbytheRegionalCooperationandIntegrationDivision(ERCI)oftheEconomicResearchandDevelopmentImpactDepartment(ERDI)oftheAsianDevelopmentBank(ADB),incollaborationwiththeInstituteofGlobalFinance(IGF),UniversityofNewSouthWales.ItwassupportedbytheADBtechnicalassistanceproject,BuildingFinancialResilienceandStabilitytoReinvigorateGrowth(TA6592),financedbytheInvestmentClimateFacilitationFundundertheRegionalCooperationandIntegrationFinancingPartnershipFacility,thePeople’sRepublicofChinaPovertyReductionandRegionalCooperationFund,theRepublicofKoreae-AsiaandKnowledgePartnershipFund,andADB’stechnicalassistancespecialfund.Contributionsfromtheauthorswhopermittedtheuseoftheirmaterialandalsoupdatedinformationaregratefullyappreciated.TheyareSearatAli,SerenaAlim,John(Jianqiu)Bai,SumanBanerjee,MillicentChang,YongqiangChu,RebelCole,GuanmingHe,MarkHumphery-Jenner,DavidJavakhadze,JonathanKearns,VinaJavedKhan,SehoonKim,NitishKumar,JongsubLee,ZhichaoLi,FariborzMoshirian,VikramNanda,JunhoOh,AnnaPark,Cyn-YoungPark,RamkishenS.Rajan,BethanyRodgers,ChenShen,YilinShi,RichardSlack,GregTindall,ChiWan,JingWu,YuZhang,andZijunZhao.RolandoAvendano(economist,ERCI,ADB)andPauloRodelioHalili(senioreconomicsofficer,ERCI,ADB)coordinatedtheproductionofthisbookundertheoverallsupervisionandguidanceofJongWooKang(director,ERCI,ADB),withsupportfromMarilynAureParra(senioroperationsassistant,ERCI,ADB).EricVanZanteditedthemanuscript.FrancisManiocreatedtheAcknowledgmentsxiicoverdesignandJoeMarkGanabanimplementedthetypesettingandlayout.TuesdaySorianoproofreadthereport,whileJoyQuitazol-GonzalezhandledthepageproofcheckingwithassistancefromCarolOngchangco(operationscoordinator,ERCI,ADB)andPauloRodelioHalili.ThePrintingServicesUnitofADB’sCorporateServicesDepartmentandthePublishingTeamoftheDepartmentofCommunicationsandKnowledgeManagementsupportedprintingandpublishing.FariborzMoshirianisdirectoroftheInstituteofGlobalFinance(IGF)andanAGSMscholarattheUNSWBusinessSchool,Sydney,Australia.TheIGFundertakescollaborativeresearchonglobalgovernance,globalfinancialstability,theroleofinnovation,climatechangeandclimatefinance.FariborzwastheBertilDanielssonProfessorofFinanceattheStockholmSchoolofEconomics.Fariborzhaspublishedanumberofinfluentialresearchworksinleadinginternationaljournals,includingtheJournalofFinance,theJournalofFinancialEconomics,andtheJournalofFinancialandQuantitativeAnalysis.Heservesasanassociateeditorofafewmajorinternationaljournals.Hehasalsobeentheeditorof15specialissuesinleadingjournalspublishedbyElsevier.Thethemescoveredincludeglobalgovernance,globalpublicgoods,theglobalbankingsystem,theglobalfinancialcrisis,theglobalhealthcrisis(COVID-19),globalization,globalfinancialarchitectures,fintechandcentralbankdigitalcurrencies,MillenniumDevelopmentGoals,sustainableeconomicgrowth,andglobalprosperity.Hehasalsobeenthecoeditorofanumberofpolicyworks,incollaborationwithseniorresearchersfromtheWorldBank,theInternationalMonetaryFund,theBankforInternationalSettlements,theFederalReserveBankofNewYork,theBankofEngland,andtheReserveBankofAustraliaonissuesrelatedtoglobalfinancialstability,includingthefollowingpublications:GlobalizationandFinancialServicesinEmergingCountries;GlobalFinancialCrisis,RiskAnalysisandRiskManagement;SystemicRisk,BaselIII,GlobalGovernanceandFinancialStabilityandSystemicRisk:LiquidityRisk,GovernanceandGlobalFinancialStability.EditorsCyn-YoungParkisdirectoroftheRegionalCooperationandIntegration(RCI)andTradeDivisionintheClimateChangeandSustainableDevelopmentDepartmentoftheAsianDevelopmentBank(ADB).Inhercurrentcapacity,sheisresponsibleformanagingADBoperationsandknowledgeonRCIandtrade.SheleadsateamofexpertstodevelopstrategiesandapproachestosupportRCIandtoprovideguidanceindesignandimplementationofADBRCIandtradeprojects.DuringherprogressivecareerwithinADB,shehasbeenamainauthorandcontributortoADB’smajorpublicationsincludingAsianDevelopmentOutlook(ADB’sflagshippublication),AsianEconomicIntegrationReport,AsiaCapitalMarketsMonitor,AsiaEconomicMonitor,AsiaBondMonitor,andADBCountryDiagnosticStudySeries.ShehasalsoparticipatedinvariousglobalandregionalforumsincludingtheG20DevelopmentWorkingGroup,theAssociationofSoutheastAsianNations(ASEAN),ASEAN+3,Asia-PacificEconomicCooperation(APEC),andtheAsia-EuropeMeeting(ASEM).ShehaswrittenandlecturedextensivelyabouttheAsianeconomyandfinancialmarkets.HerworkhasbeenpublishedinpeerreviewedacademicjournalsincludingtheJournalofBankingandFinance,theJournalofFinancialStability,theJournalofFuturesMarkets,theReviewofIncomeandWealth,andtheWorldEconomy.PriortojoiningADB,sheservedaseconomist(1999–2002)attheOrganisationforEconomicCo-operationandDevelopment(OECD),whereshecontributedtotheOECDEconomicOutlook.ShereceivedherPhDineconomicsfromColumbiaUniversity.Sheholdsabachelor’sdegreeininternationaleconomicsfromSeoulNationalUniversity.EditorsxivAuthorsSearatAliisaseniorlecturerinfinanceattheUniversityofWollongong.SerenaAlimisseniormanager,InternationalReservesattheReserveBankofAustralia.John(Jianqiu)BaiisanassociateprofessoroffinanceattheD’Amore-McKimSchoolofBusinessatNortheasternUniversity.SumanBanerjeeisanassociateprofessorattheSchoolofBusiness,StevensInstituteofTechnology.MillicentChangisaprofessorintheSchoolofBusinessattheUniversityofWollongong.YongqiangChuisdirectoroftheChildressKleinCenterforRealEstateandChildressKlein,distinguishedprofessorofrealestateandurbaneconomicsandprofessoroffinanceattheUniversityofNorthCarolinaCharlotteBelkCollegeofBusiness.RebelColeisaLynnEminentScholarChairedProfessorofFinanceintheCollegeofBusinessatFloridaAtlanticUniversity.GuanmingHeisanassociateprofessoratDurhamUniversity.MarkHumphery-JennerisanassociateprofessorattheSchoolofBankingandFinance,UniversityofNewSouthWales.AuthorsxviDavidJavakhadzeisaprofessorintheFinanceDepartmentatFloridaAtlanticUniversity.JonathanKearnsischiefeconomistandheadofregulatoryaffairsatChallenger.VinaJavedKhanisaPhDcandidateattheUniversityofWollongong.SehoonKimisanassistantprofessoroffinanceattheWarringtonCollegeofBusiness,UniversityofFlorida.NitishKumarisanassistantprofessoroffinanceattheWarringtonCollegeofBusiness,UniversityofFlorida.JongsubLeeisanassociateprofessorintheDepartmentofFinance,SNUBusinessSchool,SeoulNationalUniversity.ZhichaoLiisalecturer(assistantprofessor)infinanceandaccountingattheUniversityofExeter.FariborzMoshirianisdirectoroftheInstituteofGlobalFinanceandanAGSMscholarattheUniversityofNewSouthWalesBusinessSchool.VikramNandaisO.P.JindalprofessoroffinanceattheNaveenJindalSchoolofBusiness,UniversityofTexasatDallas.JunhoOhisanassistantprofessoroffinance,HankukUniversityofForeignStudies.AnnaParkisaseniormanager,ClimateAnalysisandPolicyattheReserveBankofAustralia.Cyn-YoungParkisdirectoroftheRegionalCooperationandIntegrationandTradeDivisionintheClimateChangeandSustainableDevelopmentDepartmentoftheAsianDevelopmentBank.RamkishenS.RajanisaYongPungHowprofessorattheLeeKuanYewSchoolofPublicPolicy,NationalUniversityofSingapore.AuthorsxviiBethanyRodgersisaresearchassociateattheInstituteofGlobalFinance,UniversityofNewSouthWales.ChenShenisanassistantprofessorintheFinanceDepartmentatOntarioTechUniversity.YilinShiisaPhDstudentattheChineseUniversityofHongKongBusinessSchool.RichardSlackisaprofessorofaccountingatDurhamUniversityBusinessSchool.GregTindallisanassistantprofessoroffinanceatPalmBeachAtlanticUniversity.ChiWanisanassistantprofessoroffinanceattheCollegeofManagement,UniversityofMassachusettsBoston.JingWuisanassociateprofessorintheDepartmentofDecisionSciencesandManagerialEconomics,ChineseUniversityofHongKongBusinessSchool.YuZhangisanassociateprofessoroffinanceattheGuanghuaSchoolofManagement,PekingUniversity.ZijunZhaoisaPhDstudentinfinanceattheWellingtonSchoolofBusinessandGovernment.CEO–chiefexecutiveofficerCO₂–carbondioxideCSI–corporatesocialirresponsibilityCSR–corporatesocialresponsibilityECB–EuropeanCentralBankESG–environmental,social,andgovernanceGMI–greenmacroprudentialindexIPCC–IntergovernmentalPanelonClimateChangeOECD–OrganisationforEconomicCo-operationandDevelopmentOLS–ordinaryleastsquaresSEC–USSecuritiesandExchangeCommissionSOX–Sarbanes-OxleyActUS–UnitedStatesAbbreviationsTheurgencyforactiononclimatechangehascapturedtheattentionofinternationalinstitutions,policymakers,regulators,andnowthecorporateworld.Companydirectors,management,shareholders,andinvestorsalikearecallingforfirmstodotheirparttoshifttoacarbon-neutralworldeconomy—frequentlyunderso-calledenvironmental,social,andgovernance(ESG)frameworks.EncouragedinitiallybydecadesofeffortbyclimateandjusticeactivistsfollowingtheUnitedNationsFrameworkConventiononClimateChangein1992andsubsequentclimatechangeconferences,corporateleaderswerefinallyspurredintoearnestactionintheyearsfollowingtheParisAgreementof2015.Morerecently,authoritieshavecalledforrealplanstoreach“netzero”economies,includingtheIntergovernmentalPanelonClimateChange(IPCC)Reportin2023,whichhighlightedthemuchgreaterincreaseinthepaceofcarbonemissionsthantheyhadreportedearlier.TheIPCCstatesthat“wehaveoptionsinallsectorstoatleasthalveemissionsby2030.”Thereportstatesthatonlysuchresoluteglobalcollectivestrategiesandactionwillbeabletolimitglobalwarmingto1.5°Cbytheearly2050s.Somecorporateleaders,however,arenowcallingwithequalurgencyforspecificsonmeetingglobalclimatechangegoals—testamenttothegrowingsenseofcommitmentintheprivatesector—lestintherushtoachievenetzeroeconomies,effortsandmoneyarewastedoreconomieshobbled.Atthesametime,policymakersandregulators,includingthecentralbanks,haveincorporatedtheimpactandconsequencesofclimatechangeintotheiroverallpolicymandatesandoperations.PolicymakersandregulatorsarealsoChapterFariborzMoshirianandCyn-YoungParkIntroduction1consultingwithvariousprotagonistsabouttheprotectionoftheenvironmentintheirsearchforfurtherclarityandmoreoptionsforconcreteandeffectiveaction,asfirmsseekwaystomakerealprogress,whilealsoprotectingcorporateinterests.Inthiscontext,thisvolumegathersthelatestanalysisonpolicymakers’andcorporates’effortsonclimatechange,climatefinance,andESG.Itidentifiesprominentareasofinterest,ofconcern,andofsuccess,togivefirmsandpolicymakersadditionalguidanceastheylooktobuildmoreeffectiveandresilientstrategiesandactionplansfortheimmediateyearsahead.Opportunitiesabound,butsodopotentialpitfalls,meaningthatgreatertransparencyandinformationsharingwillassisteffortstoensurethatthoseopportunitiesareutilizedeffectively.ClimateJusticeandCorporateSocialResponsibilityChapter2beginsbylayingdownsomehistoricalcontextinwhichthecorporatesectorisnowenteringthepicture.BethanyRodgersexaminesthecaseforactionthatclimatechangeactivistshavebuiltupoverdecadesofcampaigningfortheinterestsofthelesspowerfulplayersinglobaleconomies.Ratherthanfocusingoncorporateinterest,theclimatejusticemovementviewsclimatechangefromtheperspectiveofjustice,fairness,andequity.Itholdsthatpeopleinpovertyandtheotherwiselesspowerfulhavefewerfinancialandotherresourcestogivethemresiliencewhenclimatechangedisruptstheirlivesandlivelihoods.While,effectively,theyareexcludedfromdecision-makingabouttheenvironmentandaboutnationalandglobalenvironmentalpolicy,thewayforwardmustconsidertheneedsofeveryoneequitably.Chapter3takesahardlookatESGandtherealresponsibilitiesofcorporatemanagersastheyadvancethroughtheemergingandsometimesunclearlinesunfoldingaroundthesenewpractices.MarkHumphery-Jennerasksafundamentalquestionforthoseresponsibleforcorporateinterests,whichiswhetherandwhendirectorsshouldconsiderenvironmentalimpact.Indeed,dotheirdutiesallowit?Companiesmustcomplywithenvironmentalplanninglaws,forexample,butshouldtheyactwhennotlegallycompelled?Deviationfromduties,evenifdeemed“moral”or“ethical,”couldseeadirectorfined,sued,orfired.Withthiscorporatecontextinhand,inChapter4,YilinShi,JingWu,andYuZhangexaminethetruebehaviorofcorporatedisclosureabouttheirsocialresponsibility,asgrowingchargesof“greenwashing”raisedoubtsaboutClimateChangeandClimateFinance2thesincerityofsomeactionssofar.AssumingthatcorporationsandotherfirmshaveinfactgoneaheadwithESGefforts,publiccompaniesshouldforgestrongrelationshipswithenvironmentallyresponsiblesuppliers.However,evidenceshowsthatpubliccompaniesnotonlyvoluntarilydisclosetheirrelationshipswithenvironmentallyresponsible(“good”)suppliers,buttheyalsoselectivelychoosenottodisclosetheirrelationshipswith“bad”suppliers.Thischapterzoomsinoncorporatesocialresponsibilityinthe“deepandcomplex”yetoftenoverlookedsupplychainsoffirms—avitalmeasureofperformance.Chapter5expoundsonthecoexistenceofcorporatesocialresponsibility(CSR)andcorporatesocialirresponsibility(CSI)byprovidingevidencefromrealcasesandstudiesthatdemonstratethisrelationship.GuanmingHe,ZhichaoLi,andRichardSlackdiscusstheeconomicconsequencesofCSRandCSIandarguethattheireconomicimpactsdiffer,meaningthattheyshouldnotbetreatedasoppositeendsofthesamecontinuum.GiventhatregulationsandlegislationrelatingtoCSI(through“punishment”)arebetterestablishedthanthoseofCSR(through“reward”),policymakersemphasizebetterregulationsandlegislationforCSR.Environmental,Social,andGovernancePerformanceandCorporateDecisionsTheshareholderperspectiveisalsoanimportantone.InChapter6,GregTindall,RebelCole,andDavidJavakhadzenotethatshareholderproposalsatcompanyannualmeetingshavehelpedmitigateclimatechangebyapplyingpressureonmanagementtoinnovate.Shareholderproposalpressure“helpsfirmsfocus,”arguesthechapter,andinnovation,notdisclosure,shouldbethefocusoffirmpoliciestoavoidthe“bestlighting”and“word-smithing”thatcharacterizesgreenwashing.Thechaptertakesupasuggestionfromearlierresearch—thatshowedthatclimate-relatedproposalsatmeetingshasspurredclimatemitigatingtechnologies—andexploresthepolicyimplicationsofitsfindings.Whataresomeofthewaysinwhichfirmsdealwiththelong-term,severe,yetoftenunpredictableconsequencesofclimatechange?AsJohn(Jianqiu)Bai,YongqiangChu,ChenShen,andChiWannoteinChapter7,somecompanieshavedemonstratedthatfirmscandiversifyawayfromonelong-runclimaterisk—thatofrisingsealevels—throughmergersandacquisitions.Businesseswithcommercialpropertiesoroperationsinlow-lyingcoastalareasmightfinditincreasinglydifficulttoensuretheirassets’safetyasseasrise,yetitisachallengetoforecastsucharise.ThechapterarguesthatIntroduction3firmsexposedtosignificantsealevelrisethereforediversifyawayfromsuchrisksbyacquiringfirmsunlikelytobeaffectedandthatthisactionisrewardedbythemarket.Theinformationenvironmentintheacquiringfirmsimprovesastheydiversifyawayfromforecastuncertainty,thatis,theriskofrisingsealevels.Thechapteralsosuggeststhatthecombinedfirms’ESGscoresshouldimprovepost-merger.Chapter8takesuptheissueofESGperformancefromtheperspectiveofcorporatesocialresponsibilitybeyondtheinterestofshareholders.In2019,222CEOsofthelargestcompaniesintheUnitedStates(US)signedthe“StatementonthePurposeofCorporation”andcommittedtoleadtheircompaniesinthebestinterestsofallstakeholders:employees,customers,suppliers,andshareholders,thusdisregardingshareholdersupremacy.Thisstakeholderviewpresumestoaccountforthe“externalities”ofcompanyactivities.VinaJavedKhan,SearatAli,andMillicentChangexaminewhetherESGactivitiesdoundermineinvestorinterestsinpractice.Ittakesacontemporaryrisk-takingperspectiveonESGtoexaminewhetherESGactivitiesaffectdownsideandupsideriskdifferently.Environmental,Social,andGovernanceConsiderationsinCorporateInvestmentChapter9considershowinvestorsshouldevaluateESGinthecontextoftheirportfolios.MarkHumphery-Jenner,SumanBanerjee,andVikramNandaarguethatfactsaboutpollutionissuescanbeunclear,competenceinindustrycanbelacking,anda“cottageindustryofcourses”ontheenvironmentalsubjectarepronetohyperboliclanguage.ThiscanleaveCEOsandotherinterestedpartieswithageneraldistrustof“ESGexperts”whichcomplicatesinvestorchoices.ThechapterlooksatESGindexesandtheirproblemsandwhatinvestorsmustdoaboutESGfactorswithinaportfolio.Italsoconsiderswhatofficersanddirectorsareobligatedtodo.TheinvestmentsideofESGconsiderationsisclearlyimportant.Estimatessuggestthat“sustainable”investinghassurgedintheUS,commandingabout$15trillionundermanagementasof2022,upnearlytenfoldin10years,asJongsubLee,SehoonKim,NitishKumar,andJunhoOhnoteinChapter10.Thishasspurredinquiryintotheforcesdrivingthedemand,withonefittingfinancialoreconomicexplanationbeingthatitreflectswidespreadconcernamonginvestorsthatapoorESGprofilemayposeanimportantrisk.ClimateChangeandClimateFinance4Analternativeexplanatoryviewisthatinvestorsderivenonfinancialutilitywhentheyreflecttheirenvironmentalandsocialpreferencesintheirinvestments,andextensiveresearchinrecentyearshasextensivelystudiedtheseissuesinpubliccapitalmarkets,suchaspubliclylistedstocksorbonds.Yet,privatecapitalmarketsrepresentamuchlargersegmentofcorporatefinancing,beingasmuchastwicethatofpubliccapitalmarketsintheamountofinvestmentsin2020.Thechapterexaminessustainableinvestingfromrecentdevelopmentsinprivatecapitalmarkets,whatchallengesmaylieahead,andhowpolicymakerscanhelptoovercomethesechallenges.TheRoleandContributionsofPolicymakersThefinalthreechaptersexamineclimatepolicybycentralbanksandfinancialregulators.Chapters11and12analyticallyreviewclimatechangeimpactoneconomies,investors,shareholders,andthemostvulnerable,anddiscusshowcentralbanksshouldtakeupsuchrisksintheirmonetarypolicyandfinancialregulations.Chapter13delvesintotheroleofstandard-setters,andregulatorsinthisregard.Thefar-reachingeconomicimpactsofclimatechangeandenvironmentaldegradationhavesignificantimplicationsforfinancialstabilityandtheprofitabilityofcommercialenterprises.Assuch,centralbanksareincreasinglysteppingupeffortstoaccountforclimaticrisksintheiroperationsandanalysis.Chapter11discussestheroleofcentralbanksincombatingclimatechangeanditsassociatedeffectsonmacrofinancialstability.RamkishenS.RajanandCyn-YoungParkarguethatcentralbanksandfinancialregulatorsshouldassumetheroleofmitigatingtheimpactofclimate-relatedfinancialrisksonfinancialstabilitymoreprominently.Theadoptionofgreenprudentialpoliciesshouldaimatbothnudginginvestorstowardinvestingingreentechnologiesandmitigatingclimaterisksbysteeringinvestorsawayfrombrowninvestments.Chapter12takesnoteofthebroadandpervasiveeffectsofclimatechangeoneconomies,financialmarkets,andinvestortoleranceforrisk.JonathanKearns,AnnaPark,andSerenaAlimpointoutthatcentralbanksareincreasinglyturningtheirattentiontoclimatechangeastheychartthecourseofmonetarypolicy.Theseeffectsoccurthroughtheimpactofclimatechangeontheeconomyandmarketparticipants’risktolerance.Centralbankshavetakenactionbyexpandinganalysisandtheirresponsetothesedevelopments.Introduction5Finally,inChapter13,ZijunZhaoarguesthatclimaterisk,policymakers,standard-setters,andregulatorsneedtobemoreactiveintheireffortstocombatclimatechangeandstabilizethefinancialsystem.Thechaptersurveystheliteratureaboutgreenfinance,environmentalaccounting,managementofclimateriskdisclosure,andgreentechnologyinnovationtoprovidemoreclarityaboutthepolicyimplicationsofenhancinginformationtransparencyandfacilitatinggreeninnovation.Insodoing,sheshedslightontherolethatpolicymakersandregulatorscanplayintheseareas.FariborzMoshirianDirector,InstituteofGlobalFinanceUNSWBusinessSchoolUniversityofNewSouthWalesSydney,AustraliaCyn-YoungParkDirectorRegionalCooperationandIntegrationandTradeDivisionClimateChangeandSustainableDevelopmentDepartmentAsianDevelopmentBankClimateChangeandClimateFinance62.1IntroductionTheclimatejusticemovementviewsclimatechangethroughalensofjustice,fairness,andequity.Itseesitasunfairthatthenegativeimpactsofrisingglobaltemperaturesfalldisproportionatelyoncertainpeopleandothersless.Thisunfairnessarisesbecauseofapurporteddividebetweenresponsibilityandimpact:thepeopleleastresponsibleforthemostsevereeffectsofclimatechangearemostnegativelyimpactedbyrisingglobaltemperatures.Theseareoftenpeoplewhofaceexistingsocialandpoliticaldiscrimination,likepeopleinpoverty,indigenouspeople,women,children,andpeoplewithdisabilities.Thesepeopleoftenhavefewerfinancialandotherresources;resourcescriticalindevelopingtheresiliencenecessarytocopewithdisasterstriggeredbynaturalhazardsoradaptwhenrisingseatemperatureschangetheirfoodsupplychains(CarbonBrief2021).Keytoclimatejusticeisinclusivityindecision-making:includingthosehurtmostbyclimatechangeindecision-makingabouttheenvironmentandhelpingtodesignenvironmentalpolicy;astruggletoachievewithstatusquoapproachestodate(Newelletal.2021).Infocusingonsocialjustice,climatejusticeadvocatesseektoupholdtherightsofmarginalizedgroupsofsuchpeople;improvingtheirresiliencetoclimatechange-associatedeventslikedisasters,andensuringthebenefitsofacleanenvironment,likeaccesstosafedrinkingwater,areequitablyshared(CarbonBrief2021).ChapterBethanyRodgersClimateJustice2RisingglobaltemperaturesClimatechangeisamongthemostimportantissuesofourgeneration.Withoutasafeenvironment,manyotherhumanrightsandfreedomscannotbefulfilled,suchasaccesstohealthcare,education,housing,andtoaffordableandnutritiousfood.Greenhousegasemissionshavecontinuedtoriseoverthepast3decades(andinthecenturybeforethen),despiteclearevidencethatgreenhousegasemissionsareincreasingglobaltemperatures.Totalnethuman-generatedgreenhousegasemissionsrose12%from2010and2019andby54%whencomparedto1994,aspertheIntergovernmentalPanelonClimateChange2022report(IPCC2022,6)(Figure2.1).Figure2.1:MajorAnthropogenicGreenhouseGasEmissionsContinuetoRiseGloballyFluorinatedgasesNitrousoxideMethaneNetCOfromlanduse,land-usechange,forestryCOfromfossilfuelandindustryGt.yr-.yr-.yr-GtGtGt.GtGHGemissions(GtCO-eqyr-)GlobalnetanthropogenicGHGemissions–CO₂=carbondioxide,GHG=greenhousegas,Gt=gigatonnes.Source:IPCC(2022).ClimateChangeandClimateFinance8Certainregionswillbeparticularlyvulnerabletorisingtemperatures,includingAustralia,thePacific,andSoutheastAsia.Low-lyingandsmall,economicallydevelopingnationsinthePacificareatparticularrisk.Tuvalu,anislandof12,000people,ispredictedtobefullysubmergedbytheendofthe21stcentury.Already,40%ofthecapitaldistrictliesunderwaterathightide(Needham2022).Wildfiresareexpectedtoincreasesignificantlyinfrequencyandintensity,aburgeoningissueinAustralia,wherefireshavebeencatastrophicforhumanandanimalpopulations,particularlyinthesummersof2019and2020.Droughts,powerfulstorms,andheatwaveseachthreatenpeople’shealthandsafetyfurther.Anestimated85%oftheglobalpopulationhavealreadyexperiencedextremeweatherevents(UNEP2022).Some3billionto3.6billionpeopleliveincontextshighlyvulnerabletoclimatechange.1From2010to2020,droughts,floods,andstormskilled15timesmorepeopleinhighlyvulnerablecountries,suchasinAfrica,Asia,andsmallislandstates,thanintherichestcountries(IPCC2022).By2030,around700millionpeoplewillbeatriskofdisplacementbydrought(footnote1).2.2TheClimateJusticeConceptClimatejusticeasaconceptemergedfollowingthestrengthsoftheenvironmentaljusticemovementofthe1980s(Dietz,Shwom,andWhitley2020).Climatejusticeadvocatesinmanywaysareinspiredby,andbuildingupon,theprincipledsuccessoftheenvironmentaljusticemovement.Environmentaljusticefocusedonfairlydistributingenvironmentalgoods(suchassafefood,water,andoutdoorrecreationareas)andills(likelandfill,radioactivityfromnucleartesting,orfromlarge-scalechemicalmanufacturingnegativelyaffectinghumanhealth).EnvironmentaljusticeadvocateslikeRobertBullard(1994)(the“father”ofenvironmentaljustice)begandrawingattentiontotheintersectionbetweensocialandenvironmentalissues.Bullard,forexample,analyzed“environmentalracism”;arguingenvironmentalissuesdisproportionatelyharmracialminorities.Hisresearchpointedtoexampleslikethefactthat,inthe1970s,allgarbageincineratorsinHouston,TexaswereincommunitieswithmajorityAfricanAmericanorLatinoresidents.1UnitedNationsSustainableDevelopmentGoals.Goal13:TakeUrgentActiontoCombatClimateChangeandItsImpacts.https://www.un.org/sustainabledevelopment/climate-change/(accessed8February2023).ClimateJustice9Thetermclimatejusticewascoinedin1989(Newelletal.2021,3)andpopularizedinthe1990s(CarbonBrief2021).Itaroselargelyoutofactivismintheeconomicallydevelopingworld,whereclimateinjusticesoftenamplifyexistingsocialinequalities(CarbonBrief2021).Theunderlyingthemesofclimatejusticebecameakeyissueinthelastdecadeofthe20thcentury.Civilsocietygroupsbeganmobilizingaroundtheissueof“climatedebts,”whichtheyrefertoasthedebtsorreparationsthatwealthiernationsowepoorernationsfortheenvironmentaldamagetheyhadcaused;inotherwords,anearlyiterationoftheunderlyingthemesofclimatejustice(Newelletal.2021,4–5).Climatejusticebringshumanrightsandsocialinequalityintotheconversationsurroundingclimateaction.Includedwithintheremitofclimatejusticearearangeofsocialjusticeissues:environmentalprotection,indigenousrights,humanrights,andtherightsofotherlivingcreatures.Thenegativeeffectsofhumanactivitiesonthenaturalenvironmentarediscussedthroughasociallens,focusingonhowoftenthoseleastpowerfulliveinlesssafeandthrivingnaturalenvironments.France’snucleartestexplosionsinthe20thcenturyinremoteAustralia,theMarshallIslands,thecentralPacific,andFrenchPolynesia,forexample,causedpersistentradioactivecontaminationandcommunitydisplacement(Ruff2015).Ratherthansimplyascientificortechnicalendeavor,advocatesofclimatejusticefocusonwhatisjustor“right.”Theybelievethoselargecorporationsandwealthiernationswhichhavefinanciallybenefitedfromtheburningoffossilfuelsoughttoredistributewealthtowardthosewhomustnowdealwiththeconsequencesofchangingclimates(CarbonBrief2021).Climatechangeisdescribedasa“tripleinjustice”:thepeopleleastresponsibleforcarbonemissionsaremostvulnerabletoitsimpacts,butalsomostlikelytobefurtherdisadvantagedbyresponsestoclimatechange(Newelletal.2021,3).Industrializednationshavehistoricallyfacedminimalrestrictionsonburningoffossilfuels(CarbonBrief2021),andhave,historicallyandintothepresentday,burnedthemost.InFigure2.2,onecanseethatNorthAmericaandEuroperankhighestinanthropogeniccarbondioxideemissions.Percapita,NorthAmericastillrankshighest,butAustralia,Japan,andNewZealandjointheranksinemissions,seeninFigure2.3.ClimateChangeandClimateFinance10Thus,arisesadisconnectbetweenwhoismostresponsibleforclimatechangeandwhoismostimpactedbyclimatechange,withthemostresponsible,onaverage,beingtheleastnegativelyimpacted.Theimpactsofglobalwarmingarenotequallyfeltthroughouttheworld—“mostaffectedpeopleandareas”isatermusedtodescribethisphenomenon(CarbonBrief2021).Climatejusticecentersonthesepeopleimpactedmost—nowandintothefuture;thosewhoarecurrently,andprojectedtobeinfuture,mostlikelytoexperienceextremeweatherevents,likefloods,droughts,andtyphoons(hurricanes).Theapproachlinkshumanrightsanddevelopment,focusingonthedifferentialconsequencesofclimatechangebetweentheGlobalNorth(economicallydevelopednations),andtheGlobalSouth(economicallydevelopingnations),whichcontinuetofacehugedifficultieswithpoverty-relatedissues,likefamineandinadequateaccesstohealthcare.Poorernationsaremoreoftenexposedtoveryhightemperatures,haveagriculturallyrelianteconomies,andrisk-managementapproacheslikeair-conditioningandinsurancearelessavailable(LevyandPatz2015,312).Figure2.2:CumulativeNetAnthropogenicCarbonDioxideEmissionsperRegionfrom1850to2019CO₂=carbondioxide,Gt=gigatonnes.Source:DerivedfromIPCC(2022,10).NorthAmericaEuropeEastAsiaLatinAmericaandtheCaribbeanEasternEuropeandWestCentralAsiaSoutheastAsiaandthePacificAfricaAustralia,Japan,andNewZealandSouthAsiaMiddleEastInternationalShippingandAviationCOemissions(GtCO)ClimateJustice11Figure2.3:CumulativeNetAnthropogenicGreenhouseGasEmissionsperCapitaandforTotalPopulation,perRegion,2019a.HistoricalcumulativenetanthropogenicCOemissionsperregion(–)b.NetanthropogenicGHGemissionspercapitaandfortotalpopulation,perregion()NorthAmericaEuropeEuropeEastAsiaEastAsiaLatinAmericaandtheCaribbeanLatinAmericaandtheCaribbeanEasternEuropeandWestCentralAsiaEasternEuropeandWestCentralAsiaSoutheastAsiaandthePacificSoutheastAsiaandthePacificAfricaAfricaAustralia,Japan,andNewZealandAustralia,Japan,andNewZealandSouthAsiaSouthAsiaMiddleEastMiddleEastNorthAmericaInternationalShippingandAviation,,,,COemissions(GtCO)Population(million)GHGemissions(tCO-eqpercapita)ClimateChangeandClimateFinance12CO₂=carbondioxide,GHG=greenhousegas,Gt=gigatonnes,tCO2-eq=tonsofCO2equivalent.Source:DerivedfromIPCC(2022,10).Climatejusticecallsforindustrializedcountries—thoseitsadvocatessayaremostresponsibleforhaltingthewarmingoftheplanet—tohelpothercountriesadapttoclimatechangeanddevelopeconomicallywithnonpollutingtechnologies.Stoppinggreenhousegasemissionsisnotenoughtorepaythedebt;addressingtheconsequencesoftheseactionsonvulnerablepeopleisalsoavitalstepinachievingjustice(MITClimatePortaln.d.).Arelatedconcepthereistransformativejustice.Transformingpoweriskeytoadvancingclimatejustice;alsocrucialisequalizingsocialandinstitutionalrelations,whichwillhelpindesigningsustainable,effective,andsociallyacceptableresponsestoclimatechange(Newelletal.2021,2).22.2.1FourPillarsofClimateJusticeNewelletal.(2021)describefourpillarsofclimatejustice:procedural,distributive,recognition,andintergenerationaljustice.ProceduralclimatejusticeProceduralclimatejusticerelatestohowauthoritiesmakedecisionsabouttheclimateandclimatechangeimpacts—theprocessofdecision-making.Itpromotesfair,accountable,andtransparentdecision-makingthroughmethodslikeallowingallpartiesaccesstorelevantinformationwhendesigningenvironmentalpolicyandensuringlegalredressisavailablewhenenvironmentaldamageoccursandharmsmanifest(Newelletal.2021,4).Ratherthantokenism,thispillarofclimatejusticepromotesmeaningfulparticipation.Onetechniquetowardachievingproceduraljusticeisensuringfree,prior,andinformedconsentfromlocalcommunitiesaffectedbylandacquisitionsforplantationagricultureorcommunitiesparticipatinginforestryprojects.Informedconsentispromotedasaresponsetoinjusticesthatcanarisewhenlarge,powerfulinterestslikemultinationalcorporationshavetheauthoritytodecidewhetherforestsandforestlandsshouldbeexploitedorprotected.Insuchcases,motivatedbyprofit,corporationsgenerallywinoutoverlocalcommunitiesandfinanciallybenefitfromtheexploitation.Suchconflictshavemanifestedinmanycountries,asdiverseasUganda,Mexico,Bolivia,andmultipleSoutheastAsiannations(Newelletal.2021,4–5;CariñoandColchester2010).2Transformingpowerisattheheartofcallsfor“transformativeclimatejustice.”Itisaboutdisruptingdominantpowerrelationsandshiftinginstitutionaldecision-makingprocessestoaddressrootcausesoftheclimatecrisis,helpingensureajusttransitionwhileallowingcommunitiestoadapttoclimatechange’sexistingimpacts.Forausefulexplanation,seeNewelletal.2020.ClimateJustice13DistributiveclimatejusticeDistributiveclimatejusticerelatestotheallocationofthecostsandbenefitsofsocialgoodsontheonehand,andsocialillsontheother(Newelletal.2021,5).Thedistributionoftheseillsisdiscussedspatially,meaningthroughoutdifferentgeographicareas,andtemporally,meaningintothepast,present,andfuture.Aprimeexampleoftheunfairspatialdistributionofsocialgoodsandillswasseenintheabovediscussionofhowrichernationsarehistorically(andtothepresentday)responsibleformostgreenhousegasemissions,yetpoorernationsdisproportionatelyexperiencethemostnegativeeffectsfromrisingglobaltemperatures.Risingsealevelsthreateningsmall,low-lyingnationsinthePacificorpoorruralcommunitiesinlow-lyingareasofBangladeshareexamples.Record-breakingfloodsinJune2022impactedabout7.2millionpeopleinnortheasternBangladesh.Theregionfacedthehighestrainfallindecades(IFRC2022).Thecountryisalreadyburdenedbypoverty-relatedissues,likeinadequateaccesstocleanandsafedrinkingwaterandfood.Solutionstoclimatechangecanalsoimpactcommunitiesdifferently.Whenfloodsaredealtwithbybuildingflooddefensesonlyinoneorafewhigh-riskareas,forexample,otherhigh-riskcommunitiesdownstreamofthedefensesfacegreaterfloodriskandaremoreimpactedwhenfloodsmanifest(Newelletal.2021,5;Eriksenetal.2011,11–13).Itisvitalthatresponsestofloodingaremultifaceted,effectivelyprotectingpeopleandcommunitiesfromdisparategeographicareaswithoutworseningtheriskforothers.Floodingisasignificantfutureissueofdistributiveclimatejustice.Tellmanetal.(2021)analyzed12,719ModerateResolutionImagingSpectroradiometer,orMODISimages(aformofsatelliteimagery)from2000to2018.Theyproduced913floodmaps,andfoundthat,globally,2.23millionsquarekilometersoflandisatriskofflooding,puttinganestimated255millionto290millionpeopleatriskofdirectimpactbyfloods.Theunevendistributionofclimatechange’simpactsonwomenisanotherburgeoningproblem.Speakingatapopulationlevel,womenhavelessaccesstofinancialandotherresourcesthanmenand,asaresult,havelesscapacitytonavigatethenegativeconsequencesofclimatechange(Newelletal.2021,5),suchasrecoveringandreceivingadequateaccesstofood,shelter,andhealthClimateChangeandClimateFinance14careafteradisaster.Thisisparticularlytrueofwomenwithmarginalizedidentitiessuchas“lower”casteorsocialclass(Newelletal.2021,5).Poorerwomenoftenhavelessabilitytocopewithandadapttoachangingenvironment(Terry2009,5–18).Alsocrucialwithindistributivejusticeisconsideringthosewhohavereapedthemostfinancial,social,andculturalbenefitsfromexploitingthenaturalenvironment,whileothershavenotbenefitedfromthiswealth.Asignificant,butsometimesneglectedfactorcausingclimatechangeiscompanies,particularlythosethatextractfossilfuelsforprofit(Wright2022).RichardHeede,theDirectoroftheClimateAccountabilityInstitute,collecteddatashowingthatjust90companieswereresponsiblefortwo-thirdsofallgreenhousegasesemittedbetween1751and2016.Overhalfofthoseemissionsoccurredinthelast45years,orsince1988(KennerandHeede2021).TheGreatBarrierReef,a344,400squarekilometerWorldHeritageArea,haslosthalfitscoralssince1995(BBCNews2020),duetoacombinationofoverfishing,farmpollution,andindustrializationintheformofportexpansiononnearbycoastlines(WWFAustralian.d.).Profit-generatingactivitiesintheregionhavealsohaddeleteriousimpactsonmarinewildlife.RecognitionjusticeRecognitionjustice,whileencompassingproceduralanddistributionaljusticeprinciples,focusesparticularlyonrecognizingdifference.Recognitionjusticeseekstoacknowledgeandinclusivelyaddressthewaythatpeoplefrommarginalizedgroupswhoaresociallyorpoliticallydiscriminatedagainst,areincludedinconversationssurroundingclimatepolicy.Theviewsofthesegroups,liketheviewsofpeopleinpovertyorindigenouspeople,oughttobefairlyandaccuratelyrepresented,andreflectedindesigningclimatepolicyandpractice,withoutthesepeoplefacingreprisal.Boththeunderstandingofdifferenceandtheprotectionofequalrightsisgivenemphasisinthisaspectofclimatejustice(Newelletal.2021,6).Inmanyindigenouscultures,theenvironmentisintegraltoculturalandspiritualpractices.Theclimatejusticemovementseekstoincludeandadvocatefortheviewsandrightsofindigenouspeopleandthelandtheyoccupy(Newell2021,9).Rightsfornature,forexample,involvegivingformallegalrightstothenaturalenvironment,inmuchthesamewayindividualpeoplehaverights,andhastakenholdallovertheworld,fromNorthandClimateJustice15SouthAmericatoAsia.Theseapproachesaccepttheintrinsicvalueofnature.Therightsof“mothernature”havebeenwrittenintotheBolivianconstitution(Newelletal.2021,10).Inawell-recognizedexample,Māoripeople,theindigenouspeopleofAotearoa(NewZealand),havebeengivenownershipofpartsofNewZealand’slandandwaterways.TheTreatyofWaitangi,signedin1840,isthecountry’sfoundingdocument,enteredbyMāorichiefsandBritishofficialswhereinMāoricededrightstolandandtheBritishwereallowedtoformgovernment(NewZealandHistoryn.d.).In1975,theTreatyofWaitangiActwaspassed,formallyimplementingtheprinciplesunderthetreaty.Manyofthepoliciespassedsincethisdatereflectprinciplesassociatedwithclimatejustice.The290-kilometer-longWhanganuiRiver,inNewZealand’sNorthIsland,whichisofgreatsignificanceinindigenousculture,becamein2017thefirstriverintheworldtoberecognizedasalegalpersonafteralong-runningcourtcase.Thewaterwayhasbeensignificantforatleast880years,reliedonbyindigenouspeoplefortravelandsustenance.ThattheWhanganuiRiverisrecognizedasalegalpersonmeansthatharmtotherivergenerateslegalrights.Theriveritselfcanlitigatetoaddressharmsresultingfrompollutionorotherunauthorizedactivities,providingameanstoprotecttheriver(TheGuardian2019;Evans2020),andaninnovativelegalframeworkinwhichtoimplementclimatejustice(Newelletal.2021,10–11).IntergenerationaljusticeInlinewiththeconceptofintergenerationaljustice,currentgenerationsshouldhavearighttomeettheirneeds,butthisshouldoccurwithoutcompromisingtheabilityoffuturegenerationstodoso.IntergenerationaljusticeiscentraltothegloballyrenownedFridaysforFuturecampaign,whichdrewsignificantinternationalattentiontotheissueofclimatejustice.Itisalsocrucialinmanyindigenouscommunities’viewsofenvironmentalethics.Itispositionedasunfairthatcurrentgenerationsofpeopleareentitledtomakedecisionsabouttheenvironmentthatleadtopollutionandotherenvironmentaldegradation,andbenefitfinancially,socially,orpracticallyfromtheseactions.TheFridaysfortheFuturecampaignevolvedfromtheprotestof15-year-oldGretaThunberg,outsidetheSwedishParliamenteveryFridaywithasignsayingSkolstrejkförklimatet(schoolstrikeforclimate).Fromthere,ClimateChangeandClimateFinance16thanksinlargeparttosocialmedia,theone-personprotestevolvedintoaglobalschoolclimatestrikemovement,withpeopleprotestingoneverycontinent.Over100,000peopleturnedoutinseveralcities,suchasBerlinandNewYorkCity(TheNewYorkTimes2019).Thismovementfocusedontheunfairnessofclimatechange’simpactonchildrenandfuturegenerations.TheWorldBankhasestimatedthatbythetimetheseteenageclimateactivistsareintheirlate20s,climatechangecouldputanadditional100millionpeopleintoextremepoverty(CarbonBrief2021).Climatechangeiscausingintergenerationalinequity,withyoungandfuturegenerationsbearingthebruntofindividualandsocialharmsarisingfromrisingtemperaturesglobally.Thekeyunfairnesshereisthatfuturegenerationswillnotbeabletopolluteinthesamewayandwillinsteadbeleftwithadamagedenvironmentthattheyarenotresponsibleforcreating(Newelletal.2021,6).Implementingthesevaluesisanincreasinglypopularapproachtodecision-makingbygovernmentsallovertheworld.Forexample,futuregenerationshavebeenrepresentedindecision-makinginparliamentsinFinland,Chile,Hungary,andWales.AnothermethodofimplementingtherightsoffuturegenerationsisusingOmbudsmenthatrepresentfuturegenerationstoguidedecision-making(Newelletal.2021,6).LatestdevelopmentsinachievingclimatejusticeAddressingclimatechangeisamajorissueinternationally.TheUnitedNationsSustainableDevelopmentGoals,awidesetofgoalsaimingtopromotethebasicrightsoftheworld’smostvulnerable,explicitlymentionclimatechangeaskeytosustainabledevelopment.Goal13,“ClimateAction,”seeksto“takeurgentactiontocombatclimatechangeanditsimpacts.”Withinthisgoal,therearetargetsrelatedtostrengthening“resilienceandadaptativecapacitytoclimate-relatedhazards,”improving“humanandinstitutionalcapacity”forclimatechangemitigation,adaptation,impactreductionandearlywarning,andraisingcapacityfor“effectiveclimate-changerelatedplanningandmanagementinleastdevelopedcountriesandsmallislanddevelopingstates,includingfocusingonwomen,youth,andlocalandmarginalizedcommunities”(footnote1).ClimateJustice17TheprimaryinternationalenvironmentalagreementistheUnitedNationsFrameworkConventiononClimateChange,ineffectsinceJune1994.Itisajointcooperativeof197nations,andthusaninitiativeofalmosteverynation.ThesignatorynationstotheFrameworkConventiononClimateChangeparticipateintheConferenceoftheParties(COP),meetingsofparticipatingcountriestodiscussenvironmentalissuesandplanprograms,policies,andagreements.In2015,theCOPnegotiatedtheParisAgreement(UNFCCC2015),agroundbreakinginternationalagreementwhereincountries,througharticle2,aimtokeeptheincreaseinglobaltemperaturesto“wellbelow”2.0degreesCelsius(°C)abovepre-industriallevels,and“pursu[e]efforts”tolimitthetemperatureincreaseto1.5°Cabovepre-industriallevels(UNFCCC2015,art.2).Thiswasasignificantdiplomaticachievement.Climatechangeisahotlycontestedpoliticalissue,butallstatespresentatCOPsignedtheAgreement(Kenfack2022).UndertheParisAgreement,signatorycountriespledgenationallydeterminedcontributions(UNFCCC2015,art.3).Thisisamoreuniversalapproachthanpreviousinternationalenvironmentalagreements.TheKyotoAgreement,forexample,involvedtop-down,legallybindingrequirementsforcountriestoreduceemissions.theParisAgreementinvolvesbottom-updecisionsbyeachnation,amorecooperativemethodofaddressingclimatechange.Climatechangeandadaptationtotheeffectsofclimatechange,aswellaspreventingtheissuegettingworse,areviewedasagloballysharedchallenge.Theresponsibilityisnotjustwiththepoliciesofindividualgovernments,butasanissuethroughwhichmanystakeholdersshouldcooperateandaddresstogethertoimproveoutcomesforall.LiketheSustainableDevelopmentGoals,theParisAgreementmakesspecialmentionof“leastdevelopedcountriesandsmallislandnations”(UNFCCC2015,art.4),inrecognitionofthesignificantchallengesthesenationsalreadyface,andwillcontinuetoface,becauseofclimatechange.Inlinewiththisfocusoninternationalequality,developednationswhosignedtheParisAgreementagreedtomobilize$100millionannually,together,tofundclimateactionindevelopingnations(UNFCCC2015).Thisisknownasclimatefinance—internationalfundingtosupportclimateactionindevelopingcountries.3In2018,theclimatefinanceprovidedandmobilizedbythese3OxfamAustralia.ClimateJustice.https://www.oxfam.org.au/what-we-do/climate-justice/.ClimateChangeandClimateFinance18developedcountriestotaled$78.3billion,and$79.6billionby2019(footnote1).Whileasuccess,thesefiguresarefarbelowtheestimated$1.6trillionto$3.8trillionneededeachyearthroughto2050fortheworldtotransitiontoalow-carbonfutureandavoidwarmingtheplanetmorethan1.5°Cabovepre-industriallevels(footnote1).ResponsibilityintheParisAgreementlieswitheveryone,andaparticularfocusisonthosewhohavebeenmoreresponsibleforclimatechange.Throughthelensofdistributivejustice,thismeansinvestorsandcorporationsarealsoresponsibleforachievingclimatejustice.Climatechangeisarealitythatglobalfinancialmarketsarealreadygrapplingwith.Onewaythisoccursisthroughinvestorawarenessofclimatelitigationrisks.Climatelitigationcanforcefinancialinstitutionstoabandonassets—ifajudgeordersaprojecthaltduetoriskstothenaturalenvironment,theprojectwillhaveextremelylimitedreturns(Pearce2021).ThishasbeenakeythemeinseveralcourtcasesinAustraliarecently,anationeconomicallyreliantonfossilfuelextraction(Wrightetal.2022).ReferencehasbeenmadetoAustraliabeingasignatorytotheParisAgreementindomesticcourts.ShareholdersintheCommonwealthBankofAustralia,forexample,soughtdisclosurefrominternalbankdocumentsaboutwhethercertainprojectscompliedwiththegoalsoftheParisAgreement.Australia’sFederalCourtorderedshareholdersbegivenaccesstodocumentsonthebasisthattheprojectsmayinfringethecompany’ssocialandenvironmentalpolicies.4AfterCOP21,theagreementshiftedfromaglobalaimtolimittheriseintemperaturesnotto2°Cbutrathertoonly1.5°C.Thiswasdoneconsideringincreasinglystrongscientificevidencethat1.5°Cwarmerwasnotasafetemperatureforhumanitytoliveat(Harvey2022).ArangeofdevelopmentshaveoccurredatsubsequentCOPmeetings.In2016,atCOP22,Germanypresenteditsplantoreducegreenhousegasemissionsby80%to95%by2050—thefirstnationtohaveanambitious,long-termclimatestrategy.COP23,COP24,andCOP25eachdiscussedtheParisRulebook(WorldResourcesInstituten.d.),whichexecutestheParisAgreement,dictatinghowcountriesmeasureandreportontheirgreenhousegasemissions.ThisParisRulebookwasagreed-uponatCOP264AbrahamsvCommonwealthBankofAustralia,No.NSD864/2021(FederalCourtofAustralia2021).ClimateJustice19ofNovember2021,rescheduledfrom2020duetotheCOVID-19pandemic.NationsatCOP26alsoagreedtoend“inefficient”fossilfuelsubsidiesandmoveawayfromcoal(ClimatePartner2022).Inlate2022,atthemeetingofthepartiestotheUNFCCCinSharmel-Sheikh,Egypt(COP27),thefocuswasonmoresubstantialandspeediereffortstowardmitigationandadaptationtotheeffectsofclimatechange.Somenationswantedtoremovethe1.5°Cwarmingtarget,whileotherscriticized“weak”languagesurroundingtheobligationstophaseoutfossilfuels(Harvey2022).Climatefinanceandcompensationforlossanddamagewereontheagenda(footnote3).Asignificantfocuswasfinancialassistancefordevelopingcountriesforlossanddamage.Manyarguedfortheneedtohelppoorernationsrebuildphysicalandsocialinfrastructuredamagedbyextremeweathereventsoverthepast3decades.Atthesummit’sconclusion,attendingnationsagreedtocreatesuchafund,butcouldnotreachagreementonthemeansofcreatingsuchafund,andexactlywheresuchmoneywillcomefrom(Harvey2022).Taskslikethese,andtheimplementationofclimatejusticepolicieslikethefundtohelpdevelopingnationscopewithclimatechangearekeyissuesofthenext12monthsandbeyond.Focusisexpectedtobeonrichernationssubmittingmoreambitiousnationallydeterminedcontributions,pledgingtotakegreateractiontoreducetheirgreenhousegasemissionsandtoagreetooffermorefinancialassistancetopoorernations(footnote3).Somehopeinternationalagreementswillbecomemorebindingintheirlanguageandthusimposegreaterlegalobligationsoncountriestotransitionawayfromfossilfuels.ArecognizedlimitationoftheParisAgreementisthattoachieveconsensusamongnations,someofthelanguageisnonbindingbynature(Sunetal.2022).Thepictureisnotallgrim—achievingclimatejusticeandreducingthecurrentandfutureimpactofclimatechangeareontheglobalagendalikeneverbefore.Asaresultofindividualandcollectiveaction,momentumforchangeisbuilding.Agrowinggrassrootsmovementispushingfortheprotectionofthenaturalenvironment.Itisnotjusttheschoolstrikeforclimatecampaign,thereisincreasingconsumerdemandforgoodsthatareenvironmentallysustainableandethicallyproduced(leadingtoincreasedsupplyofsuchproductsbymanycompanies,includingmajormultinationalcompanies).Evenlargeoilcompanies,likeBPandShell,aremakingcommitmentstoreducetheirenvironmentalimpact.Boththesecompanies,in2020,madesimilarClimateChangeandClimateFinance20commitmentstobecomenetzeroby2050,withmarketpressuresforcingthisdecision,includingnationalclimatepolicyandpublicopinion(KennerandHeede2021).LegalactionlikethedisclosureordersagainsttheCommonwealthBankofAustraliamentionedabovearealsobecominganincreasinglypopularmethodofclimateaction.Throughthecourts,individuals,nongovernmentorganizations,andothergroupsareincreasinglyassertingtheirrightstoasafeandhabitableenvironment,andsometimeshavingsignificantsuccessdoingso.IntheUnitedStates,lawsuitsinthe5yearssince2017havebeenlaunchedagainstExxonMobil,RoyalDutchShell,BP,Chevron,PeabodyEnergy,andothermajorenergycompanies.Thesehavesoughtcompensation,withtheaimofusingthatmoneytoadapttotheimpactsofclimatechange,likebuildingseawallsinCaliforniatocopewithrisingsealevels,orcombatingwildfires,floods,agriculturallosses,andheatwavesinColorado(Jarvisn.d.).Theinvolvementofaffectedcommunitiesindesigningandimplementingsolutionstoclimate-relatedissueswillbevitalinachievingclimatejustice.Developingbottom-uppoliciesinconsultationwiththosewhoareaffectedbypolicies,likelocalcommunities,businesses,schools,andcharities,willmeanthatthesepoliciesreceivebroad-basedsupportintothefuture,increasingthelegitimacyofclimatejusticeresponses.Indesigningamoreenvironmentallysustainablefuture,justtransitionswillbeimportant.Ajusttransitionseekstoensurethatthetransitionawayfromgreenhousegasemittingactivitiesoccursfairly,withoutdisproportionatelyharmingthosefrompoorercommunitiesandworseningpreexistinginequalities(Newelletal.2021,10).Inclusionof,andconsiderationtowardthosemostaffectedbyclimatechange,inthepast,present,andintothefuture,intheglobaldiscussiononclimatechange,iscriticalforachievingclimatejustice.ClimateJustice212.3ConclusionClimatejusticetakesissuesofenvironmentalsustainabilityandraisesimportantquestionsrelatedtofairnessandequity.Theclimatejusticemovementisseekingtoensurethatclimatechangedoesnotundotheimmenseprogresstowardimprovingpeople’swell-beingandbasiclivingstandardsinrecentdecades.Theclimatejusticemovement’sfourpillars—procedural,distributive,recognition,andintergenerationaljustice—seektoensurethosemostimpactedbyextremeweathereventsareresilientenoughtorecoverwhentheirlivelihoodsareimpactedbydroughts,floods,heatwaves,andotherdisasters.Notableprogresshasbeenmadeonclimatejusticeinrecentyears.TheParisAgreementwasasignificantdiplomaticachievement,providingafoundationfromwhichtheworldcancooperatetoequitablyaddresstheexistingconsequencesofclimatechangeandtrypreventingthisissuefromescalating.Climatechangewillremainacomplexpolicyissueforgenerationstocome.Climatejusticecanhelpensuresolutionstoclimatechangearetargetedtowardareasandpopulationswherehelpismostneeded,likeensuringadequateclimatefinanceforthoseindevelopingcountries.ClimateChangeandClimateFinance22ReferencesBBCNews.2020.GreatBarrierReefHasLostHalfofItsCoralssince1995.14October.https://www.bbc.com/news/world-australia-54533971.Bullard,R.1994.EnvironmentalRacismandInvisibleCommunities.WestVirginiaLawReview.96(4).pp.1037–1050.CarbonBrief.2021.In-DepthQ&A:WhatIs‘ClimateJustice’?4October.https://www.carbonbrief.org/in-depth-qa-what-is-climate-justice/.Cariño,J.andM.Colchester.2010.FromDamstoDevelopmentJustice:Progresswith‘Free,PriorandInformedConsent’SincetheWorldCommissiononDams.WaterAlternatives.3(2).pp.423–437.ClimatePartner.2022.FromPledgestoBindingCommitments–AReviewofKeyMilestonesinPreviousCOPConferences.https://www.climatepartner.com/en/climate-action-insights/complete-review-of-key-milestones-from-previous-cop-conferences.Dietz,T.,R.L.Shwom,andC.T.Whitley.2020.ClimateChangeandSociety.AnnualReviewofSociology.46(1).pp.135–158.Eriksen,S.,P.Aldunce,C.S.Bahinipati,R.D’AlmeidaMartins,J.I.Molefe,C.Nhemachena,andK.O’Brien.2011.WhenNotEveryResponsetoClimateChangeIsaGoodOne:IdentifyingPrinciplesforSustainableAdaptation.ClimateandDevelopment.3(1).pp.7–20.https://doi.org/10.3763/cdev.2010.0060.Evans,K.2020.TheNewZealandRiverThatBecameaLegalPerson.BBCTravel.21March.https://www.bbc.com/travel/article/20200319-the-new-zealand-river-that-became-a-legal-person.TheGuardian.2019.SavingtheWhanganui:CanPersonhoodRescueaRiver?29November.https://www.theguardian.com/world/2019/nov/30/saving-the-whanganui-can-personhood-rescue-a-river.Harvey,F.2022.WhatAretheKeyOutcomesofCop27ClimateSummit?TheGuardian.20November.https://www.theguardian.com/environment/2022/nov/20/cop27-climate-summit-egypt-key-outcomes.ClimateJustice23IntergovernmentalPanelonClimateChange(IPCC).2022.SummaryforPolicyMakers.https://www.ipcc.ch/report/ar6/wg3/downloads/report/IPCC_AR6_WGIII_SummaryForPolicymakers.pdf.InternationalFederationofRedCrossandRedCrescentSocieties(IFRC).2022.MillionsinBangladeshImpactedbyOneoftheWorstFloodingsEverSeen.IFRCPressrelease.28June.https://www.ifrc.org/press-release/millions-bangladesh-impacted-one-worst-floodings-ever-seen.Jarvis,B.n.d.ClimateChangeCouldDestroyHisHomeinPeru.SoHeSuedanEnergyCompanyinGermany.TheNewYorkTimes.9April.Kenfack,C.E.2022.TheParisAgreementRevisited:DiplomaticTriumphalismorDenialofClimateJustice?JournalofEnvironmentalProtection.13(2).pp.183–203.https://doi.org/10.4236/jep.2022.132012.Kenner,D.andR.Heede.2021.WhiteKnights,orHorsemenoftheApocalypse?ProspectsforBigOiltoAlignEmissionswitha1.5°CPathway.EnergyResearch&SocialScience.79(12).102049.https://doi.org/10.1016/j.erss.2021.102049.Levy,B.S.andJ.A.Patz.2015.ClimateChange,HumanRights,andSocialJustice.AnnalsofGlobalHealth.81(3).pp.310–322.http://dx.doi.org/10.1016/j.aogh.2015.08.008.MITClimatePortal.n.d.ClimateJustice.https://climate.mit.edu/explainers/climate-justice.Needham,K.2022.Tuvalu,SinkinginthePacific,FearsBecomingaSuperpower‘Pawn.’Reuters.13May.https://www.reuters.com/world/asia-pacific/tuvalu-sinking-pacific-fears-becoming-superpower-pawn-2022-05-13/.TheNewYorkTimes.2019.ProtestingClimateChange,YoungPeopleTaketoStreetsinaGlobalStrike.20September.NewZealandHistory.n.d.TheTreatyinBrief:TreatyFAQs.https://nzhistory.govt.nz/politics/treaty/treaty-faqs.ClimateChangeandClimateFinance24Newell,P.,S.Srivastava,L.O.Naess,G.A.TorresContreras,andR.Price.2020.MovingTowardsTransformativeClimateJustice:WhatNeedstoBeDone?.GlobalDevBlog.https://www.globaldev.blog/blog/moving-towards-transformative-climate-justice-what-needs-be-done(accessed27March2023)._____.2021.TowardTransformativeClimateJustice:AnEmergingResearchAgenda.WIREsClimateChange.12(6).e733.https://doi.org/10.1002/wcc.733.Pearce,P.2021.DutytoAddressClimateChangeLitigationRisksforAustralianEnergyCompanies—PolicyandGovernanceIssues.Energies.14(23).p.7838.https://doi.org/10.3390/en14237838.Ruff,T.A.2015.TheHumanitarianImpactandImplicationsofNuclearTestExplosionsinthePacificRegion.InternationalReviewoftheRedCross.97(899).pp.775–813.https://doi.org/10.1017/S1816383116000163.Sun,R.,X.Gao,L.Deng,andC.Wang.2022.IstheParisRulebookSufficientforEffectiveImplementationofParisAgreement?AdvancesinClimateChangeResearch.13(4).pp.600–611.https://doi.org/10.1016/j.accre.2022.05.003.Tellman,B.,J.A.Sullivan,C.Kuhn,A.J.Kettner,C.S.Doyle,G.R.Brakenridge,T.A.Erickson,andD.A.Slayback.2021.SatelliteImagingRevealsIncreasedProportionofPopulationExposedtoFloods.Nature.596(7870).pp.80–86.https://doi.org/10.1038/s41586-021-03695-w.Terry,G.2009.NoClimateJusticewithoutGenderJustice:AnOverviewoftheIssues.Gender&Development.17(1).pp.5–18.https://doi.org/10.1080/13552070802696839.UnitedNationsEnvironmentProgramme(UNEP).2022.Australia:AftertheBushfiresCametheFloods.17March.http://www.unep.org/news-and-stories/story/australia-after-bushfires-came-floods.UnitedNationsFrameworkConventiononClimateChange(UNFCCC).2015.ParisAgreement.https://unfccc.int/sites/default/files/english_paris_agreement.pdf.ClimateJustice25WorldResourcesInstitute.n.d.NavigatingtheParisRulebook.https://www.wri.org/paris-rulebook.Wright,C.,R.Irwin,D.Nyberg,andV.Bowden.2022.‘We’reintheCoalBusiness’:MaintainingFossilFuelHegemonyintheFaceofClimateChange.JournalofIndustrialRelations.64(2).pp.544–563.WWFAustralia.n.d.GreatBarrierReef.https://www.wwf.org.au/what-we-do/oceans/great-barrier-reef/great-barrier-reef.ClimateChangeandClimateFinance263.1IntroductionEnvironmental,social,andgovernance(ESG)principleshaveproliferatedintheinvestingworld.NumerousindexeshaveemergedtocapturewhetherfirmssufficientlyadheretoESGdoctrines.1ThemostcontroversialpartsofESGpertaintosocialandenvironmentalimpact.Thishasattractedsignificantinvestorattention,ahighprofileexamplebeingthecampaigntopreventenergycompanyAGLfromdemerging.2Butfromacorporategovernanceperspective,thefundamentalquestioniswhether,andwhen,officersanddirectorsshouldconsiderenvironmentalimpact:morespecifically,whether—andwhen—directors,dutiesallowdirectorstoconsiderimpact.Myriad“impact”fundsandspecialinterestgroupshavepushedforcorporationstoconsiderESGfactors.Likewise,myriadlawscaninfluencewhether,andwhen,officersanddirectorsshouldconsiderenvironmentalimpact.Manyofthoselawsareindustry-orlocation-specific.Theseincludeenvironmentalplanninglawsandlawsgoverningpollution.Companiesshouldcomplywiththeselesttheysufferlegalconsequences.However,themorepertinentquestioniswhetherofficersanddirectorscan,orshould,considerenvironmentalimpactevenwhennotlegallycompelledtodoso.1SeeBerg,Kölbel,andRigobon(2019).2Forexample,seeKeepItTogetherAustralia.GrokVentures.GrokInvestmentMemo.https://www.keepittogetheraustralia.com.au/(accessed25September2022).ChapterMarkHumphery-JennerDoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?3Thischapterfocusesonwhetherdirectors’dutiesallowthoseofficersanddirectorstoconsiderenvironmentalimpact.Notably,theymustcomplywithdirectors’duties.Thesearenotoptional.Officersanddirectorscannotdeviatefromtheirdutieseveniftheybelieveitis“moral”or“ethical.”Iftheydo,theycouldbefined,sued,orbannedasadirector.Therearethreeoverarchingtypesofdutyhere:3(i)theobligationtoexercisecareanddiligence;(ii)therequirementtoactingoodfaith,inthecompany’sbestinterests,andforaproperpurpose;and(iii)theprohibitiononusingone’sposition(orinformationgainedfromit)forimproperpersonalbenefitorindetrimenttothecorporation.Thesedutiesalsointerfacewithfirms’andmanagers’disclosurerequirements.Thedutiesandlegalobligationsinformwhatofficersanddirectorsshoulddo.Theexactnatureofthesedutiesvariesbyjurisdiction.Thedutiescanpermitandencouragedirectorstoconsidersocialandenvironmentalimpact,butonlywhenitisrelevanttothecorporation.Inthisrespect,socialandenvironmentalimpactaremuchlikeanyotherconsideration:officersanddirectorsmustconsiderhowtheyinfluencethefirm’scashflows,risk,andcostofcapital.Reputationalconsiderationsarerelevantiftheyinfluencethefirm’soperations.Andcompliancewithlegalobligationsisalwaysrelevantandnecessary.Thisimpliesthatofficersanddirectorscanpursueenvironmentalorsocialimpactonlyifitsimpactonshareholdersisnotnegative.Officersanddirectorsmaynotconsiderimpactmerelyasthe“rightthingtodo,”asnoted.Theyshouldresistoutsidepressuregroupsthatpromotespecificcausestothedetrimentofshareholders.Afterall,theirdutiesaretoshareholdersasawhole,nottoaspecificshareholderorgroup.Directorsmustalsobehonestwithinvestorsabouttheprecise“impact”ofinitiativesandhowthosewillinfluencecashflows,risks,andaccesstocapital.Theymustfocusonhowimpactinvestmentsinfluenceshareholderwealthandthereforeonfinancialmetricssuchasaccesstocapital,cashflows,andtheriskthereof.Theyshouldhonestlypresenttherisks,costs,andpayoffs.Thischapterdetailshowimpactinitiativesinterfacewithdirectors,duties.Itconsidershowdirectorsoweadutytoactinthebestinterestsofthecorporationasawholeaswellasimproperuseofpositionforapersonalpolicy3CorporationsAct2001(Cth)Section180–183.ClimateChangeandClimateFinance28agenda,disclosureobligations,andtherequirementforaccuratedisclosureof“impact”activitiesandthefinancialimplications.Thenextsectiondiscusses“dutyofcare,”whichrequiresdirectorstoconsiderrelevantrisks.3.2“Best-Interests”DutyandSocialandEnvironmentalImpactDirectorsmustact“foraproperpurpose”andinthe“bestinterestsofthecorporation.”4Thisisafundamentaldutyandiscommonacrossjurisdictions,ingeneral.However,itiswellknownthat“agencyconflicts”existwherebyagents(i.e.,managers)prefertheirowninterestsoverthoseoftheprincipals(i.e.,theshareholders).Thiscanmanifestinself-interested,capricious,orvalue-destroyinginvestments,5philanthropicpetcauses,6andshirking.7Shareholdersacknowledgethatitisimpossibletoeliminateagencyconflicts.ButtheyaimtostructureincentivecontractstoamelioratethemandwilltoleratesomeagencycoststosecureaqualityCEOwhootherwisecreatesvalue.Butthefundamentalquestioniswhetherconsideringimpactcouldviolatethebest-interestsduty.3.2.1DoesBest-InterestsDutyAllowEnvironmentalConsiderations(andWhen)?Officersanddirectorsmustevaluatethefinancialimpactofallenvironmentalinitiatives.Thisisbecauseofficersanddirectorsmustact“inthebestinterestsofthecorporation.”8Indoingthis,theymustmakeinformeddecisions,ratherthandecisionsonawhimoramerefeelingaboutwhattheyregardas“right”or“moral.”9Thus,theymustconsidertheinterestsofexisting4SeeCorporationsAct2001(Cth)Section180.5Forexample,thereisevidencethatCEOsmakevalue-destroyingacquisitions,especiallywhen“entrenched”andprotectedfromoutsidediscipline:Masulis,Wang,andXie(2007).ThisispartlyattributabletoCEOsexercisinginsufficientdisciplinewheninvesting,andpotentiallyprioritizinginvestmentstheypreferthatmightnototherwisecreateshareholderwealth:Harford,Humphery-Jenner,andPowell(2012).6See,forexample,MasulisandReza(2015).7“Shirking”especiallyappearstobethecasewhenmanagersareentrenched;andthus,whereagencyconflictscanbeespeciallypronounced:BertrandandMullainathan(2003).8CorporationsAct2001(Cth)Section181(1)(a).9ThisfollowsthecommentsinAustralianMetropolitanLifeAssuranceCoLtdvUre(1923)33CLR199at206perKnoxCJ.DoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?29shareholders.10TheAustralianSecuritiesandInvestmentsCommission(ASIC)(Australia’scorporationsregulator)hasspecificallystatedthatdirectors,“primarydutyistothecompany’sshareholders.”11Further,thisisadutytoshareholdersasawhole,ratherthantospecificshareholdersortothelargestorloudestshareholder.12Theinterestsofotherstakeholdersarerelevantiftheyinvolvemaximizingshareholdervalue.Forexample,beforeAustralia’sCorporationsActwaspassedin2001,therehadbeendiscussionaboutincludingdutiestothewidercommunity.TheNewZealandCompaniesAct1993Section132contemplatesconsideringemployees’interests.Australia’slegislatorshaveconsideredwhetherdirectors’dutiesshouldexplicitlyencompassenvironmentalissues(SenateStandingCommitteeonLegalandConstitutionalAffairs1989).In1989,theStandingCommitteeonLegalandConstitutionalAffairsnotedthatdirectors’dutiesencompassenvironmentalconsiderationsifeithertheyhaveafinancialimpactor(potentially)arerelevanttootherlegislation.Despitethispriorconsideration,theCorporationsAct2001doesnotincludeenvironmentalmattersindirectors’duties.Thissuggeststhatthelegislatorsintendedfinancialconsiderationstodrivewhetherandwhendirectorsconsiderenvironmentalimpact.13ThegovernmentinAustraliaalsoconsideredamendingtheCorporationsActtoincludebroaderstakeholderinterests.However,ithasdeclinedtodoso.TheCorporationsandMarketsAdvisoryCommitteeconsideredwhethertoamenddirectors’dutiestoincludemyriadconceptssurroundingsocialresponsibility(CMAC2006).Itnotedthatdoingsowouldcreateconcernsabouthowdirectorsbalancecompetinginterestsandwouldhamperaccountabilitybyrenderingdutiesvague.TheCorporationsActwassubsequentlyamended.TheBillsDigestforthatamendmentspecificallyreferencedthecommitteereport.Buttheamendmentdidnotalterdirectors’duties(Donaldson2010).Thisfurthersuggeststhatlegislatorsconsideredexpandingdirectors’dutiesbutdeclinedtodoso.10PilmervDukeGroupLtd(inliq)(2001)207CLR165;[2011]HCA31at[18];GreenhalghvArderneCinemasLtd[1951]Ch286at[291].11AustralianSecuritiesandInvestmentsCommission(ASIC).InsolvencyforDirectors:InformationSheet42.https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/#directors-duties.12PercivalvWright[1902]2Ch421;BrunninghausenvGlavanics(1999)46NSWLR538.13SeeCICInsuranceLtdvBankstownFootballClubLtd[1997]HCA2;141ALR618at634–5perBrennan,CJ,Dawson,TooheyandGummow,JJ.ClimateChangeandClimateFinance303.2.2IsImpactRelevantThen?Officersanddirectorscanthereforeconsiderenvironmentalimpactifithasacommercialimpact.However,theymaynotconsiderenvironmentalimpactmerelybecauseitismoralorethicalitself.Nonetheless,environmentalimpactcaninfluenceacorporation’sfinancesanditsstockprice.Thefirm’svalueisthepresentvalueofallfuturecashflows,discountedattheappropriatecostofcapital.Thus,ifcashflowsfall,orthecostofcapitalincreases,thefirm’svaluewilldecrease.Therefore,officersanddirectorsshouldconsidersustainabilitymuchlikeanyotherinvestment.14Thepreciseimpactdependsonthecompany’scircumstances.StrongESGscoresarenotnecessarilyassociatedwithhigherstockreturns(Cornell2021),andarepotentiallynegativelyrelatedtostockreturns,onaverage(Avramovetal.2022).Further,ifthefirmreliesonexternalratingsagenciestocertifyitsenvironmentalimpact,therecanbesignificantdisagreementbetweenratingsagenciesandmethods(Berg,Kölbel,andRigobon2019).Thiscanbothreducethetrustworthinessofthoseratingsandtheirabilitytoimproveperformance.Interestingly,themoredisagreementthereisbetweenESGratings,thehigherthestockreturn(Brandon,Krueger,andSchmidt2021).Thus,thereisevidencethatstockreturnsarelowerforfirmswith“better”ESGratings,especiallywhencertaintyaboutthoseratingsisgreater.15Environmentalimpactcaninfluencefirms’cashflows.Harmingtheenvironmentcancreatenegativepublicity,potentiallyharmingsales.Itmightalsoviolateenvironmentallaws,triggeringfinesandexclusionfromgovernmentcontractsorprohibitionsoncorporateactivities.Additionally,someenvironmentallydamagingactivitiesmighthavealimitedtimehorizon.Forexample,coalpowergeneratorshaveafinitelifeduetoregulation.Thus,whenmaximizingshareholdervalue,itisimportanttoanalyzewhetherenvironmentallydamagingactionsarefinanciallysustainable.14ThisfollowstheanalysisthatESGinvestingissimilartootherinvestinginthatitfocusesonfirms’cashflowsandcostofcapitaland,thus,theirsharepriceandexpectedreturn(Edmans2022).15Avramovetal.(2022,19).Therearedifferentinterpretationsofthisresult.Ontheonehand,itmightsuggestthatstockreturnsarelowerwhenESGscoresarestrongerandmorecertainbecauseinvestorsdemandalowerreturnfromthesecompanies.Therefore,greatercertaintylowersthecostofcapital.Ontheotherhand,itcanalsosimplysuggestthatfirmsthatfocusonESGindexesunderperform,evenaftercontrollingforotherfactorsthatcaninfluencereturns.DoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?31Sustainability-relatedfactorsmightalsoreduce“tailrisk”:theriskofextremenegativeevents.Thisisdistinctfromthepresenceofextremeenvironmentalevents:anindividualcompany’sdecisiontoprioritizesustainabilityisunlikelytosignificantlyinfluenceextremeeventsbyitself.Rather,thatrequireseconomy-wideaction.However,focusingonsustainabilitymightenablecompaniestoreduceregulatoryrisk,whichcouldcausesuddenandsignificantcashflowimpacts.Thisreducestheriskofextremecashflowevents.Inturn,thiscanbenefitshareholdersbyreducingthefirm’srisklevel,whichcanreducestockpricerisk.16Environmentalimpactcanaffectfirms’costofcapital.MSCIassertsthistobethecase(Lodh2020);however,MSCIalsoproducesandsellsanESGscore.Itcanespeciallyinfluenceinterestratesondebtandevidenceexistsofthis(Hoque,Ahmed,andRichardson2020),albeitmainlyforfirmsinenvironmentallysensitiveindustries(Gerwanski2020).Thiseffectalsoappearstobestrongerinmore“stakeholder”orientedcountries(Eliwa,Aboud,andSaleh2021).ThismightoccurbecauseadditionalmediascrutinyintheESGspacechillslendingtoenvironmentallydamagingcompanies.17Itcouldalsobebecauseenvironmentallydamagingcompaniesfacegreaterregulatoryandfinancialrisks.Thiswouldcauselenderstobelesswillingtolendtodamagingcompaniesandtochargehigherrateswhendoingso.Environmentaldisclosuresandsustainabilityperformancemightmakeitlesscostlytoraiseequity.Thiscouldbebecauseinvestorsperceivesustainabilitytoreducecashflowrisk(NgandRezaee2015).However,investorsalsoappeartoincorrectlyvalueenvironmentalinitiatives.Forexample,whilesomeinvestorsmightbewillingtopaymoreforsustainablecompanies,theymightnotaccuratelydistinguishbetween“low”and“high”impactinitiatives(Heebetal.2023).Thus,companiesshouldbepreciseaboutthespecificwayinwhichsustainabilityimprovesaccesstocapitalwhenmakingsuchassertions.Theforegoingsuggeststhatofficersanddirectorsshouldconsidersustainability.Itcanhaveafinancialimpact.However,itisimportanttobespecificaboutpreciselywhyinitiativeswouldinfluencethefirm’scashflowsoritscostofcapital.16EvidenceexiststhatahigherESGratingmightberelatedtolowerstockcrashrisk(Gieseetal.2019).However,thisisnotnecessarilycausalinnatureandcouldbeattributabletoothercharacteristics.17ThisfollowstheanalysisoftherelationshipbetweenmediaESGscrutinyandthecostofdebtinGao,He,andLi(2022).ClimateChangeandClimateFinance323.3ImproperUseofPositionOfficersanddirectorsmustnot“improperly”usetheirpositiontoeither“gainanadvantageforthemselvesorsomeoneelse”or“causeadetriment’tothecorporation.”18Managerscanviolatethisdutybymerelygaininganadvantage,evenifthatdoesnotharmthecorporation.19Thisdutycancreateasignificantbarriertoprioritizingimpactattheexpenseofshareholderwealth.Thisisthecaseevenifasetofshareholdersarewillingtobearthecostofthatimpact:officersanddirectorsactforshareholdersasawhole,notmerelyonesetofshareholders.Thisdutyiscommonacrossjurisdictionsandhasseveralimpacts.Thisdutyprohibitsofficersanddirectorsfromharmingthecorporation(i.e.,usingthecorporation’smoney)tobenefitthemselves.Thisbenefitcanincludenonpecuniarybenefits(i.e.,feelingmorallygoodaboutwhatthecorporationisdoing).Thus,officersanddirectorsshouldnotsupportpetcausesthathavenoclearcorporatebenefit.Indeed,supportingsuchpetinterestscouldbean“inkind”benefit,whichinturncouldbeakintoimproperlyobtainingfees.20Unfortunately,suchactionsarecommonplace.21However,thecostofpolicingsuchactionsoftenoutweighsthebenefitofstoppingthem.Andshareholdersmightregardtoleratingsmallactsofpersonalphilanthropyasa“costofdoingbusiness”withaCEOthatcanotherwiseperformwell.Inthiscase,thismeansthatofficersanddirectorscannotmerelysupportimpactbecausetheybelieveitismorallyright:thiswouldinvolvegaininganadvantageforthemselveswhilecausingamonetarycosttothecompany.Directorswouldviolatetheirdutiesiftheymerelysupportedtheinterestsofasubsetofinvestorsorprioritizedthoseinvestors’viewsoverthoseofotherinvestors.Asindicatedabove,directorsoweadutytoactforshareholdersasawhole.Thisisnotadutytotheloudestshareholder,thelargestsingleshareholder,orthemostmediasavvyshareholder.Further,evenifspecificinvestorssupportedandadvocatedforadirector’sappointment,18CorporationsAct2001(Cth)Section182.19ThisfollowsfromChewvR(1992)173CLR626,wherethecourtfoundthatitisnotnecessarytoshowthattheactionsdidinfactcauseadetriment,ascouldbethecaseifaninjunctionpreventedthemfromdoingso.20Forexample,seethesituationinAustralianSecuritiesandInvestmentsCommissionvLewski(2018)362ALR286.Directorsusedtheirpositiontogeneratesignificantfeesforaresponsibleentity,whichwouldbenefitthemselves.21Empiricalevidenceexiststhatmanymanagersdosupportpetcausesviatheircompanies:MasulisandReza(2015,6).DoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?33thatdirectormuststillactforshareholdersasawhole.Additionally,werethedirectortoactforonesetofshareholders—attheexpenseofthecompany—theywouldbeusingtheirpositionto“gainanadvantage[…]forsomeone”whilecausingadetrimenttothecompany.AnexampleisthesituationthatenergyproviderAGLmustconsider.AGLhaslookedatmovingtowardrenewableenergy.In2022,thefirmaimedtodemergeintotwoentities.However,backlashfromclimate-focusedinvestorssubsequentlyhaltedthis.Akeyvoiceinblockingthedemergerwasthelargestinvestor:MikeCannon-Brookes.SubsequentmediareportinghasfocusedonhisspecificviewsaboutAGL’srenewablespush,22andhispersonalviewsaboutboardappointments.23ThereisnoevidencethatAGL,itsofficers,oritsdirectorsactedimproperly.Similarly,MikeCannon-Brookes—andhisinvestmentgroup—areactingwithintheirrightsasinvestors.However,thisflagstherisksthatcanarise:wheninteractingwithactivistinvestors,directorsmustshowtheyareactingforshareholdersasawhole—notmerelyasubsetofinvestors.Thisisthecaseeveniftheyarethelargestshareholderorpurporttobe“doinggood.”3.4WhatabouttheDutyofCare?Thedirectors’dutyofcaremightrequiredirectorstoconsidersocialandenvironmentalimpact,butonlyineconomicterms.Here,theCorporationsActrequiresdirectorsto“exercisetheirpowersanddischargetheirdutieswiththedegreeofcareanddiligencethatareasonablepersonwould.”Thedutybegsthequestionofwhata“reasonableperson”woulddowhenrunningacorporation.Thereareseveralkeyimplications.Directorsmustconsidersocialandenvironmentalimpactliketheywouldanyotheractivity.Here,theymustconsidertheeffectofsocialandenvironmentalfactorsonthefirm’scashflows,cashflowrisk,andthecostofcapital.Officersanddirectorscanalsoconsiderreputationalharm,compliancewithlegalobligations,andtheabilitytocontinueoperating.2422Forexample,seeThomsonandKoob(2022)andJohnson(2022).23Forexample,seeHannam(2022).24AustralianSecuritiesandInvestmentsCommissionvCassimatis(No8)(2016)336ALR209at[480]-[483].ClimateChangeandClimateFinance34Thisimpactwilldependonthecorporation’scircumstances.25Inthisrespect,impactconsiderationsarenodifferenttoanyotherconsideration.Failingtoconsiderthefinancialimplicationsofsocialandenvironmentalimpactcouldbreachtheduty.However,if,afterevaluation,thereisnocorporatereasontoactonsocial/environmentalfactors,thendirectorsoughtnotdoso.Further,ifsocialandenvironmentalimpactwillhaveagreaterimpactonacompany’svalue,thentheywarrantgreaterconsideration.Climateriskscouldenliventhisduty.Directorsandofficersshouldconsidertheimpactofclimatechangeandclimaterisksontheirbusinesses.26Similarly,ifthecompany’sroleinclimatechangecouldimposefinancialcosts(i.e.,throughregulation,orworseaccesstodebt),thentheofficersanddirectorswouldseeminglyneedtoconsiderit.Thiscan—andlikelyshould—involveaproactiveassessmenttoputinplacesystemstodeterminewhethersocialandpoliticalfactorshaveagenuinefinancialimpact.27However,here,thefocusisonthecorporateimpact,ratherthanonthealleged“moral”impact.Prioritizingsocialandenvironmentalfactorsoverfinancialconsiderationswouldlikelybreachthisduty.Forexample,engaginginarisky,orcostly,transactionthathaslittlechanceofafinancialpayoffcanbreachthisduty.28Rather,officersanddirectorsshouldconsiderthosefactorsinabroaderriskanalysis.29Thus,focusingonwhatmanagersdeem“morally”or“ethically”justified,withonlycursoryconsiderationtothecorporateorfinancialriskscouldbreachtherelevantdutyofcare.Directorswouldalsolikelycontravenethisdutyiftheyuncriticallyaccepted,ordismissed,reports.Directorsmustconsiderreportsaboutsocialandenvironmentalimpact.Whiledirectorswouldnotnecessarilybeexpectedtobeexpertsinallareas,theyshouldaskrelevantquestionsorobtainrelevant25Forexample,seeAustralianSecuritiesandInvestmentsCommissionvMaxwell(2006)59ACSR373at397perBreretonJ.26ThisfollowsfromAustralianSecuritiesandInvestmentsCommissionvVines(2005)55ACSR617.Here,thedefendantsfailedtofurnishrelevantinformationaboutinsurancecostsassociatedwithahurricane.Byparityofreasoning,failuretoconsiderfinancialimpactsofclimatechangecouldcontravenethedutyofcare,dependingonthecircumstances.27ThisfollowsfromDSHEHoldingsLtd(recsandgrs.apptd)(inliq)vAbboud(No3).Here,thedefendantdirectorshadfailedtoputinplacesystemstoensureproperinventorymanagement.Thisimpliesthatofficersanddirectorsshouldalsohavesystemstoconsiderwhether—ifatall—environmentalorsocialfactorsmightinfluencethecorporation’sfinancialposition.28AustralianSecuritiesandInvestmentsCommissionvSydneyInvestmentHouseEquitiesPtyLtd(2008)69ACSR1;[2008]NSWSC1224at[28].29ThisfollowstheapproachofMasonJinWyongShireCouncilvShirt(1980)146CLR40.Here,MasonJexpresslyreferredtoconsideringtheriskandmagnitudeofaneventwhendeterminingwhethertoactonit.DoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?35research-translationstoensurethattheyareadequatelyinformed.30Further,officersanddirectorscannotmerelydelegatetheirdecision-making,oranalysis,tothirdparties.Forexample,directorscannotmerelyavoidtheirresponsibilitytoensurefinancialsareaccuratebyhiringanauditor.31Thus,directorscannotsimplydelegatetheirdecision-makingtoESGconsultantsandmustcriticallyevaluatethefinancialimpactofanysocialorenvironmentalinitiatives.Theoverallimplicationofthisdutyisthatdirectorsmustconsidersocialandenvironmentalimpactmuchliketheywouldconsideranyothercorporateriskfactor.Ifthereisafinancialrisk,directorsshouldactuponthatrisk.However,thismustinvolveagenuine,andwellinformed,financialriskassessment.Thisshouldconsidertherisksandreturnsofacting.3.5GreenwashingandMisleadingStatementsGreenwashingandmisleadingstatementscouldalsoviolatedirectors’duties.Mostoften,issuingfalseormisleadingstatementscanviolatethedutyofcare.32Therefore,ifthedirectorsmakefalseormisleadingstatementsaboutthefirm’senvironmentalorsocialimpacttheycouldviolateboththerelevantdisclosureobligationsandtheirdutiesofcare.However,thereisadditionalnuance.Theseobligationscomemostcommonlyfromtwomaingroups.Buttheprecisenaturevariesbetweencountries.ThedutiesaresimilarinAustraliaandtheUnitedStates,forexample.InAustralia,therulesaresimilartoSECRule10b-5overallandderivefromtwoareas.First,CorporationsActSections1041Eand1041Hprohibitfalseandmisleadingstatements.Section1041Eprohibitsfalsestatementsthatwouldencourageapersonto“applyfor”ordisposeofafinancialproduct,orwouldimpactthepriceofafinancialproduct.ItisanalogoustoUnitedStatesSECRule10b-5.Section1041Hbroadlyprohibitsconductthatis“misleadingordeceptive”inrelationtofinancialproductsandservices.Second,theASXcontinuousdisclosurerequirementshavelegalforceviaCorporationsActSection674.30AnextremeparallelisAustralianSecuritiesandInvestmentsCommissionvSinoAustraliaOilandGasLtd(inliq)(2016)115ACSR437.Here,thedirectorsapprovedprospectusesbutseeminglyneitherunderstoodtheEnglishinthetextnorsoughttranslationstounderstandthem.31Forexample,seeASICvHealey&Ors[2011]FCA717,discussedinBanerjeeandHumphery-Jenner(2016).32Forexample,directorsinAustralianSecuritiesandInvestmentsCommissionvVocationLtd(inliq)(2019)371ALR155violatedtheirdutyofcarebyprovidingfalsestatementsinaduediligencequestionnaire.ThisenlivenedCorporationsActSection1041HandcontravenedtheASXlistingrules,enliveningCorporationsActSection674.Similarly,inAustralianSecuritiesandInvestmentsCommissionvBigStarEnergyLtd(No3)(2020)148ACSR334,thedirectorsviolatedtheirASXlistingrules,whichinturnviolatedthedutyofcare.ClimateChangeandClimateFinance36Issuingfalseandmisleadingstatementscanhavecorporateconsequences,evenifthestatementisnotpersematerial.Thatis,thedecisiontomisleadthemarketsendsanegativesignalaboutthefirm’scorporategovernance.Thishasimplicationsforthefirm.Forexample,afteraclassactionoranenforcementaction,firmsoftenhaveworseaccesstodebtandworsetradeterms,suggestingasignificantfinancialandreputationalpenalty(Karpoff,Lee,andMartin2008a).Evidencingthesenegativeeffects,CEOs’jobprospectsoftenworsenaftersecuritiesclassactionsandenforcementactions(Humphery-Jenner2012;McTierandWald2011;Karpoff,Lee,andMartin2008b).Thecorollaryisthatofficersanddirectorsshouldnotengageingreenwashing.Here,therearetwomaintypesofmisleadingconduct:(i)misleadingpeopleabouthowenvironmentallyorsociallyfriendlythecompanyis,and(ii)misleadingaboutthepayoffstosuchactions.Greenwashingistypicallyseenasthepracticeofmakingthefirmseemmoreenvironmentally(orsocially)friendlythanitreallyis.Thereisaspectrumofgreenwashing,rangingfromproducingcontent-freepuffpiecesthroughtoactivelymisleadinginvestorsaboutthefirm’sgreen(orsocial)credentials.Evenifinvestorsdonotvaluethoseenvironmentalandsocialstatements,investorswilllikelypenalizethefirmifitliesaboutthem.Thus,thefactofissuingafalseormisleadingstatementcouldviolatedirectors’duties.Greenwashingcanalsoinvolvemisleadinginvestorsaboutthefinancialpayoffsfrom(orcostsof)socialorenvironmentalinitiatives.Thus,directorsmustexercisereasonablecareandskilltoensurethattheirpayoffandcostestimatesareaccurate.Iftheyinflatethebenefits(ordeflatethecosts)ofsuchactions,itwouldlikelyviolatedisclosurerequirementsinCorporationsActSections674,1041E,and1041Hby(amongotherthings)inflatingthestockprice.Further,thisalsomeansthatdirectorscannotmerelydelegatethistoanESGconsultantanduncriticallyacceptESGrecommendationswithoutundertakingtheirownindependentassessment.3333ThisfollowsfromASICvHealey&Ors[2011]FCA717.Here,thecourtheldthatdirectorscouldnotmerelyblindlydefertoauditorstosidesteptheirdutytoensurethatfinancialreportswereaccurate.Byparityofreasoning,officersanddirectorscannotobviatetheirdutytoprovideaccuratefinancialinformationbydeferringtoenvironmentalandsocialimpactreports.DoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?37ThisisasignificantriskgiventhatthereislittleevidencethatmerelyhavingahigherESGscoreimprovescompanyperformance(indeed,itisoftenassociatedwithnegativereturns)34andthereissignificantdisagreementaboutwhat—ifanything—mattersforESGscores.35Further,investorsappeartohavedifficultyvaluingthecostorbenefitofenvironmentalinitiatives,36makingthemevenmoredependentonmanagers’disclosures.Thedisclosureobligationshaveaclearimplication:managersshouldconsiderenvironmentandsocialimpactinthesamewaytheyconsiderothercorporatedecisions.Andtheyshouldbehonestwithinvestorsaboutwhatspecificinitiativestheyareundertakingandtheirfinancialbenefitifany.3.6WhatabouttheBusinessJudgmentRule?Theforegoingraisesthequestionwhetherthebusinessjudgmentrulecanhelpdirectorswhomightotherwiseappeartobreachtheirduties.Thebusinessjudgmentruleonlyprotectsdirectorsagainstallegedbreachesoftheirdutyofcare,notagainstotherallegedbreaches.37Thatis,itwillnotprotectdirectorsagainstallegationsthattheyimproperlyusedtheirpositionoractedagainstthecompany’sbestinterests.Thescopeofthebusinessjudgmentrulevariesacrosscountries.IntheUnitedStates,theruleisrelativelygenerous,andcouldlikelyreducetheriskofbeingsuedforsuchbreaches.However,thisisnotthecaseinalljurisdictions.Australia,forexample,hasarelativelyrestrictiveapproachtothebusinessjudgmentrule.There,therulestipulatesthatofficersordirectorsaredeemedtohavesatisfiedtheirdutyofcareiftheytakeanactionorjudgmentthat(i)isdoneingoodfaithandforaproperpurpose,(ii)doesnotinvolveamaterialpersonalinterest,(iii)forwhichtheyhaveinformedthemselvestotheextentthey“reasonablybelieve”isappropriate,and(iv)they“rationally”believeisinthebestinterestsofthecorporation.Thishasseveralcorollaries.34SeeAvramovetal.(2022,19).35SeeBerg,Kölbel,andRigobon(2019,1).36Forexample,evidenceexiststhatinvestors“care”aboutenvironmentalimpact,buttheyappearnottobeabletovaluethecost/benefitofthatimpact:Heebetal.(2023,30).Thismakesitincumbentonmanagerstoprovideaccuratestatementsgiventhata“reasonable”directorinthesecircumstanceswouldappreciatethedifficultiesthatinvestorsfaceinthiscontext.37ThisisclearfromthetextinCorporationsActSection180(2).ClimateChangeandClimateFinance38Thedirectorswillnotbeabsolvedfromignoringhowenvironmentalorsocialfactorsimpactcashflowsorrisks.ThisisclearfromSection180(2)(c):thedirectormusthaveinformedthemselvesaboutamattertoinvolvethebusinessjudgmentrule.Ifdirectorsignoreamatterorpaysonlycursoryattentiontoit,theycannothaveinformedthemselves.Thus,ontheonehand,ifdirectorsignoreenvironmentalorsocialfactors,theymightstillbreachSection180.Directorsshouldthereforeconsiderwhethercausingenvironmentalorsocialdamagewilladverselyimpactthecorporation.Conversely,ifadirectorzealouslypursuessocialcauseswhilepayingonlylipservicetohowthatmightimpactthecorporation’s“bottomline,”theycouldalsonotinvolvethebusinessjudgmentrule.Directorsmustact“ingoodfaith”and“foraproperpurpose”andinawaythattheyrationallybelieveisinthe“bestinterests”ofthecorporation.Thus,inthiscontext,thisinvolvesactingintheinterestsofthecompany.38Altruisticpurposeswouldgenerallynotsatisfythis.Thus,ifthedirectoractsforreasonsotherthanmaximizingshareholderwealth,thedirectorwouldlikelynotbeabletoinvokethebusinessjudgmentrule.Thisisthecaseevenifoneormoreshareholderswouldlikethedirectortoactinaspecificaltruisticway.39Acomplexissueisifadirectorerroneouslybelievesthatfocusingonimpactmaximizesshareholderwealthwhenitdoesnot.“Impact”initiativesmay,butneednot,maximizeshareholderwealth.Inthiscase,thedirectorswillbeattemptingtoact“ingoodfaith”and“foraproperpurpose.”Here,whetherthebusinessjudgmentrulewouldfocusonwhetherthedirectorscould“rationally”believetheywereactinginshareholders’bestinterestsandwhethertheyhadinformedthemselvestotheextentthey“reasonablybelieved”wasappropriate.Ataminimum,thiswouldlikelyrequirethedirectorstoobtaincredibleandimpartialfinancialmodelingofhowtheimpactinitiativeswouldinfluencethefirm’sfinancialposition,muchaswithanyothermajorcorporatedecision.Thisaltogethersuggeststhatwell-meaningdirectorscouldusethebusinessjudgmentruleiftheymaketheirbesteffortstofinanciallymodelimpactinitiativesproperly.However,asindicated,thisonlyhelpsinrelationtothedutyofcare.Andinvokingthebusinessjudgmentrulereliesonthedirectorsfocusingonwealthmaximization.However,asindicated,somejurisdictions—suchastheUnitedStates—aremoregenerousintheirapplicationofthebusinessjudgmentrule.38FitzsimmonsvR(1997)23ACSR355.39ThisfollowsfromGlovervWillert(1996)20ACSR182at188.DoDirectorsHaveaDutytoConsiderSocialandEnvironmentalImpact?393.7ConclusionESGinvestinghasbecomepopular.Ithasalsorecentlycomeunderscrutiny,withconcernsaboutthearbitrarinessofsomeESG“analysis”andunclearbenefitstoshareholders.Allegationsofgreenwashingexacerbatethesituation.Thisraisesthequestionofwhether—andtowhatextent—directorsandofficersareunderadutytoconsiderenvironmentalandsocialimpact.Theclearestoutcomeisthatdirectorsandofficersmustconsiderenvironmentalandsocialimpactmuchliketheymustconsideranyfactorthatmightinfluencecorporatevalue.Indeed,failingtoconsidersuchimpact—whererelevant—couldbreachthedirectors’dutiesofcare.However,whenconsidering“impact,”theymustanalyzeitthroughthelensofshareholderwealthmaximization.Thus,theymustconsiderthecostsandbenefitsofpursuingimpactinitiatives.Theseincludehowsuchfactorswillinfluencethefirm’scostofcapital,cashflows,andtheriskinessthereof.Directorsandofficerscannotpursueinitiativesmerelybecausetheybelievetheyare“right,”orarepassionateaboutthem.Thiscouldviolateboththedutyofcare,theobligationtoactinthecorporation’sbestinterest,andtheprohibitiononbenefitingthemselvesatthecostofshareholders.Directors’andofficers’primarydutyistotheirshareholders.Directorsandofficersmustalsobehonestwithinvestorsaboutthecostsandbenefitsofimpactinitiatives.Directorsshouldnotmisleadinvestorsabouteithertheamountofimpactactivitiestheyaredoingoraboutthepayoffsfromsuchactivities.Suchmisleadingactionscanultimatelyharmthefirm,violatedisclosureobligations,andbreachdirectors’duties.Theoverallimplicationisthatenvironmentalandsocialconsiderationsarenotirrelevantperse.Buttheirrelevanceislimitedandofficersanddirectorsmustconsiderthesefactorswithinabroadercorporateframework.Directorsshouldnottreatcorporationsasavehicletopursuetheirownpolicygoals.Directors’dutiesaretotheirshareholdersasawhole,nottospecificshareholdersthatpressureforcausesnortooutsideinterestgroups.ClimateChangeandClimateFinance40ReferencesAustralianSecuritiesandInvestmentsCommission(ASIC).2020.InsolvencyforDirectors:InformationSheet42.https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/#directors-duties.Avramov,D.,S.Cheng,A.Lioui,andA.Terrelli.2022.SustainableInvestingwithESGRatingUncertainty.JournalofFinancialEconomics.145(2).pp.642–664.Banerjee,S.andM.Humphery-Jenner.2016.Directors’DutiesofCareandtheValueofAuditing.FinanceResearchLetters.19(C).pp.1–14.Berg,F.,J.Kölbel,andR.Rigobon.2019.AggregateConfusion:TheDivergenceofESGRatings.ForthcomingReviewofFinance.https://ssrn.com/abstract=3438533orhttp://dx.doi.org/10.2139/ssrn.343853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tedshareholderproposalsshowsuperiorfinancialperformance.ChapterYilinShi,JingWu,andYuZhangGreenorGreenImage?SelectiveDisclosureofCorporateSuppliers4Corporatesocialresponsibilityisalsorelatedtotheresilienceofcompaniesinwithstandingshocks.Lins,Servaes,andTamayo(2017)findthatfirmswithhighercorporatesocialresponsibilityscoresexperiencehigherstockreturnsduringfinancialcrisesandshowbetteroperationalperformanceafterward.Inaddition,Bardos,Ertugrul,andGao(2020)providedirectevidencethatcorporatesocialresponsibilityscoresarepositivelyassociatedwithproduct-marketperceptions.Ascorporatesocialresponsibilityiswelcomedbybothconsumersandthefinancialmarketduetoitsmultiplebenefits,firmsareincentivizedtopresentanimageofenvironmentalresponsibility.Nonetheless,thedisclosureofsuppliersismostlyvoluntary.Firmscandeterminewhattheywanttodisclosetothepublicafterconsideringboththebenefitsandcostsofdisclosure.Therefore,itispossibleforafocalfirmtoselectivelydiscloseitssupplierstopresentspecificcorporatesocialresponsibilityimages.Understandingwhetherlistedcompaniestrulycareforenvironmentallyresponsiblesupplychainsorsimplywanttoportrayanovertly“green”supplychainimageisthekeytoaccuratelyassessingtheenvironmentalresponsibilityoflistedcompanies.However,nostudiestodateexaminewhetherandtowhatdegreelistedfirmsselectivelydisclosegreensuppliers.Theanalysishereprovidesthefirstexaminationoflistedfirms’selectivedisclosureofgreensuppliersandnondisclosureoflessgreenones,usinglarge-scaledatasetsoflistedfirmsandtheirrespectivesuppliersworldwide.ThekeypieceofinformationitusesfromthesupplychaindatasetFactSetRevereisthedisclosingpartyoftherelationship,whichindicateswhetherasupplierisvoluntarilydisclosedbythecustomerfirmitself.Whetherasupplierisvoluntarilydisclosedbythecustomerfirmissignificantlypredictedbythesupplier’senvironmentalrating(measuredbytheenvironmentalscoreinThomsonReuters’ASSET4).Theempiricalspecificationisalinearprobabilitymodelinwhichthedependentvariableisvoluntarydisclosurebythecustomer,andtheexplanatoryvariableofinterestistheenvironmentalratingofthesupplier.Theanalysisadoptscustomer-by-yearfixedeffectsandcontrolsforknownfactorsthatinfluencevoluntarydisclosure.Thisensuresthattheanalysiscomparesthevoluntarydisclosureofsuppliersthatbelongtothesamecustomerinthesameyearandthatareobservationallyequivalent,barringtheirenvironmentalratings.GreenorGreenImage?SelectiveDisclosureofCorporateSuppliers45Theanalysisidentifiesseveralfirm-levelfactorsthatintensifytheselectivedisclosureofgreensuppliers.First,althoughstudiesfindthatthepositivefinancialeffectsofcorporatesocialresponsibilityarestrongerforcompaniesthatoperateinahighlycompetitiveindustry(Bardos,Ertugrul,andGao2020;Dingetal.2020),thisanalysisfindsthatfirmsthatfacemorecompetitivepressure(asmeasuredbyfirmmarketshare)aremorelikelytoselectivelydisclosegreensuppliersandpresentapositivecorporatesocialresponsibilityimage.Second,studiesfindthatmarketvalueincreaseswithcorporatesocialresponsibilityforfirmsthathavehigheradvertisingexpenditures(ServaesandTamayo2013).Similarly,theanalysisfindsthatfirmsthatcaremoreaboutcustomerawarenessandreputation(asmeasuredbytheirselling,general,andadministrativeexpenses)aremorelikelytoselectivelydisclosegreensuppliers.Third,theanalysisshowsthatfirmswithlargerholdingsbyinstitutionalinvestorsaremorelikelytogreenwashtheirsupplychains,whichisconsistentwiththecateringhypothesis(DesaiandJin2011;Golubov,Lasfer,andVitkova2020).Finally,listedcompanieswithlowerenvironmentalratingstendtobemoreselectiveindisclosingsupplierswithhigherenvironmentalratings.Theanalysisalsofindsthatpublicawarenessofclimatechangeandgovernmentpoliciesoncorporatesocialresponsibilitydisclosuresinfluencessupplychaingreenwashing.Itfindsthatlistedfirmsincountriesorregionswithhighersurvey-reportedawarenessofclimatechangearemoreselectiveintheirdisclosureofsuppliersbasedonthesuppliers’environmentalratings.Thispatternisnotspecifictocross-sectionalvariationsinpublicawarenessofclimatechange.Consistently,theevidenceheresuggeststhatsupplychaingreenwashingincreaseswhenthestateorthecountryinwhichthecustomerislocatedexperiencesahighfrequencyofwildfires,aswildfiresareoftenacatalystforclimatechangeawareness.Ifsocialawarenessisnotsufficienttodetersupplychaingreenwashing,thenwhatis?Theanalysisfindsthatwhenregulationsoncorporatesocialresponsibilitydisclosurearetightened,theextentofsupplychaingreenwashingissubstantiallyreduced.ThisisconsistentwiththeoreticalfindingsinWu,Zhang,andXie(2020)thatlowinformationtransparencyenvironmentsingeneralincentivizeprofit-drivenfirmstoengageingreenwashing.ClimateChangeandClimateFinance46Thechapter’sanalysiscontributestotheliteratureonseveralfronts,firstasresearchonpublicfirms’sociallyresponsiblesupplychainpractices.Studiesinthiscross-disciplinaryfieldmakesignificantefforttocovertopicssuchassustainablesupplychainpracticesimplementedbybuyerfirms(PlambeckandTaylor2016;AgrawalandLee2019)andresponsiblesupplychainregulationsandpolicies(SunarandPlambeck2016).Inparticular,Schiller(2018)andDai,Liang,andNg(2021)showthatcustomerfirmsexertinfluenceonsuppliers’corporatesocialresponsibilitythroughpositiveassortativematchingandtheirdecision-makingprocess.Theprevalentbehaviorthisanalysisfindsisthatcustomerfirmsstrategicallydisplayanethicalimagebyselectivelydisclosing“good”supplierswhileconcealing“bad”ones.Thiscontrastswith—yetatthesametimecomplements—theliterature’spriorfocusonpromotingsupplierstobe“good”orestablishingbusinessrelationshipswith“good”suppliers.Therefore,thefocusonadifferentsideofthecustomer’scorporatesocialresponsibilitybehavioroffersamoreholisticpicture:oncecustomersselectedsuppliersandexertedinfluenceonsupplies’environmentalstandards,thecustomer’sdisclosurepracticescanbebiasedinthesuppliers’environmentalperformance.Second,theanalysiscontributestothecorporatesocialresponsibilityliteratureongreenwashing(KimandLyon2011;LyonandMaxwell2011;LyonandMontgomery2015;Marquis,Toffel,andZhou2016;LiandWu2020)fromaninnovativenewangle,i.e.,thevoluntarydisclosureofsupplychains.Studiesongreenwashingprimarilyfocusonactionswithinthefirmsthemselves.Theanalysisinthischaptershowedthatinadditiontorepresentingthemselvesas“good,”firmsrepresentingtheirsupplychainsas“good”isacommonmethodofgreenwashing.Inaddition,theanalysisisthefirstempiricalstudytolinkresearchoncorporatesocialresponsibilitytothatonsupplychaininformationdisclosure,addingtotheverylimitednumberofempiricalstudiesonvoluntarysupplychaindisclosure.Ellis,Fee,andThomas(2012)reportthatsuppliers’disclosureoftheircustomerscomesataproprietarydisclosurecost,astheircompetitorsmaytakeadvantageofsuchinformation.Thisanalysisprovidesacontrastingperspectiveonthestrategicdisclosureofsupplychains,whichisthatcustomersarelikelytoselectivelydisclose“good”suppliersthatareenvironmentallyresponsible.GreenorGreenImage?SelectiveDisclosureofCorporateSuppliers47Intherestofthechapter,section2presentsbaselineempiricalresultsonsupplierenvironmentalratingsandcustomerdisclosure.Section3discussesmoderatingfactorsandsection4concludeswithdiscussionofimplications.4.2SelectiveDisclosureofGreenSuppliers4.2.1EmpiricalSpecificationandBaselineResultThebaselineregressionanalysisestimatesalinearprobabilitymodelinwhichthesupplierisvoluntarilydisclosedbythecustomer.Thelinearprobabilitymodelallowstheanalysistocontrolforanarrayoffixedeffects,whichensuresthatitcomparesthelikelihoodofbeingvoluntarilydisclosedfortwosupplierswithdifferentenvironmentalratings,withthecustomer,theyearofthesupplychainrelationship,andothercharacteristicsofthesuppliersthatcaninfluencecustomervoluntarydisclosureheldconstant.Themodelisasfollows:Discloseci,j,t=+Envscoresj,t,–1+sZsj,t+FE+i,j,t(1)whereDiscloseci,j,tisadummythatdenoteswhetherthesupplychainrelationshipisvoluntarilydisclosedbycustomerfirmiinyeart.ThemainexplanatoryvariablefocusedonisEnvscoresj,t,–1,whichisthelaggedvalueofenvironmentscoreinASSET4forsupplierjinyeart–1.AvectorofcontrolvariablesZsj,tincludessuppliercharacteristicsthatcapturetwochannelsthatpreviousstudiesonsupplychainvoluntarydisclosurefindtobeimportant:goodnewsbiasandproprietarycosts(Ellisetal.2012).Specifically,Zscomprisesize(Sizes),profitability(ROAs),marketvaluation(Tobin’sQs),andproportionofinstitutionalshareholding(InstOwns),allofwhichcapturethegoodnewsbiaschannel.Inaddition,thesupplier’sresearchanddevelopment(R&D)expendituresandtheindustrydisclosureratio(DisRatios)canserveasproxiesfortheproprietarycostchannel.Toensuretheestimatedinfluenceofsupplierenvironmentalratingsonthecustomer’svoluntarydisclosureisheldconstantgiventhecustomerandtheperios,theanalysiscontrolsforcustomerfirmandyearfixedeffects.Column(1)ofTable4.1showsestimatesofequation(1).Itfindsthatthesupplier’senvironmentscoreissignificantlypositivelyassociatedwiththeprobabilityofthecustomervoluntarilydisclosingthesupplier.ClimateChangeandClimateFinance48Inotherwords,customersselectivelydisclosesupplierswithhigherratingsforenvironmentalresponsibilityanddonotdisclosefewergreensuppliers.Toguardagainstthepossibilitythattheindustry,thecountry,orthecustomeritselfexperiencestrendsintheunconditionalprobabilityofvoluntarilydisclosingsuppliers,theanalysisprogressivelyaddsmorefixedeffects.Columns(2)–(4)considerthepossibilitythatthetimetrendsofcustomerdisclosurebehaviorsdifferintermsofcountryorindustryorthepair,countryandindustry.Thus,theanalysisaddscountry-yearfixedeffectsincolumn(2),industry–yearfixedeffectsincolumn(3),andcountry–industry–yearfixedeffectsincolumn(4).Incolumn(5),itfurtherconsidersthepossibilitythatacustomer’strendfortheunconditionalprobabilityofreportinganysuppliermaycorrelatewiththesupplier’senvironmentalratingsandaddcustomer-by-yearfixedeffects.Thatis,theanalysisestimatestheinfluenceofthesupplier’senvironmentalratingsontheprobabilityofthecustomervoluntarilydisclosingthesupplier,usingonlythecomparisonbetweensuppliersthattheanalysisobservesstrictlywithinthesameyearforthesamecustomer.Theresultsincolumns(2)–(5)ofTable4.1areconsistentlythesameasincolumn(1).Thecoefficientsarealmostthesameincolumns(1)–(4)andareonlyslightlysmallerincolumn(5).Theresultsincolumn(5)indicatethattheeffectofthesupplier’senvironmentalratingonthecustomer’svoluntarydisclosureiseconomicallysignificant:aone-standard-deviationincreaseinasupplier’senvironmentscorecorrespondstoa3.7%higherprobabilityofbeingdisclosedbythecustomer.Thedirectionofcoefficientsonthecontrolvariablesisconsistentwithexpectations.Highervaluesforthesupplier’ssize,returnonassets(ROA),institutionalownership,andTobin’sQincreasesthelikelihoodofthecustomerdisclosingthesupplier,indicatingthatcustomerstendtodisclosesupplierswithbetterperformance.SupplierswithhigherR&Dexpenditurearelesslikelytobedisclosed,indicatingthatcustomersaremoreinclinedtoconcealthesesuppliersastheymayincurhigherproprietarycostsiftheidentitiesofthesesupplychainpartnersaremadepublic.Asupplier’sindustrydisclosureratioispositivelyassociatedwiththelikelihoodofbeingdisclosedbytheirrespectivecustomers.Thissuggeststhatpeerinfluenceplaysaroleinvoluntarydisclosure.Evenaftercontrollingforthesenonenvironmentalsuppliercharacteristics,theanalysisfindssignificantselectivedisclosuresbasedonEnvscores.Thissuggeststhattheselectivedisclosureofgreensupplierscannotbeexplainedbyapreferenceforvariousobservablecharacteristicsofthesupplierfirm.Overall,theeconomicandstatisticalGreenorGreenImage?SelectiveDisclosureofCorporateSuppliers49Table4.1:MainResultsDependentVariableCustomerVoluntaryDisclosureofSupplier(Disclosec)(1)(2)(3)(4)(5)Envscores0.1330.1320.1330.1300.118(22.404)(22.309)(22.361)(21.672)(19.312)Sizes0.0990.0990.0990.0970.091(37.128)(37.130)(37.049)(36.064)(32.884)ROAs0.0060.0050.0060.0050.005(3.679)(3.190)(3.649)(3.452)(2.796)InstOwns0.0200.0210.0200.0210.021(9.854)(10.423)(10.067)(10.536)(10.121)R&Ds–0.005–0.004–0.005–0.004–0.004(–2.837)(–2.602)(–3.123)(–2.264)(–2.087)Tobin’sQs0.0150.0160.0160.0150.016(7.927)(8.257)(8.121)(7.719)(7.813)DisRatios0.0550.0540.0540.0520.048(27.142)(26.923)(26.259)(25.619)(22.529)Constant0.3650.3650.3650.3690.374(88.457)(88.878)(88.200)(89.350)(88.549)FixedeffectCustomerCustomerCustomerCustomerCustomerFirm+Firm+Firm+Firm+FirmYearCountryIndustryCountryYearYearYearIndustryYearObservations107,627107,627107,627107,627107,627R-squared0.6990.7030.7030.7190.748c=customer,Envscore=environmentscore,InstOwn=proportionofinstitutionalshareholding,DisRatio=industrydisclosureratio,R&D=researchanddevelopment,ROA=returnonassets,s=supplier,Tobin’sQ=marketvaluation.Note:Valuesinparenthesesrepresentt-statistics,whereasvalueswith,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Source:Shi,Wu,andZhang(2020).significanceoftherelationshipbetweenEnvscoresandwhetherthecustomervoluntarilydisclosesthesupplierisstableaftercontrollingforotherpotentialconsiderationsinvoluntarysupplychaindisclosure.Insum,theestimatesofequation(1)suggestthattheenvironmentalperformanceofsuppliersisindeedanimportantindependentconsiderationinthecustomerdisclosureofsupplychains.ClimateChangeandClimateFinance504.3FactorsDrivingtheSelectiveDisclosureofGreenSuppliers4.3.1CustomerFirmCharacteristicsasModeratingChannelsTheanalysisfirstinspectsthecustomerfirm’sinternalaspects,i.e.,firm-specificcharacteristics.Itfindsthatcustomersthatfacemorecompetitivepressure,caremoreaboutbrandimageandreputation,andareownedmorebyinstitutionalinvestorsaremorelikelytoselectivelydisclosetheirsuppliersdependingonthesupplier’senvironmentalrating.Column(1)showsthatcustomerfirmswithlowenvironmentscoresaremorelikelytoselectivelydisclosesuppliersbasedontheirenvironmentalratings.Thisisbecausefirmsthatarealreadylaggingbehindinenvironmentalperformancemayhavefewerresourcestoinvestincorporatesocialresponsibilityimprovementstotheirproductlifecyclesthaningreenwashing.Therefore,theypreferto“talkthewalk”asopposedtoactuallymakingchangestobecomemoreenvironmentallyfriendly.Column(2)inTable4.2showsthatfirmswithalowermarketsharearemorelikelytoselectivelydisclosesuppliersTable4.2:Moderator—CustomerFirmCharacteristicsDependentVariableCustomerVoluntaryDisclosureofSupplier(Disclosec)(1)(2)(3)(4)Envscores×Envscorec–0.054(–7.260)Envscores×MSc–0.012(–2.203)Envscores×SG&Ac0.018(2.899)Envscores×InstOwnc0.047(7.617)Envscores0.135(18.488)0.118(19.329)0.120(18.451)0.113(18.813)ControlYesYesYesYesFixedeffectCustomerFirmYearCustomerFirmYearCustomerFirmYearCustomerFirmYearObservations73,919107,62795,921107,627R-squared0.6590.7480.7460.749c=customer,Envscore=environmentscore,InstOwn=proportionofinstitutionalshareholding,MS=industrymarketshare,s=supplier,SG&A=selling,general,andadministrativeexpenses.Note:Valuesinparenthesesrepresentt-statistics,whereasvalueswith,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Source:Shi,Wu,andZhang(2020).GreenorGreenImage?SelectiveDisclosureofCorporateSuppliers51basedontheirenvironmentalratings.Therefore,firmsthatfacemorefiercecompetitionintheproductmarketmayalso“talkthewalk”more,i.e.,comparedwithfirmswithlargermarketshares,thosewithsmallermarketsharesdisplayastrongerpatternofselectivelydisclosinggreensuppliers.Flammer(2015)andAghionetal.(2020)suggestthatproductmarketcompetitionincreasesafirm’sengagementincorporatesocialresponsibility.However,thegreenwashingfindingsherereconcileconflictingevidenceinthecorporatesocialresponsibilityliterature,suchasDuanmu,Bu,andPittman(2018),whofindthatmarketcompetitionnegativelyaffectsafirm’senvironmentalperformance.Otherthandemonstratingarealcorporatesocialresponsibilityimpact,greenwashingservesasavisiblestrategybywhichtopresentanimageofbeinggreen,especiallyforfirmsthatfacefiercecompetition.ServaesandTamayo(2013)findthatcorporatesocialresponsibilityaffectsfirmvalueonlythroughitsinteractionwithadvertisingintensity.HarjotoandJo(2011)findthathighcorporatesocialresponsibilityfirmsonaveragespendmoreonadvertisingandhavealargershareofinstitutionalholding.Bardosetal.(2020)findthatcorporatesocialresponsibilitypositivelyimpactsproductmarketperception.Column(3)examinesafirm’sspendingonadvertising,asproxiedbyselling,general,andadministrativeexpenses.Itisfoundthatfirmswithmoreadvertisingspendingconductmoresupplychaingreenwashing.Thesefirmscaremoreaboutreputationandconsumerawareness(ServaesandTamayo2013)andthus,havemoreincentivetocreateabettercorporatesocialresponsibilityimagethroughthestrategicdisclosureofgreensuppliers.Inaddition,theanalysisfindsthatfirmswithmoreinstitutionalownershipperformmoresupplychaingreenwashing,asshownincolumn(4)inTable4.2.Itarguesthatinstitutionalinvestorscaremoreaboutportfoliofirms’corporatesocialresponsibility,duetopecuniaryandnonpecuniarymotivations(Flammer2015;Amiraslanietal.2017;HartzmarkandSussman2019;Kimetal.2019).However,aninformationasymmetrymayexistbetweenfirmsandinstitutionalinvestors.Oncethelow-corporatesocialresponsibilitysuppliersaredisclosed,thenewsspreadsquicklytoinvestors,andfirmswithhigherinstitutionalownershipreceivemoreseverepunishmentsfromtheirinstitutionalinvestors.Analternativeexplanationisthat,inreality,notallinstitutionalinvestorsmandatesincerecorporatesocialresponsibilityefforts.Someinstitutionalinvestorsareprofit-mongersandsupportgreenwashingstrategies.ClimateChangeandClimateFinance52Dycketal.(2019)andChoi,Gao,andJiang(2020)findthatthepresenceofinstitutionalinvestorsincreasesafirm’scorporatesocialresponsibilityperformance,butthatperformanceislowerwhentheinstitutionalinvestorsaredistractedandpaylittleattentiontoitsoperations.Inparticular,Choi,Gao,andJiang(2020)reviewtheliteratureoncorporatesocialresponsibilityperformanceandinstitutions’portfoliochoices,andproposetwohypotheses:(i)realeffort(hasaneffect),and(ii)catering(norealeffect).Theyfindevidencefor(i)butnotfor(ii).Incontrast,theresultsinthischapteraddevidencefor(ii);itshowsthatinstitutionalinvestorspartiallycatertoinvestorsbyholdingstocksthataremorelikelytoselectivelydisclosegreensuppliers.4.3.2PublicAwarenessofClimateChangeThisanalysisnextinspectstheroleofexternalattributesofcustomerfirms.Itfindsthatcustomersincountrieswithhigherpublicenvironmentalawarenessmayintensifytheirselectivedisclosureofgreensuppliersandselectivenondisclosureoflessgreensuppliers.Themechanismproposedhereisthatincreasedgeneralpublicawarenessofclimatechangeattractsmorestakeholderattentiontocorporateenvironmentalmanagement.However,thisgreaterawarenessmayalsoincreaseincentiveforacustomertomanageitsenvironmentalimagethroughtheselectivedisclosureandnondisclosureofsuppliers.Theanalysisfirstdirectlymeasuresthepublic’senvironmentalawarenessbasedonresponsesintheWorldValueSurvey.Thesurveyincludesnationallyrepresentativesurveysconductedinalmost100countries,whichaccountfornearly90%oftheworld’spopulation.Sevenwavesofthesurveywereconductedfrom1981to2020,witheachcross-sectionalwavetaking4–5yearstocompleteonaglobalscale.Theanalysishereusestheanswersfortheitem“takingcareoftheenvironment/caringfornatureisimportant”fromwave5(2005–2009)andwave6(2010–2014).Theanalysishereassigns1–6pointsfortheanswertomeasurethedegreetowhichrespondentsagreewiththisstatement,with1pointrepresentingmaximumdisagreementand6pointsrepresentingmaximumagreement.Itthenaveragesthescoreofeachrespondenttothecountrylevel,whichrepresentsthecountry-levelpublicawarenessofenvironmentalissues.Theresultsarereportedincolumn(1)inTable4.3.ThepositivecoefficientoftheinteractiontermbetweenSurveyAwarenesscandEnvscoresindicatesthatgreaterpublicattentiontotheenvironmentcorrespondstoahigherlikelihoodofafirmgreenwashingitsimage.GreenorGreenImage?SelectiveDisclosureofCorporateSuppliers53Toensurethatresultsusingthesurvey-basedmeasureofpublicenvironmentalawarenessarenotinfluencedbythe(in)frequencywithwhichthesurveysareconducted,thisanalysisfurtheremployswildfiresasashocktopublicawarenessofclimatechange.Theexogenousshockapproachdesignatestheoccurrenceofwildfiresasexternaltothefirmsandnotdirectlyrelatedtootherpotentialdriversofsupplychaindisclosures.However,theoccurrenceofwildfiresisrelatedtothestrengthoftheenvironmentalawarenessofthemarketandthepublicfacedbycustomers.Wildfireshavecausedparticularlyseveredamageinrecentdecades.Wildfiresaredrivenbyclimatechangeandhelppropelit.Publicawarenessofclimatechangeincreaseswhenpeopleabandontheirhousesduetowildfiresandseetheburnedforestsandscorchedanimals.TheanalysishereconstructsadummyWildFirec,whichequals1ifatleastonewildfireoccursinthecountry/stateinwhichthecustomerislocatedinagivenyear.1DataonwildfireeventsareobtainedfromtheEM-DATdatabase,whichrecordscoredisastersacrosstheworldfrom1990tothepresentday.Column(2)ofTable4.3reportstheresults.ThepositivecoefficientsoftheinteractiontermsbetweenEnvscoresandWildFirecindicatethatcustomersaremorelikelytogreenwashtheirimagesifwildfiresoccuraroundthefirms.1ForUSfirms,WildFirecequals1ifawildfireoccursinthestateinwhichthecustomerfirmislocated;fornon-USfirms,WildFirecequals1ifawildfireoccursinthecountryinwhichthecustomerfirmislocated.Table4.3:Moderator—PublicAwarenessandRegulationDependentVariableCustomerVoluntaryDisclosureofSupplier(Disclosec)(1)(2)(3)Envscores×SurveyAwarenessc0.014(2.207)Envscores×WildFirec0.037(2.509)Envscores×Regulationc-0.029(-2.071)Envscores0.1220.1130.142(16.992)(17.897)(10.488)ControlsYesYesYesFixedeffectCustomerFirmYearCustomerFirmYearCustomerFirmYearObservations83,572107,627107,627R-squared0.7440.7480.748c=customer,Envscore=environmentscore,s=supplier.Note:Valuesinparenthesesrepresentt-statistics,whereasvalueswith,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Source:Shietal.2023.ClimateChangeandClimateFinance544.3.3GovernmentRegulationandSupplyChainGreenwashingThusfar,allofthemoderatorsanalyzedcomplementthemainresults.Howcansupplychaingreenwashingbestopped?Thissectionidentifiesonefactorthatmitigatesgreenwashingbehavior.Usingcountry-levelgovernmentregulatorypolicyimplementation,theanalysisfindsthatinformationtransparencyreducesgreenwashingbehavior,assuchcorporatesocialresponsibilitymimickingbehaviorgainsfewerrewardswhenthemarketismoretransparentintermsofinformation.Theanalysiscollectsacomprehensivesampleofsignificantchangestomandatoryenvironmentreportingrequirementsaroundtheworld.ThemaindatasourceforenvironmentalreportingregulationsistheCarrots&Sticks,awebsitethatcollectssustainabilityregulationsworldwide.Althoughnoneofthereportingregulationsclearlydemandthatfirmsmustdisclosetheirsupplierlists,itisreasonabletobelievethatinformationtransparencyregardingcorporatesocialresponsibilityincreasedtosomeextentaftertheregulationswereimplemented.Theanalysisconstructsadummythatequals1ifmandatoryreportingrequirementsareineffectandtheninteractsthedummyvariablewiththesupplierenvironmentscore.Theresultsareshownincolumn(3)ofTable4.3.Itagainusesthemoststringentcustomer-by-yearfixedeffects.ThenegativecoefficientsoftheinteractionterminTable4.3indicatethatsupplychaingreenwashingreducesaftertheimplementationofmandatorydisclosureandreportingpolicies.Countrieswithtightcorporatesocialresponsibilityenforcementshavelessroomforgreenwashing,whichagreeswiththetheoreticalpredictionsmadebyWu,Zhang,andXie(2020).4.4ConclusionAlthoughcorporatesocialresponsibilityhasbecomeahighpriorityforcompanies,withincreasingrecognitionofitsbusiness-relatedbenefits,theprevalenceofgreenwashinghasskyrocketedinrecentyears.Thisstudyinvestigatescorporatesocialresponsibilityinthesettingofvoluntarysupplychaindisclosure.Ituncoversrobustempiricalevidenceshowingthatlistedfirmsselectivelydiscloseenvironmentallyfriendlysupplierswhileselectivelynotdisclosingsupplierswithpoorenvironmentalperformance.Thatis,theyconductsupplychaingreenwashing.Thisisaprevalentbehaviorinthesampleofcountriesstudiedinthisanalysis.GreenorGreenImage?SelectiveDisclosureofCorporateSuppliers55Factorsareidentifiedthatcanmoderateselectivedisclosureofsuppliersbythesupplier’senvironmentalrating.Infirm-specificattributes,itisfoundthatcustomerfirmsthatfacemorecompetitivepressure,caremoreaboutbrandimageandreputation,andhavelargersharesofinstitutionalholdingsaremorelikelytoconductsuchselectivedisclosure.Theanalysisadoptsvariationsinthepublicawarenessofclimatechangefromworldwidesurveysandtheoccurrenceofwildfirestoshowthatpublicconcernsaboutclimatechangedoinfactinducelistedfirmstoselectivelydisclosemoreaggressively.Usingcountry-levelregulatorypolicyimplementations,theanalysisfindsthatinformationtransparencyreducessuchbehavior.Thefindingshaveimplicationsforfinancialmarketsandsocialwelfareinunderstandingthegreenpracticesoflistedfirms.Consumersandinvestorsshouldbecomemoreknowledgeableandpayattentiontolistedfirms’strategicdisclosuresintheircorporatesocialresponsibilityimage.Supposeconsumersandinvestorsdonotbecomesavvyenoughtodetectgreenwashing.Inthatcase,companiesthatactuallyhavesuperiorenvironmentalperformanceinthesupplychainmaynotreceivefairrecognition.Thefindingsherearealsorelevanttogovernmentregulatorsandnongovernmentorganizations.Countriesaroundtheworldhaveimplementedvariousregulationsonenvironmentalresponsibility,whichusuallyfocusdirectlyonfocalfirms’behaviors,butpaylessattentiontotheirsuppliers.Therefore,fromtheperspectiveoffirms’environmentalfootprint,regulationsthataimtoincreasetransparencyinthefirm’ssupplychainnetworkshouldbestrengthened.ClimateChangeandClimateFinance56ReferencesAghion,P.,R.Bénabou,R.Martin,andA.Roulet.2020.EnvironmentalPreferencesand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xploredtopicsrelatedtocorporatesocialresponsibility(CSR)—particularlywithinthecontextoftheSustainableDevelopmentGoals—includingitsimpactonfirms’performance,theevidenceismixedandinconclusive.1Further,evenastheresearchfocusingonCSRhasincreased,arelativelysmallnumberofstudieshaveinvestigated“corporatesocialirresponsibility”(CSI).Yet,CSRandCSImayexistsimultaneouslyandhavedistincteconomicconsequencesonfirms.ThischapterfirstdiscussesthecoexistenceofCSRandCSIthenexpoundsontheirdifferenteconomicconsequences.ItanalyzesfactorsthataffecttheeconomicconsequencesofCSRandCSI,summarizesrelevantregulationsandlegislation,anddetailsthepolicyimplicationsofCSRandCSI.Asgovernmentsandwidercivilsocietyhavegrownmoreawareofenvironmentalandsocialissues,thepublictoohasstartedtoemphasizeandexpectcompaniestoplayaroleassocialcitizens.ThishasfueledinterestinCSRinacademia,inpractice,andfrompolicymakers.1AchievingsustainabledevelopmentisaprimarygoaloftheUnitedNations.InSeptember2015,UNmemberstatesadoptedthe2030AgendaforSustainableDevelopment,withits17goals.Theagendarecognizesthecriticalimportanceofenvironmentalandsocialissues,suchasendingpoverty,improvinghealthandeducation,reducinginequality,andtacklingclimatechange.61TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplications5.2CoexistenceofCorporateSocialResponsibilityandCorporateSocialIrresponsibilityCSRandCSIcoexist,accordingtoconsiderableevidence.Forinstance,Siemens,aGermanmultinationalconglomeratecorporation,operatedwithhighsocialandenvironmentalstandardsbutwasfoundguiltyofbriberybytheUnitedStates(US)CorruptForeignPracticesActinDecember2008.AnotherGermancompany,theautomakerVolkswagenGroup,claimedtobea“corporatecitizen,”andheldaleadingpositioninvariousinternationalCSRindexes(RieraandIborra2017).DespitethisoutstandingperformanceinCSR,theUSEnvironmentalProtectionAgencyinSeptember2015accusedthecompanyofcheatingontheemissionstestbyinstallinga“defeatdevice”indieselenginestodeflatethereportedlevelofexcessivecarbondioxideemissions.Thesetwoscandalsresultedinsignificantreputationallossesand,relatedly,severeunfavorableeconomicconsequencesforthefirms.ExtantstudiesfurthersuggestthatafirmcanhaveastrongCSRperformanceinonedimensionofCSRoronegeographiclocationbutcommitsocialmisconductinanotherdimensionorgeographiclocation(Strike,Gao,andBansal2006;HerzigandMoon2013;Keig,Brouthers,andMarshall2015).ResearchersfurtherexploretheseseeminglycontradictorybehaviorsoffirmsandproposeacausalrelationshipbetweenCSRandCSI.CSRengagementcanbeusedasavehicletooffsetafirm’spastsociallyirresponsiblebehaviors.2Inthisregard,firmsthatbehavemoresociallyirresponsiblywillinvestmoreinCSRtorebuildtheirreputationorconcealunethicalbehavior.CSRcanalsoactasinsuranceagainstfutureCSIandalleviatethepotentiallossesstemmingfromCSI(Godfrey,Merrill,andHansen2009;MinorandMorgan2011).KleinandDawar(2004)findthatgoodCSRperformancewillmitigatethenegativebrandevaluationofconsumersinthecaseofaproduct-harmcrisis.Flammer(2013)demonstratesthatfirmsthatenjoyhigherenvironmentalCSRwillexperiencelighteradversestockmarketreactiontoecologicallyharmfulevents.2Forexample,seeMullerandKräussl2011;KotchenandMoon2012;Kang,Germann,andGrewal(2016);Lenz,Wetzel,andHammerschmidt(2017);RaghunandanandRajgopal(2022);Chen,He,andKrishnan(2023).ClimateChangeandClimateFinance625.3EconomicConsequencesofCorporateSocialResponsibilityandCorporateSocialIrresponsibility5.3.1CorporateSocialResponsibilityFrompolitical,economic,andsocietalexpectations,thereislittledoubtthatfirmsshouldtakeresponsibilityfortheirimpactonsocietyandtheenvironment.However,therehasbeenconsiderabledebatewhetherCSRbehaviorsviolatemaximizationofshareholderwealth(Karnani2011).Conventionalwisdomarguesthatthepriorityofafirmistogenerateprofitsforitsshareholders.UsinglimitedcorporateresourcestoperformCSRactivitieswillgenerateunnecessarycostsandsiphonofftheresourcesthatcanbeinvestedinvalue-enhancinginvestmentoroperationactivities(Friedman1970;BrammerandMillington2008).Inthesamevein,evenifafirmhastheresources,itshoulddistributemoredividendstoshareholdersratherthandevoteitselftoCSRactivities.ThisisbecauseinvolvementinCSRimpliesatransferofwealthfromthecompany’sownerstoathirdpartywithoutrightfulclaims.Further,involvementinCSRactivitiescanbetime-consuming.ManagersemphasizingCSRperformancetoomuchmayoverlooktheirprimarymanagementresponsibilitiesandprofitable-investmentopportunities.ThisinefficientresourceallocationismoreevidentwhenmanagersuseCSRengagementtoburnishtheirreputation3ortoconcealcorporatewrongdoing(HemingwayandMaclagan2004;KotchenandMoon2012).However,althoughenactingCSRactivitiesiscostly,substantialevidencehasfoundthatCSRactivitiescanbringmyriadbenefitstoafirminvariousfacets.First,goodCSRperformancecanenhancecorporatereputationandstrengthentherelationshipwithstakeholders(Sen,Bhattacharya,andKorschun2006).Corporatereputationisanessentialintangibleassetconducivetoafirm’scompetitiveadvantages.AgoodreputationduetoCSRsignalsfirmabilityandcommitmenttoworkintheinterestofstakeholdersandincreasesitscreditworthiness,contributingtoitssocietallegitimacyandasolidcontractualrelationshiportacitagreementwithitsstakeholders(ChoiandWang2009;Caoetal.2015).Stakeholders,inturn,willhavemorefavorableattitudestowardthefirmandbemoreinclinedtosupplytheirresources(Frooman1999;Backhaus,Stone,andHeiner2002).3Forexample,seeHaley(1991);Galaskiewicz(1997);Cennamo,Berrone,andGomez-Mejia(2009);andBarneaandRubin(2010).63TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplicationsEmployeesarethemostcriticalinternalstakeholdersforafirm,andtheirattitudestowardCSRengagementwouldsignificantlyaffecttheirworkperformanceandevenemployeeretention.ExtantresearchrevealsthatastrongcommitmenttoCSRshowcasesaprosocialfirmculture(CollierandEsteban2007;LinnenlueckeandGriffiths2010)andproducesasenseofmeaningfulness(BaumanandSkitka2012;Grant2012)thatincreasesemployees’commitment,4jobsatisfaction(ValentineandFleischman2008),andidentificationwiththefirm(Berger,Cunningham,andDrumwright2006;RodrigoandArenas2008;Kimetal.2010).Thesepositiveemployeeworkattitudeswillimproveproductivityandcreatepositiveword-of-mouthforafirmasagoodemployer.Thiswill,inturn,attractandretainmoretalentedemployees.5Customersandsuppliersaretwoexternalstakeholdersthatsignificantlyimpactcorporateperformance.PriorstudiesindicatethatfirmswithhigherCSRperformancecanreapeconomicbenefitsfromcustomersandsuppliers.CSRinitiativesportrayapositivecorporateimageamongcustomers,fosteringloyaltytotheproducts/servicesofafirmandincreasingtheirwillingnesstopayahigherpriceandresistothernegativenewsaboutthefirm.6Theseincreasedbrandvalueandcustomersatisfactionfurtherprovokepositiveword-of-mouthamongcustomers,raisetheiractiveadvocacybehavior,andenablethefirmtodifferentiateitselffromitscompetitors.Inthelongrun,firmsalesandprofitabilitywillincrease(Bloometal.2006;Lev,Petrovits,andRadhakrishnan2010).Further,goodCSRperformancehelpsafirmmaintainasolidrelationshipwithitssuppliersandtherebyattractmoretradecreditfromthem(Zhangetal.2014;Xu,Wu,andDao2020).Second,goodrelationshipswithbroadstakeholdersfacilitateinformationcommunicationbetweenafirmanditsstakeholdersandenablethefirmtoderivemoreexternalknowledge(Jansen,VanDenBosch,andVolberda2006),spurringitsinnovationpotential(LuoandDu2015).Fromanotherperspective,bettercommunicationbetweeninsidersandoutsidersreducesinformationasymmetry,mitigatingconflictofinterestbetweenmanagersandstakeholders(JoandHarjoto2011,2012;Cui,Jo,andNa2018).4SeePeterson(2004);Ruppetal.(2006);Brammer,Millington,andRayton(2007);andCollierandEsteban(2007).5SeeGreeningandTurban(2000);Bhattacharya,Sen,andKorschun(2008);Hansenetal.(2011);andCarnahan,Kryscynski,andOlson(2017).6SeeLuoandBhattacharya(2006);Du,Bhattacharya,andSen(2007);Lev,Petrovits,andRadhakrishnan(2010);andIglesiasetal.(2020).ClimateChangeandClimateFinance64Third,firmsbehavingsociallyresponsiblyaremorelikelytorealizecapitalmarketbenefits,includinglowercostofcapitalandbetterdebtcovenantswithcreditors.Thecostofcapitalistherequiredrateofreturnbasedoncapitalproviders’perceptionofafirm’sfinancialperformanceandrisks.Abetter(lower)financialperformance(risk)isinstrumentalinloweringthecostofcapital.NumerousstudiesdocumentapositiveassociationbetweenCSRandfinancialperformancethatisproxiedbyaccountingratiossuchasreturnonassetsandreturnonequity(WangandQian2011).Meanwhile,researchersdemonstratethatCSRactivitieswillreducefirms’riskincludinginvestment,operational,financial,andinformationrisks.7InvestorswhoperceivebetterfinancialperformanceandlowerriskasaresultofCSRparticipationwillchargelowercostsforprovidingcapitaltothefirm.8Overall,contributingtoCSRinvolvesbotheconomiccostsandbenefitsforafirm.Onthisaccount,whetherandtowhatextentCSRwillultimatelyinfluencefirmvaluerestsonthetrade-offbetweenthecostsandbenefitsofpursuingCSR.ExistingliteratureprovidesconflictingevidenceontheimpactofCSRengagementonfirmvalue.Ontheonehand,somestudiesshowthatfirmsexecutingCSRinitiativeswillhavehigherfirmvalue.9Ontheotherhand,someresearcharguesthatCSRactivitieshavenegativeornoinfluenceoncorporatefinancialperformanceandfirmvalue(Brammer,Brooks,andPavelin2006;NellingandWebb2009;Crisóstomo,deSouzaFreire,anddeVasconcellos2011).SomeevidenceindicatesthatthepositiveimpactofCSRonfirmvalueonlyexistsinsomeconditions,withoutwhichthereisno,orevenanegative,relationshipbetweenCSRandfirmvalue.Forexample,ServaesandTamayo(2013)findthatthevalue-enhancingroleofCSRonlyexistsforfirmswithhighcustomerawareness(i.e.,brandorfirmvisibility),whereastherelationshipbetweenCSRandfirmvalueiseithernegativeorinsignificantforfirmswithlowcustomerawareness.ArouriandPijourlet(2017)findthatahighCSRratingresultsinahighervalueofcashholdingsonlyforfirmsoperatingincountrieswhereshareholdersarewellprotectedfromexpropriationbymanagersandincountrieswheretheinstitutionalandregulatoryqualityishigh.Buchanan,Cao,andChen(2018)findthat7SeeBoutin-DufresneandSavaria(2004);LeeandFaff(2009);HongandAndersen(2011);Kim,Park,andWier(2012);Oikonomou,Brooks,andPavelin(2012);MishraandModi(2013);Kim,Li,andLi(2014);SunandCui(2014);Bozzolanetal.(2015);Shahrour,Girerd-Potin,andTaramasco(2021);andShihetal.(2021).8SeeSharfmanandFernando(2008);ElGhouletal.(2011);GossandRoberts(2011);YeandZhang(2011);Chava(2014);Oikonomou,Brooks,andPavelin(2014);GeandLiu(2015);ShiandSun(2015);andLin,Servaes,andTamayo(2017).9SeeGuensteretal.(2011);JoandHarjoto(2011);KimandStatman(2012);GregoryandWhittaker(2013);Gregory,Tharyan,andWhittaker(2014);andLin,Servaes,andTamayo(2017).65TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplicationsfirmswithhighCSR-investmentintensityexperiencemorelossinfirmvalueduringfinancialcrisis,whilethesefirmshavehighervaluebeforeacrisis.ThisconflictingevidencemaybeattributedtothefactthatCSRdoesnotalwaysbringbenefitsthatoutstriptheassociatedcoststoallfirms.Section4detailscountry-,industry-,andfirm-levelcharacteristicsthataffectthebenefitsascomparedwiththecostsofCSR.5.3.2EconomicConsequencesofCorporateSocialIrresponsibilityCSIactivitiesrefertoeitherintentionalorunintentionalactivitiesofafirm.Inmostscenarios,firmssociallymisbehaving,suchaspollution,childlabor,andbribery,haveobjectivestoreducecostsandincreaseprofits.NotwithstandingthepotentialofintentionalCSItocreatepositiveramificationsforthefirm,itmaybemoredetrimentalforthefirmoncetheCSIisdiscoveredbystakeholders.Whenregulatorsuncovercorporatemisbehaviorinrelationtoenvironmental,social,andgovernanceaspects,thismayresultinlawsuitsthatmaytakeyearstosettleandwouldposesubstantiallitigationcosts,regulatoryfines,reputationalharm,andotherexpensesonthefirm.Forinstance,Siemenspaidaround$1.6billionbyDecember2008toresolvecorruption-relatedcharges;10BritishPetroleumpaidabout$65billionbyJanuary2018tocoverenvironmentalcleanup,compensation,andpenaltiesfortheDeepwaterHorizonoilspillin2010(Vaughan2022).Thispendinglitigationandassociatedexpensesbringshugereputationallossesanduncertaintytothefirm’sfutureperformance.Besidestheprecedingcosts,CSIdestroysfirmvalueanddiminishesthecompetitiveadvantagesofafirmbyerodingitsrelationshipwithstakeholders.Ampleresearchevidencerevealsstakeholders’negativeattitudestoward,andstrongintentstopunish,unethicalandsociallyirresponsiblefirms.11Consumersareinclinedtostopbuyingproductsorservicesfromafirmthatbehavesinasociallyirresponsiblemannerandtospreadnegativeword-of-mouthtoarangeofacquaintancestoboycottthefirm’sproductsorservices(BraunsbergerandBuckler2011).Inaddition,CSIbehaviorsalsoelicitemployeeanger,resulting10InformationobtainedfromtheUSSecuritiesandExchangeCommission.https://www.sec.gov/news/press/2008/2008–294.htm(accessed20December2022).11Forexample,seeLindenmeier,Schleer,andPricl(2012);Grappi,Romani,andBagozzi(2013);Sweetinetal.(2013);Xie,Bagozzi,andGronhaug(2015);AntonettiandMaklan(2016);andXieandBagozzi(2019).ClimateChangeandClimateFinance66innegativeword-of-mouthamongthem(HericherandBridoux2022).Thesepotentialstakeholdersanctionsorboycottssignificantlylimittheabilityofafirmtoachievesatisfactoryfinancialoutcomes.Inlinewiththisargument,priorresearchprovidesempiricalevidencethatCSIisnegatively(positively)relatedtofinancialperformance(risk).125.3.3ComparingtheEconomicConsequencesofCorporateSocialResponsibilityandCorporateSocialIrresponsibilityTheimpactofCSRandCSIvariesindirection,magnitude,andduration.StakeholdersmaynotrequireallfirmstoparticipateinCSRactivitiesproactively,buttheyaremoresensitivetoanyCSIissuethatharmstheirinterests(Foreman2011;Barnett2014;Kölbel,Busch,andJancso2017).Soanasymmetryexistsofstakeholders’reactionstogoodversusbadnewsassociatedwithCSRversusCSIbehavior.Inparticular,giventhatsomefirms—suchasfinanciallyconstrainedandstart-upcompanies—cannotaffordtobesociallyresponsible.Thisisbasedontheircapacitiesandavailableresourcesandstakeholderexpectations,andtheattentiontotheCSRperformanceofthesefirmsmayberelativelylow.However,allfirmsareexpectedtoavoidtakingsociallyirresponsibleactions.ThisdifferenceintheemphasesonCSIascomparedwithCSRbystakeholdersmayresultinstrongerstakeholders’negativereactionstoCSIscandals,includingmoreseverepunishmentforCSI,comparedwiththepositiverewardsforCSR.Indeed,somestudiescorroboratethatCSIhasagreatereffectoncorporateperformanceandriskthanCSR.13Hawn(2021)findsthatmediacoverageofCSRhasnoimpactonthefirms’cross-borderacquisitions,whilemediacoverageofCSIimpedesthecompletionofsuchacquisitions.Lietal.(2021)showthatprovidingCSRdisclosuresinthemanagementdiscussionandanalysissectionofannualreportsdoesnotincreasethevalueoffirmswithgoodCSRperformancebutdoesdecreasethevalueoffirmswithhighESGconcerns.CSRandCSIaffectcorporatereputationandthefirm’srelationshipwithitsstakeholdersandtherebyinfluencefirmperformanceandfirmvalue.Nevertheless,itoftentakesalongperiodforafirmtoestablishagoodreputationviaCSRactivities.Incontrast,corporatereputationcouldbequicklyruinedbyCSIscandalsoncediscoveredinthepublicarena.12SeeGuptaandGoldar(2005);Karpoff,Lott,andWehrly(2005);Oikonomou,Brooks,andPavelin(2012);MishraandModi(2013);Kölbel,Busch,andJancso(2017);andHarjoto,Hoepner,andLie(2021).13Forexample,seeChava(2014);GossandRoberts(2011);Jayachandran,Kalaignanam,andEilert(2013);andOikonomou,Brooks,andPavelin(2014).67TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplications5.4CharacteristicsThatAffecttheBenefitsversustheCostsofCorporateSocialResponsibilityandCorporateSocialIrresponsibilityAstheeconomicramificationsofCSRandCSIareinconclusive,itisofgreatimportancetounderstandthemajorfactorsthatwouldaffectthebenefitsinrelationtothecostsofCSRandCSI.5.4.1Country-LevelCharacteristicsFirmsincountrieswithdiversecultures,economicconditions,institutionalenvironments,etc.mayhavedistinctlevelsofbenefitsandcostsofCSRandCSI(DohandGuay2006;WangandQian2011;Wang,Dou,andJia2016).Therationalesbehindthisnotionaremultifaceted.Firstisrelatedtostakeholders’differentialperceptionsofCSRinrelationtoCSI,whichplayacrucialroleinshapingtheireconomicconsequencesonfirms.Stakeholderswithhighlevelsofsocialconcernswillexpectfirmstotakemoreresponsibilityinsociety.Consequently,theywillvalue(punish)thefirmwithbetterCSRperformance(worseCSIbehaviors)toalargerextent.Stakeholders’attitudestowardCSRandCSIarerootedinthecultureofacountryandtherebyvarysignificantlyacrosscountries(Husted2005;WilliamsandZinkin2008).Comparedwithpeoplelivingindevelopedcountries,citizensofdevelopingcountriesaregenerallylesssensitivetoCSRbehaviors(XuandYang2010).Customersindevelopingeconomies,asanillustration,caremoreaboutthepriceandqualityofaproductandaremoreunawareofCSR(ChouandChen2004;ArliandLasmono2010).Apartfromthedivergenceofstakeholders’views,theinstitutionalvariationsinthecross-nationalcontextcanalsoexplainthedifferenteconomicconsequencesofCSRandCSIindifferentcountries.Developedmarketsusuallyhavewell-established“rewardandpunishment”policies,asexemplifiedbytaxrelieftoencouragefirmstopursueCSRandbyhugepenaltiestodeterCSI.Insuchascenario,firmsmaygainbenefitsfromCSRthatoutweightheassociatedcostsandwouldsuffersubstantialreputationalandlegallossesduetoCSI.Conversely,inalooseandineffectiveinstitutionalsystem,boththedegreeofregulatorysanctionscausedbyCSIandtheeconomicbenefitslinkedtoCSRarelower.Hence,sociallyconsciousfirmsunderthisinstitutionalsystemmayfindthecostsofCSRoutweighthebenefits,whilefirmsactinginasociallyirresponsiblewaywillnotexperiencenegativeeconomicconsequences.Furthermore,developedcountrieswithmatureClimateChangeandClimateFinance68capitalmarketshavemoreprofessionalinstitutionalinvestors.ExistingstudiesshowthatinstitutionalinvestorsaremorepositivetowardsocialcapitalandthusareinclinedtoinvestinfirmspursuingCSR.14Therefore,CSRactivitiesarelikelytobebetterrecognizedbyinvestorsindevelopedcountries,soitismorelikelytoseethevalue-enhancing(value-destroying)roleofCSR(CSI)indevelopedeconomies.TheeconomicconsequencesofCSRorCSIarealsocontingentonhowwellstakeholdersareawareoftheCSRandCSIactivitiesandperformanceoffirms.15OnlytheinformedstakeholderscanrespondappropriatelytoCSRandCSI.Inotherwords,ahighlevelofstakeholderawarenessgivesrisetogreatereconomicbenefits(sanctions)towardCSR(CSI).Developedmarketsprovidediverseinformationchannelsandeffectivemarketsupervision.Hence,firmsoperatingindevelopedcountriesaremorevisibleandtransparenttostakeholdersthanthoseindevelopingcountries,facilitatingthegreaterflowofinformationamongstockmarketparticipants.Inthissense,thepositive(negative)associationbetweenCSR(CSI)andcorporatefinancialperformanceismoreevidentforfirmsindevelopedmarkets(Wang,Dou,andJia2016).Someotherstudiesalsoprovideevidenceofhowdifferentcountry-levelcharacteristicsaffecttheeconomicconsequencesofCSRandCSI.Breueretal.(2018)showthatthelevelofinvestorprotectioninacountrywilldeterminehowCSRaffectsthecostofequityofafirm.Incountrieswithahigher(lower)levelofinvestorprotectionthatsafeguardstheshareholdersagainstexpropriationbyinsiders,CSRreduces(increases)thecostofequity.Chang,Shim,andYi(2019)illuminatetheroleofcountry-levelmediafreedomintherelationshipbetweenCSRandfirmvalue,andspecificallythatCSRispositivelyassociatedwiththefinancialperformanceoffirmsincountrieswithfullmediafreedombutisnegativelyorinsignificantlyassociatedwiththecorporateperformanceincountrieswithpartialornomediafreedom.Sampath,Gardberg,andRahman(2018)elucidatethatfirmsengaginginbriberyinalesscorruptcountryhavegreatermarketpenalties.Harjoto,Hoepner,andLie(2021)findthatthenegativeimpactofCSIonfirmsislargerforcivillawcountriesandfornationswithhigherinstitutionaltrustandhigherconfidenceincorporations.14SeeGravesandWaddock(1994);Wang,Choi,andLi(2008);PetersenandVredenburg(2009);andZhang,Xie,andXu(2016).15SeeMcWilliamsandSiegel(2001);SchulerandCording(2006);Du,Bhattacharya,andSen(2010);ServaesandTamayo(2013);andDycketal.(2019).69TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplications5.4.2Industry-LevelCharacteristicsStakeholdershavedifferentexpectationsofCSRengagementforfirmsindifferentindustries,soindustry-levelcharacteristicsmayaffecttheeconomicconsequencesofCSRorCSI.Forinstance,firmsin“sin”industries,whichrelatetotobacco,alcohol,gambling,firearms,military,andnuclearpower,amongothers,areconsidered“harmful”tosocietyandreceivenegativeattitudesfromstakeholdersbecausethesefirmsprovideproducts/servicesthatdonotconformtosocialnorms.Sociallyconsciousinvestorsorinvestorsunderhighregulatoryandpublicscrutinytendtoavoidinvestinginfirmsoperatinginsuchindustries(HongandKacperczyk2009;Fu,Lin,andZhang2020).Itisthusofgreaterimportanceforfirmsinsinindustries,relativetothoseinotherindustries,tostrengthentheirreputationamongstakeholders.CSRengagementisagoodmeanstoachieveso.PriorstudiesfindthatengagementinCSRreducesfirmriskandincreasesfirmvalueinsinindustries(Cai,Jo,andPan2012;JoandNa2012),andtherisk-reductioneffectismorepronounced,botheconomicallyandstatistically,forfirmsinsinindustriescomparedtothoseinotherindustries(JoandNa2012).Someotherstudiesalsoprovideevidencethatindustry-levelcharacteristicsshapetheeconomicconsequencesofCSRandCSI.Forexample,Lenz,Wetzel,andHammerschmidt(2017)proposethatafirmwithCSRrecordsinadomainwhereitalsoperformssociallyirresponsiblywillbeperceivedasinsincere,significantlydamagingfirmvalue.Yet,forfirmsinindustrieswithahighlevelofCSI,thisvalue-destroyingeffectisattenuated,asstakeholdersmayinterpretthisinconsistentbehavioroffirms(i.e.,engaginginCSRandCSIsimultaneouslyinonedomain)asactivecorporateresponsestothenegativeimpactoftheindustriallyunavoidableCSIratherthanalackofmorality.SunandDing(2021)documentthatthenegativeimpactofCSIonfirmvaluepersistslongerandisstrongerforfirmsinindustrieswithhighlevelsofbusinessuncertaintyorcompetition.5.4.3Firm-LevelCharacteristicsFirmcharacteristicsreflectthecapabilitiesandresourcesofafirm,sostakeholders’expectationsofCSRorCSIalsovaryfromfirmtofirm.Assuch,firmsoperatinginthesameindustryandinthesamecountrymaybesubjecttodifferenteconomicconsequencesofCSRandCSI.Researchonthemoderatingeffectoffirm-levelcharacteristicsontheassociationbetweenCSR/CSIandfirmperformanceseemslimited.Theopinioninthischapteristhattherearethreemainfirm-leveldeterminantsofCSR/CSI.ClimateChangeandClimateFinance70Visibility.CorporatevisibilityistheprerequisiteforfirmstobenefitfromCSRendeavorsandreceivepunishmentsasaresultofCSI.Ahigherlevelofcorporatevisibilitywillheightenstakeholders’awarenessofCSR/CSIandprompttheirreactionstothiscorporatebehaviortoalargerextent.Therefore,visibilityshouldincreasethebenefitsorpenaltiestoafirmforpursuingCSRorCSIactivities.Firmswithconsiderableinvestmentsinadvertisingaremorelikelytobeseenandfollowedbyvariousstakeholders.Agreatdealofliteraturehasprovedthatfirmswithhigheradvertisingintensitywillattractmoreattentionfromstakeholders,andconsequently,CSR/CSI,ifany,willinducemorepronouncedeconomicbenefitsorpenaltiesforthesefirms(e.g.,WangandQian2011).Firmsize.Largerfirmstendtohavemoreresources(Gupta,Raj,andWilemon1986).Hence,theyareabletoinvestmoreinprojectswithuncertainfuturereturnsandlongpaybackperiods,suchasCSR-relatedprojectswhichstrengthenfirmperformanceinthelongrun(vanBeurdenandGössling2008;AguinisandGlavas2012).Ontheotherhand,largerfirmsaremorevisibletothemarket,andthusmorelikelytoattractstakeholders’attentionandreactiontotheirbehaviors.Inthisregard,theeconomicconsequencesofCSRandCSIaremorepronouncedforlargerfirms.Financialhealth.Financialconstraintswillrestrictmanagers’discretionaryinvestmentinCSR.Inthiscircumstance,stakeholdersmayunderstandthatthefirm’slimitedresourcesshouldbeprimarilyappliedtothecorebusinessactivitiesratherthanthepursuitofCSR.Assuch,stakeholdersmaynotexpectfinanciallyconstrainedfirmstoperforminasociallyresponsiblewayandwillbelessinterestedintheirCSRperformance.Conversely,financiallyhealthyfirmsnotconstrainedintheirfinancialabilitytopursueCSRwillenjoymorebenefitsfromtheirCSRinvestment,asitwilllikelybemorerecognizedandexpectedbystakeholders(WangandQian2011).5.5RegulationsandLegislationofCorporateSocialResponsibilityandCorporateSocialIrresponsibilityandItsPolicyImplicationsCorporatesocialresponsibilityisgenerallyavoluntaryinitiativeratherthanalegalmandateinmostcountriesworldwide(Lin2021).Yet,withtheincreasingimportanceandexpectationsattachedtofirms’roleinservingsociety,agrowingnumberofcountrieshaveenforcedlegislationthatexplicitlyrequires71TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplicationsfirmstocarryoutCSR.Againstthisbackdrop,MauritiusisapioneerinlegallymandatingfirmstodevoteaspecificamounttoCSR.Sinceindependencein1968,Mauritiushaslongbeenplaguedbypovertyandinequality.Therefore,itisimperativetoappealtocorporatecontributioninCSRactivitiesforMauritius.In2009,theGovernmentofMauritiusamended“TheIncomeTaxActof1995”andreleased“TheFinance(MiscellaneousProvisions)Bill(No.XVIof2009),”whichcompelsallprofitablefirmstosetupaCSRfundthataccountsfor2%oftheirprecedingyear’sbookprofits.16Accordingtothecurrentregulation,atleast75%ofthisCSRfundshouldberemittedtotheMinistryofFinance.ThentheNationalSocialInclusionFoundationwillallocatethisremittedmoneytoCSR-relatednationalschemes,suchaspovertyreduction,educationalsupport,andenvironmentalprotection.ThecompanycanusetheremainingCSRfundtoimplementaCSRprogramorlendfinancialsupporttoanongovernmentalorganizationimplementingaCSRprograminthepriorityareasofgovernmentalinterventionasspecifiedinthe10thScheduleofIncomeTaxAct(MauritiusRevenueAuthority2021).17InAugust2013,IndiapassedamandatoryCSRlaw,Section135oftheCompaniesActformulatedbytheMinistryofCorporateAffairs.Thisactrequiresfirms,whichhaveanetworthofover50billion(about$616million),asalesturnoverofover100billion(about$1.2billion),oranetprofitofover50billion(about$616million)inthepreviousfinancialyear,toestablishaCSRboardcommittee.Thisboardcommitteeshouldensurethatthefirmannuallyallocatesatleast2%oftheaverageofitsnetprofits,whicharemadeinthethreeimmediatelyprecedingfinancialyears,toitsqualifiedCSRprograms.Ifafirmfailstoinvesttherequiredamount,theboardshouldexpoundthereasonsforthenoncomplianceinitsannualreport.18FollowingMauritiusandIndia,corporatephilanthropybecamecompulsoryinNepal.Underthe“IndustrialEnterpriseAct(IEA)2076(2020),”afirminindustrieswithanannualsalesturnoverofmorethanNRs150million(about$1.2million)mustdepositatleast1%ofitsannualprofitsintheCSRfund.Besides,in2017,NepalRastraBank,thecentralbankofNepal,issuedtheCircularNo.11/073/74thatforcesallNepalesebanksandfinancialinstitutions16SeeTheFinance(MiscellaneousProvisions)Bill(No.XVIof2009):ExplanatoryMemorandumathttps://mauritiusassembly.govmu.org/Documents/Bills/intro/2009/bill1609.pdf.17SeeMauritiusRevenueAuthority(2022).Specificpriorityareasofgovernmentalinterventioncanbegainedfromthesamereport.18TheclauseoftheSection135oftheCompaniesActwasacquiredfromtheMinistryofCorporateAffairsathttps://www.mca.gov.in/Ministry/pdf/InvitationOfPublicCommentsHLC_18012019.pdf.ClimateChangeandClimateFinance72tospendatleast1%oftheirnetprofitsinspecificCSRsectors—socialprojects,directdonation,SustainableDevelopmentGoals(SDGs),and/orchildcarecentersforemployees.19ExceptfortheforegoingthreecountriesthathaveenactedmandatoryCSRlawsandcreatedquantifiablelegalstandardstomeasurecorporateendeavorsinCSR,othercountrieshavealsomadeCSRalegalobligationinrelevantlaws,althoughtheydonothavequantitativecriteria.Forinstance,intheUnitedKingdom(UK),Section172oftheCompaniesAct(2006),saysthatitisastatutoryandfiduciarydutyofdirectorstoconsidertheinterestsoffirms’stakeholders,includingemployees,suppliers,customers,communities,environments,etc.,whenpromotingthesuccessofthefirm.20Article5oftheChinaCompaniesLaw,revisedin2018,stipulatesthatfirmsshouldbearsocialresponsibility.21Likewise,Article74oftheIndonesianLawNo.40of2007onLimitedLiabilityCompaniesspecifiesthat“thecompanyhavingitsbusinessactivitiesinthefieldof,and/orrelatedto,naturalresourcesshallbeobligedtoperformitssocialandenvironmentalresponsibility.”22Unliketheforegoinglaws,theFrenchDutyofVigilanceLaw2017interpretsCSRasamanagementprocess,andrequiresbusinessgroups,whichemployabove5,000employeesinFranceor10,000worldwide,toidentifysocialandenvironmentalhazardsrelatedtotheiroperationsandimplementpracticalplanstomitigatethehazardrisks.23AlthoughonlyafewcountrieshaveexecutedmandatoryCSRlaws/regulations,mostcountrieshaverelevantlaws/regulationsfocusingonsocialissues(i.e.,humanrightsandlabor)andenvironmentalissues.Anyviolationoftheselaws/regulations,suchascorporatesocialandenvironmentalmisconduct,willengenderlegalpunishments,includingfinesandimprisonments.2419ArticlesofthelawinEnglishcanbefoundinChapters9–54oftheIndustrialEnterpriseAct2076fromhttps://moics.gov.np/uploads/shares/laws/Industrial%20Enterprises%20Act%20%202020.pdf.TherelevantinformationinEnglishaboutCircularNo.11/073/74wasobtainedfromhttps://pioneerlaw.com/existing-laws-on-corporate-social-responsibility/.20Legalprovisionretrievedfromhttps://www.legislation.gov.uk/ukpga/2006/46/section/172.21“CompanyLawofthePeople’sRepublicofChina”(Chineseversion)fromhttp://www.gov.cn/ziliao/flfg/2005–10/28/content_85478.htm.Englishtranslation:http://zyxy.zuel.edu.cn/_upload/article/files/e1/f1/78afb97f426d88d621c8a14e725d/774ca606–4d62–4729–8009–9f6c816441ec.pdf.22TheIndonesianLawNo.40of2007onLimitedLiabilityCompanies(inEnglish)fromhttps://www.indonesia-investments.com/business/foreign-investment/company-law-indonesia/item8311.23TheEnglishversionofFrenchDutyofVigilanceLaw2017couldbecheckedviahttps://vigilance-plan.org/wp-content/uploads//2019/06/2019-VPRG-English.pdf#page=80.24Sincespecificregulationsandlawsfocusingonenvironmentalandsocialissuesdifferfromcountrytocountry,andthatthenumberoftheselawsislargeevenforonecountry,thischapterdoesnotdiscussdetailedprovisionsoftheselawsforanycountry.73TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplications5.6ConclusionResearchershavewidelyexploredtopicsrelatingtoCSRandCSI,asemphasisontherolethatfirmsplayinsocietyhasincreased.MoreandmoreresearchdistinguishesbetweenCSIandCSR,andstudiesthesetwodistinctconceptsseparately.ThischapterexpoundsonthecoexistenceofCSRandCSIbyprovidingevidencefromrealcasesandstudiesthatshowtherelationshipbetweenCSRandCSI.ItdiscussestheeconomicconsequencesofCSRandCSIandidentifiesthecountry-,industry-,andfirm-levelcharacteristicsthatshapetheeconomicoutcomesofCSRandCSI.Ingeneral,giventhecoexistenceofCSRandCSIandtheirdifferenteconomicimpactsonfirms,CSIshouldberegardedasaconstructseparatefromCSRratherthantheoppositeendofthesamecontinuumofCSR.GiventhatregulationsandlegislationrelatingtoCSI(through“punishment”)arebetterestablishedthanthoseofCSR(through“reward”),policymakersshouldputmoreemphasisonimprovingtheregulationsandlegislationofCSR.Finally,whenfoundingtherelevantregulationsthatencouragefirmstocontributetoCSR,itisessentialtoconsidertheassociatedcostsandbenefitsfordifferentfirmsinvariousindustriesinthecontextofaspecificcountry.ClimateChangeandClimateFinance74ReferencesAguinis,H.andA.Glavas.2012.WhatWeKnowandDon’tKnowaboutCorporateSocialResponsibility:AReviewandResearchAgenda.JournalofManagement.38(4).pp.932–968.Antonetti,P.andS.Maklan.2016.AnExtendedMoralofMoralOutrageatCorporateSocialIrresponsibility.JournalofBusinessEthics.135(3).pp.429–444.Arli,D.I.andH.K.Lasmono.2010.Consumers’PerceptionofCorporateSocialResponsibilityinaDevelopingCountry.InternationalJournalofConsumerStudies.34(1).pp.46–51.Arouri,M.andG.Pijourlet.2017.CSRPerformanceandtheValueofCashHoldings:InternationalEvidence.JournalofBusinessEthics.140(2).pp.263–284.Backhaus,K.B.,B.A.Stone,andK.Heiner.2002.ExploringtheRelationshipbetweenCorporateSocialPerformanceandEmployerAttractiveness.BusinessandSociety.41(3).pp.292–318.Barnea,A.andA.Rubin.2010.CorporateSocialResponsibilityasaConflictbetweenShareholders.JournalofBusinessEthics.97(1).pp.71–86.Barnett,M.L.2014.WhyStakeholdersIgnoreFirmMisconduct:ACognitiveView.JournalofManagement.40(3).pp.676–702.Bauman,C.W.andL.J.Skitka.2012.CorporateSocialResponsibilityasaSourceofEmployeeSatisfaction.ResearchinOrganizationalBehavior.32.pp.63–86.Berger,I.E.,P.H.Cunningham,andM.E.Drumwright.2006.Identity,Identification,andRelationshipthroughSocialAlliances.JournaloftheAcademyofMarketingScience.34(2).pp.128–137.Bhattacharya,C.B.,S.Sen,andD.Korschun.2008.UsingCorporateSocialResponsibilitytoWintheWarforTalent.MITSloanManagementReview.49(2).pp.37–44.75TheEconomicConsequencesofCorporateSocialIrresponsibilityandPolicyImplicationsBloom,P.N.,S.Hoeffler,K.L.Keller,andC.E.B.Meza.2006.HowSocial-CauseMarketingAffectsConsumer.MITSloanManagementReview.47(2).pp.49–55.Boutin-Dufresne,F.andP.Savaria.2004.CorporateSocialResponsibilityandFinancialRisk.JournalofPortfolioManagement.13(1).pp.57–66.Bozzolan,S.,M.Fabrizi,C.A.Mallin,andG.Michelon.2015.CorporateSocialResponsibilityandEarningsQuality:InternationalEvidence.TheInternationalJournalofAccounting.50(4).pp.361–396.Brammer,S.,C.Brooks,andS.Pavelin.2006.CorporateSocialPerformanceandStockReturns:UKEvidencefromDisaggregateMeasures.FinancialManagement.35(3).pp.97–116.Brammer,S.andA.Millington.2008.DoesItPaytoBeDifferent?AnAnalysisoftheRelationshipbetweenCorporateSocialandFinancialPerformance.StrategicManagementJournal.29(12).pp.1325–1343.Brammer,S.,A.Millington,andB.Rayton.2007.TheContributionofCorporateSocialResponsibilitytoOrganizationalCommitment.InternationalJournalofHumanResourceManagement.18(10).pp.1701–1719.Braunsberger,K.andB.Buckler.2011.WhatMotivatesConsumerstoParticipateinBoycotts:LessonsfromtheOngoingCanadianSeafoodBoycott.JournalofBusinessResearch.64(1).pp.96–102.Breuer,W.,T.Müller,D.Rosenbach,andA.Salzmann.2018.CorporateSocialResponsibility,InvestorProtection,andCostofEquity:ACross-CountryComparison.JournalofBankingandFinance.96(C).pp.34–55.Buchanan,B.,C.X.Cao,andC.Chen.2018.CorporateSocialResponsibility,FirmValue,andInfluentialInstitutionalOwnership.JournalofCorporateFinance.52(C).pp.73–95.Cai,Y.,H.Jo,andC.Pan.2012.DoingWellWhileDoingBad?CSRinControversialIndustrySectors.JournalofBusinessEthics.108(4).pp.467–480.Cao,Y.,J.N.Myers,L.A.Linda,andT.C.Omer.2015.CompanyReputationandtheCostofEquityCapital.ReviewofAccountingStudies.20(1).pp.42–81.ClimateChangeandClimateFinance76Carnahan,S.,D.Kryscynski,andD.Olson.2017.WhenDoesCorporateSocialResponsibilityReduceEmployeeTurnover?EvidencefromAttorneysBeforeandAfter9/11.AcademyofManagementJournal.60(5).pp.1932–1962.Cennamo,C.,P.Berrone,andL.R.Gomez-Mejia.2009.DoesStakeholderManagementHaveaDarkSide?JournalofBusinessEthics.89(4).pp.491–507.Chang,K.,H.Shim,andT.D.Yi.2019.CorporateSocialResponsibility,MediaFreedom,andFirmValue.FinanceResearchLetters.30(C).pp.1–7.Chava,S.2014.EnvironmentalExternalitiesandCostofCapital.ManagementScience.60(9).pp.2223–2247.Chen,L.,G.He,andG.Krishnan.Forthcoming.DoesCEODebt-LikeCompensationMitigateCorporateSocialIrresponsibility?AccountingForum.Choi,J.andH.Wang.2009.StakeholderRelationsandthePersistenceofCorporateFinancialPerformance.StrategicManagementJournal.30(8).pp.895–907.Chou,T.andF.Chen.2004.RetailPricingStrategiesinRecessionEconomies.JournalofInternationalMarketing.12(1).pp.82–102.Collier,J.andR.Esteban.2007.CorporateSocialResponsibilityandEmployeeCommitment.BusinessEthics:AEuropeanReview.16(1).pp.19–33.Crisóstomo,V.,F.deSouzaFreire,andF.C.deVasconcellos.2011.CorporateSocialResponsibility,FirmValueandFinancialPerformanceinBrazil.SocialResponsibilityJournal.7(2).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onanddrawtheireofcorporatelawyersacrosstheUSpreciselybecausethereisnoroomfornegotiation.Gadfliesoftenrefusetomeetevenwiththefourthhighestrankingmemberofpublicfirms—thecorporatesecretaries.Suchstubbornbehaviorclearlycontradictstheintentof14a-8.Despitethemanypersuasiveelementsof14a,gadfliesmightneedabitofcoercing.AsGillanandStarks(2007)explain,these“gadflies”continuetobeaconcern:thebenefitofprovidingshareholderswithavoicecomesattheexpenseoffirmresourcesdedicatedtocompilinginformation.AccordingtoGibsonDunn(2018,4),onegadflysubmittedorco-filed187shareholderproposalsduringthe2018proxyseason—anastounding24%ofallproposalsthatyear.1Whenashareholdermakesaproposal,managementcanrespondoneofthreeways:negotiatetowithdraw,petitiontheSECtoexcludetheproposalfromanannualmeeting,orallowtheproposaltobefiledonDEF14A,thedefinitiveproxystatement.SeeFigure6.1forageneraloverviewofthesubmissionandresubmissiondynamicsofproposalsandtheirtimeframes.ClimateChangeandClimateFinance90Inresponsetothisandotherconcerns,theSECconducteda2018roundtablediscussionentitled“StatementAnnouncingSECStaffRoundtableontheProxyProcess.”Thisroundtableresultedinnewlegislationpassedduring2020andeffectiveasof1January2022,intendedtobalanceshareholdervoicewithfirmresources(SEC2020).The2020amendmentcontainsthreemainprovisions:(i)increasedthresholdsforresubmission;2(ii)lengthenedperiodsofstockownership;and(iii)increasedminimumamountsofstockownership,wheretheselasttwoprovisionstradeoffbetweeneachother.Ownershipamountgiveswaytolengthoftimeforashareholdertoresubmitthesameproposal.Forexample,priortothe2020change,theminimumstockholdingamountedto$2,000heldfor1year.Effective1January2022,astockholdercouldsubmitaproposalbyowningonly$2,000worthofstockbutonlyifshehadhelditfor3years,orastockholdercouldmakeaproposalhavingonlyownedastockfor1year,butshewouldhavetoownatleast$25,000worthofstock(themidpointontheslidingscalebeing$15,000and2years).Again,oneoftheSEC’sintentsbeingabalancebetweenvoiceforsmallshareholdersthatdoesnotinvitegadfliestodominateannualmeetingsandfirmresourcesrequiredinpreparationofannualmeetings.Yet,climatechangeproposalsaredifferentthanmostproposals,atleastwithrespecttosponsortype.PanelAinFigure6.2showsthat“individuals”3comprisethelargestpercentageofsponsoringshareholders(38%,showningray)forallproposaltypes.Climatechangeproposals,ontheotherhand,aredominatedbyreligiousgroups,notgadflies.In1994,theBenedictineSistersofSanAntonio,Texas,firstsetinmotiononeofthemostcontentiousissuesraisedatannualmeetings.“Don’tMesswithTexas,”isasloganandsourceofprideforTexasthatNewYorkhabituallyignores,whetherinpopularpoliticsorthoseatthefirmlevel.Thetwostatesoftenlockhorns,mostlynotablywhenNewYorkAttorneyGeneralEricSchneidermansuedExxonforwhathesuspectedthefirmknewbutfailedtodiscloseaboutclimatechange.Suspicions,however,heldnoswaywiththeNewYorkSupremeCourt,asSchneiderman“producednotestimonyfromanyinvestorwhoclaimedtohavebeenmisledbyanydisclosure,”(PaulWeiss2019)resultingina“completedefenseverdict”forExxon,i.e.,Schneidermanfailedonallclaims.2Toresubmitaproposalinsubsequentyears,ashareholdermustgathersufficientvotersupport.Priortothe2020change,thefirsttimeaproposalisvotedonattheannualmeeting,itneedsatleast3%infavortoberesubmittedatthenextmeeting.Thenexttimethesameproposalissubmitted,itneeds6%supportorgreatertoberesubmittedagain.Forthesameproposaltobesubmittedthreeormoretimes,itmustgatheratleast10%support.Thesethresholdsincreasedin2020to5%,15%,and25%,respectively,forsubsequentresubmissions.3Theterm“gadfly”—accordingtoMerriamWebster,apersonwhostimulatesorannoysotherpeopleespeciallybypersistentcriticism—appliestoanindividual,but,ofcourse,notallindividualsaregadflies.ClimateChange:Policy,Innovation,andProposals91SRI=sociallyresponsibleinvestor.Source:InstitutionalShareholderServices.Figure6.2:ProposalsbySponsorCompanyFundIndividualOtherPensionReligiousSpecialinterestSRIfundUnionPanelC:NumberofClimateChangeProposalsbyTopTwoSponsorsReligiousSRIFundCompanyFundIndividualOtherPensionReligiousSpecialinterestSRIfundUnionPanelA:AllProposalSponsors()PanelB:ClimateChangeProposalSponsors()ClimateChangeandClimateFinance92Yet,injuxtaposedroleplay,theSistersofSanAntonio,Texas,articulatedtheirclimateconcernstoMohawkPowerCorporationlocatedinNiagaraFalls,NewYork,atthe1994annualmeeting:thefirstappearanceof“climatechange”onashareholderproposal.DespiteMohawk’scontentionthatitwenttogreatlengthstomitigateitsclimaterisk(withanendorsementfromAlGore,noless),theSisterssetinmotionwhatbecameaproposalcrusadedominatedbyfaith-basedinvestors.Alsoin1994,theTexanSisterswerejoinedbytheImmaculateHeartMissionsfromArlington,Virginia,whosponsoredaproposaltoGeneralPublicUtilitiesCorporationofNewJersey,andbytheSistersofSt.DominicofCaldwell,NewJersey,whosponsoredaproposaltoAlleghenyPowerSystemsofNewYork.Theseoriginsandearlycompositionofshareholderssponsoringclimateproposalsprovideabasisforustosuspectthatfirmlevelpoliticsmightbedifferentthanpopularpolitics,andthatclimatechangemightnotbeafrivolousissuethatgivesrisetogadflyvoices.TheExxonexperiencewithclimate-relatedproposalsshedslightonwhatcomprises“propersubjectmatter”asdefinedbytheFederalCodeofRegulation,whichtheSECtriestobalancewheneithersideoftheowner-agentdividegainsdisproportionateweight.Exxon’sfirstclimatechangeproposalin1998strikesmuchdeeperthaninvestorprotection,shareholdervoice,orconservationoffirmresourcesinrespondingtoproposalresolutions.Thisproposalcutstothecoreofwhatitmeanstobookaliability.Fordecades,accountantshavestruggledindeterminingwhenfirmsmustrecognizeliabilitiesontheirbalancesheetsandsubsequentlychargedagainstincome,especiallyinconnectionwithanticipatedlitigation.Istherecognitionitselfanadmissionofguiltoratleastapublicinvitationtobesued,foranamountspecifiedonthefinancialstatementnoless?ThatisthequestionweighedatlengthbytheUSFinancialAccountingStandardsBoard(FASB)inissuingStatementNo.5:AccountingforContingencies.Tobeclear,theFASBstates:“Accrualsforgeneralorunspecifiedbusinessrisks(“reservesforgeneralcontingencies”)arenolongerpermitted”(FASBn.d.).Nonetheless,basedonthepopularpressinaBusinessWeekarticle,theProvinceofSt.JosephoftheCapuchinOrderinMilwaukee,Wisconsin,requestedthatExxon’sboard“included…anyanticipatedliabilities[Exxon]mayincurfromitspossiblecontributionto”4(ExxonMobil1998)climatechange.WhileitisdifficulttoextrapolatepreciselywhattheCapuchinOrdermeantby“anyanticipatedliabilities”fromtheirproposal,therequestcertainlyfellshortofFASB’sstandardforbookingaliability.Exxon’smanagementbaseditsresponsetothisshareholder4Seepage19fortheproposalentitled“Additionalreportonclimatechange”onExxon’sDEF14Afilingin1998,athttps://www.sec.gov/Archives/edgar/data/34088/000119312517122538/d182248ddef14a.htm.ClimateChange:Policy,Innovation,andProposals93proposalonMassachusettsInstituteofTechnology’s(MIT)JointProgramontheScienceandPolicyofGlobalChange(Jacoby,Prinn,andSchmalensee1997),whichexpressedskepticismaboutclimatechangethatwasgainingmomentum,atleastin1997.BusinessWeekorMITsourcesshouldalwaysbeconsideredwhenforminganopinion,butespeciallywhencomplyingwithFASBNo.5standard“thatitisprobablethat…aliabilityhadbeenincurred”and“anamountoflosscanbereasonablyestimated”(FASBn.d.).Toappreciatetheabilityofshareholderproposalstofleshoutfirminterests,fast-forwardto2017andagainfocusonExxon.Bythistime,religiousgroupswerenotissuingthemostclimateproposalsbysponsortype;SRIfundshadbecomethedominantforceforsponsoringclimateproposalsfrom2013onward(Figure6.2,panelC).In2017,theNewYorkCommonRetirementFundtooktheleadofaproposalrequestingthatExxonprovidean“assessmentofthelong-termportfolioimpactsoftechnologicaladvancesandglobalclimatechangepolicies”5(ExxonMobil2017).ThisproposalwascoveredintheWallStreetJournalinastoryhighlightingthe62.3%supportitgatheredandthecriticalrolethatinstitutionalinvestorssuchasVanguard,StateStreet,Fidelity,andBlackRockplayinsendingemphaticalmessageswhenopposingmanagementatannualmeetings(Olson2017).From1998to2017,intheExxonexperiencealone,thedelicatebalancetheSECweighsasmoderatorcanbeappreciated.WhentheCapuchinOrdersponsoredExxon’sfirstclimateproposals,theymayhavebeenvastlymisguidedinwhatitmeanstobookaliabilitybuttheirsentimentwentontoexpresswhatsomeoftheworld’smostdiligentmonitors(theNewYorkCommonRetirementFund)wouldeventuallyarticulate.Itjusttookadecadetogetthere.WhethershareholderproposalsplayadefinitivelycausalroleinthetechnologicaladvancesthattheNewYorkRetirementFundalludedto,mightbeasdifficulttoproveasthe“smokinggun”thattheBusinessWeekarticleclaimedtohavefound.6.2ClimateChangeas“ProperSubjectforAction”Climatechangeisnothingnew.6In1859,JohnTyndalldiscoveredtheheattrappingpropertiesofgreenhousegases.In1896,NobellaureateSvanteArrheniusconcludedthatfossilfuelcombustioncouldraiseglobal5Forthefullproposal,seeItem12–ReportonImpactsofClimateChangePoliciesathttps://www.sec.gov/Archives/edgar/data/34088/000119312517122538/d182248ddef14a.htm#toc182248_23.6ThecontentforthefollowingparagraphhasbeenadaptedfromNathanielRich’sNewYorkTimesarticleof2018“LosingEarth:TheDecadeWeAlmostStoppedClimateChange”(Rich2018).ClimateChangeandClimateFinance94temperatures.In1957,RogerRevellehelpedCharlesKeelingmeasurecarbondioxideconcentrations11,500feetatopHawaii’sMaunaLoatocreatetheKeelingCurve.Thatsameyear,HumbleOil,whichwasacquiredbyStandardOilandwouldlaterbecomeExxon,issuedareportconcludingthatfossilfuelswerereleasingan“enormousquantityofcarbondioxide”intotheatmosphere(Brannonetal.1957).By1968,theStanfordResearchInstituteexplainedtheramificationsoffossilfuelcontributionstoawarmingatmosphere:meltingicecapsandrisingsealevels.Eventhen,thescientistsfounditoddhowpoliticiansseemtoperseverateonindividualevents,insteadoffocusingonthebroadwarmingtrends.In2022,thefourthmostdisastroushurricaneonrecorddevastatedsouthwestFlorida.Afterwards,theGovernorofFloridaRonDeSantisandPresidentJoeBidenmettosurveythedamage,promptingBidentoclaimthatHurricaneIan“ended”thedebateonclimatechange.Yet,asof29December2022,TomKnutson,aseniorscientistatNationalOceanicandAtmosphericAdministration,stated“Insummary,itisprematuretoconcludewithhighconfidencethathuman-causedincreasesingreenhousegaseshavecausedachangeinpastAtlanticbasinhurricaneactivitythatisoutsidetherangeofnaturalvariability,althoughgreenhousegasesarestronglylinkedtoglobalwarming.”7Possiblythebestindicationofhowfirm-levelpolicyimplicationsmayunfoldalsotookplaceonthewestcoastofFloridain1981.Fortyyearsearlier,Congresssummonedthenation’stopexpertsundertheEnergySecurityActof1980andrequestedthattheyproposelegislationforhowtohandleglobalwarming.Despitelargelyagreeingonthesciencebehindclimatechangeandthecontributionstoit,theexpertsfailedtocraftanypolicyrecommendation,evenafteraweekofdiscussions.Thesciencewasfairlyclear.Theparagraphortwothattheexpertswroteonpolicywassovaguethattheyessentiallygaveupinfrustration,notduetopersonalitydifferencesorpoliticalstancesbutwhattoreportbacktoCongress.Indeed,thediscussionoverclimatechangeendedlongbeforeHurricaneIanrevisitedthefirstattempttolegislateit.7SeeGeophysicalFluidDynamicsLaboratory.GlobalWarmingandHurricanes:AnOverviewofCurrentResearchResults.Asupdated9February2023.https://www.gfdl.noaa.gov/global-warming-and-hurricanes/.ClimateChange:Policy,Innovation,andProposals956.3TheInstigationandLessonsfrom2008Theglobalfinancialcrisisthatbeganduring2008wasnotthebestchapterintheSEC’shistory.AsthegatekeeperbetweenWallStreetandMainStreet,manylookedtotheSECforexplanationsaboutthe$65billionponzischemeperpetratedbyBernieMadoffandhowitwentundetectedforsolong,aswellasthemorecrypticrepackagingoftoxicdebtanditsconversiontothehighestAAAratings.Justkeepingtrackofanacronymsandjargoninvolved—CDO,FDIC,RMBS,NINJAloans,securitiestranches,etc.—mightbedifficultfortheaverageperson.MostAmericansdonotknowthedifferencebetweenAAAandAAbondratings.Butaponzischeme?Mostpeoplegetthat.TheSECdidnot.Ontheheelsofthe2008globalmeltdown,manyinvestorswerespeculatingaboutwhatmightbethenextbigsurpriseofhiddenrisk,somethingalltooobviouswhenseeninhindsight.Climatechangeandglobalwarmingappearedtobeagoodcandidate.Outcryformoredisclosureonpotentialhiddenriskcausedthen-SECCommissionerMaryShapirotoissueapressreleaseinJanuary2010entitled,“SECIssuesInterpretiveGuidanceonDisclosureRelatedtoBusinessorLegalDevelopmentsRegardingClimateChange”(SEC2010).Giventhesensitivenatureofthesubject,sheclarifiedtheSEC’spositionregardingwhatthecommissioncouldandcouldnotaddress.“Wearenotopiningonwhethertheworld’sclimateischanging,atwhatpaceitmightbechanging,orduetowhatcauses.NothingthattheCommissiondoestodayshouldbeconstruedasweighinginonthosetopics.”Essentially,theSECdeferredtoexistingregulationondisclosurewherematerialityisathresholdnofirmpolicycanescape.Ifmaterial,itmustbedisclosed.TheSEC’spositiononclimatedisclosuresbegantoshiftsomewhatduring2021,whenitsentoutletterstospecificfirmsbutremainedfocusedonmaterialrisks(Kiernan2021).During2022,theSECbegangatheringinputonstandardizingdisclosureforallfirms,includingauditedclimate-relatedfinancialmetrics.TheSEC’sProposedRulefor“TheEnhancementandStandardizationofClimate-RelatedDisclosuresforInvestors”8releasedforpubliccommenton11April2022,appearstofacesimilardifficulties.Conversely,theinternal8Forthefullproposal,pleaserefertoSECathttps://www.sec.gov/rules/proposed/2022/33–11042.pdf.ClimateChangeandClimateFinance96firmpoliticsthattakeplaceatannualmeetingsthroughtheproposalprocessappeartohavehadtheintendedeffect:climateproposalsincreaseclimatemitigatingtechnologiesthatareeconomicallyefficient(Tindall,Cole,andJavakhadze2023),whereasexternalpopularpoliticsoftenhaveuncertainandunintendedeffects.TheattorneysgeneralofthestatesofWestVirginia,Arizona,Alabama,Alaska,Arkansas,Florida,Georgia,Idaho,Indiana,Kansas,Kentucky,Louisiana,Mississippi,Missouri,Montana,Nebraska,NorthDakota,Ohio,Oklahoma,SouthCarolina,SouthDakota,Utah,Virginia,andWyomingappearreadytosuetheSECongroundssimilarthoseusedtosuccessfullysuetheUSEnvironmentalProtectionAgencyinarecentdecisionbytheUSSupremeCourt.9Theattorneysgeneralcollectivelywrote:“Weurgeyou[theSEC]tosaveeveryoneyearsofstrifebyabandoningtheProposedRule.”10Theliteratureoninnovationhasshownthatpolicyuncertaintythwartstheinnovativeprocess(Bhattacharyaetal.2017;CongandHowell2021)andthatinnovationcansufferinresponsetomandatorydisclosure(GaoandZhang2019).Inaparallelfashion,theSarbanes-OxleyAct(SOX)enjoyednearunanimouspoliticalsupportbutdisproportionatelyburdenedsmallfirms,especiallytheinnovative.Intheviewoftheauthorshere,asfinancialeconomists,SOXisabitofahead-scratcher.Isnottheverybasisoftheauditfunctiontoferretoutfraudandunintentionalmisstatement?Whythenalltheextratests,specificallyforfraudfromthefalloutofEnron,WorldCom,andArthurAndersen?Itisabitlikerequiring“thewholetruthandnothingbutthetruth.”Ifaperson(orfirm)isgoingtolie,dotheextradescriptorsdoanythingmoretocompelthetruth?AsSOXgainedmomentumtowardbecominglaw,themarketdidnotthinkso.AccordingtoaneventstudythatLitvak(2007)conducted,eachsteptowardtheenactmentbySOXresultedinabroadmarketdecline.Themarketreactednegativelyeachtime.TheonlyexceptionwasthesuggestionofanexemptionfromSOXforforeignfirms,raisedbythen-SECChairmanHarveyPitt.11Thesinglepositivemarketreactionwasquicklynegatedbyastrongernegativereactionwhentheforeignexemptionwaswithdrawn920–1530WestVirginiav.EPA(06/30/2022)seethefullopinionathttps://www.supremecourt.gov/opinions/21pdf/20-1530_n758.pdf.10SeetheircommentstotheSECathttps://www.sec.gov/comments/s7–10–22/s71022–20134128–303943.pdf.11Ironically,PittwouldresignforhisendorsementofWilliamWebster,whoservedasthefirstpresidentofthePublicCompanyAccountingOversightBoardforweeksbeforeinvolvementontheauditcommitteeofatechnologycompanybeinginvestigatedbytheSEC(Wikipedia.PublicCompanyAccountingOversightBoard.https://en.wikipedia.org/wiki/Public_Company_Accounting_Oversight_Board).ClimateChange:Policy,Innovation,andProposals97fromSOX.Litvak(2008)alsodemonstratesthelong-termnegativeeffectsofSOXonfirmvalue.Evenwhenpopularpoliticshasnearunanimoussupport,firmscanbepenalizedbygoodintentionswhichmaynotfindcommensuratebenefit.SOXcannotpreventfraud,asWirecard12andTheranos13continuetoprove.Whenpopularpoliticsisverydivided,asitappearstobeformandatoryclimatedisclosure,theabilityofpolicytocrafteconomicallyefficientsolutionsisfurthereroded.Givenhistoricalprecedent,anunintendedconsequenceofmandatoryclimatedisclosurecouldbeclimatemitigatingtechnologies.TheevidenceprovidedbyTindall,Cole,andJavakhadze(2023)demonstratesthatthepersuasiveelementsofshareholderproposalsareeffectiveinspurringclimatemitigatinginnovation,whereasrequireddisclosuremightdistractfirmattentionfrominnovatingandcouldpotentiallyfocusiton“cleveraccountingandcreativePR[publicrelations].”14Certainly,neithersideseekstothwartfirmeffortstoaddressclimatechangeinmoremeaningfulways,likemitigatingandadaptivetechnologies.6.4SubstantialImplementationOn13July2022,theSECissuedapressreleasetoamend3ofthe13basesforexcludingshareholderproposals.15Tindall,Cole,andJavakhadze(2023)provideguidancetotheSEConthefirstofthethree,SubstantialImplementationand,inparticular,aproposed“essentialelements”test.Currently,ashareholderproposalcanbeexcludedfromannualmeetingsifafirmhasalreadysubstantiallyimplementedwhattheshareholderisproposing.(Thisisthetenth16ofthethirteenprovisionsforexclusionin14a-8.)TheproposedamendmentonSubstantialImplementationwouldprovideatesttoseeif“thecompanyhasalreadyimplementedtheessentialelementsoftheproposal.”SECCommissionerHesterPiercehasexpressedherreservationsagainsttheamendmentforlackingclarityonhowtoassessessentialelements.17Weagree.Someissues,likeauditorratification,arestraightforwardtodetermineessentialelementsforsubstantialimplementation.Otherissues,likeclimatechange12SeeReuters(2021)formoreinformation.13SeetheDepartmentofJustice’sdiscussionofitscaseagainstElizabethHolmes,theformerCEOofTheranosathttps://www.justice.gov/usao-ndca/us-v-elizabeth-holmes-et-al.14SeeGretaThunberg’sspeechattheUNClimateConference,11December2019,courtesyofNBCNews,availableathttps://www.youtube.com/watch?v=UlRKuUm5P_A.15Seetheproposalathttps://www.sec.gov/news/press-release/2022–12.1617CFR§240.14a-8(i)(10).https://www.govinfo.gov/content/pkg/CFR-2011-title17-vol3/pdf/CFR-2011-title17-vol3-sec240-14a-8.pdf.17Seeherobjectionsathttps://www.sec.gov/news/statement/peirce-statement-shareholder-proposals-proposal-071322.ClimateChangeandClimateFinance98concerns,mightbeimpossiblefortheSEC’sDivisionofCorporateFinancetoidentifywhathasbeenimplemented.Todate,priorliteratureonshareholderproposals(Cuñat,Gine,andGuadalupe2012;Flammer2015;FlammerandBansal2017)hasusedchangesinenvironmental,social,andgovernance(ESG)scorestoconceptualizeimplementation.Indeed,bothCuñat,Gine,andGuadalupe(2012)andFlammer(2015)estimateprobabilityofimplementationforpassingproposalsat52%,i.e.,theflipofacoin.Thus,a“passing”shareholderproposaldoesnotnecessarilyleadtoimplementation.TheviewinthischapteristhatacoinflipdoesnotprovidetheSECmuchguidanceforjudginghowsubstantialimplementationhasbeen,muchlessinsightonessentialelements,therein.Conversely,whentheUnitedStatesPatentandTrademarkOfficeissuesapatent(andevenwhenafirmfilesone),ithasbeenimplemented,completewithalltheessentialelementsnecessarytograntitexclusiverightsofuse.Certainly,whenonepatentcitesanotherpatent,thecitationsdemonstratesubstantialimplementation.Tindall,Cole,andJavakhadze(2023)makeacompellingcasethatclimateproposalsleadtomoreclimatemitigatingpatentsandcitations.Consequently,itisbelievedherethattheresearchprovidesguidancetotheSECasitdeliberatesnotonlySubstantialImplementationgroundsforexclusionbutalsoCommissionerPierce’ssuggestion“toallowsufficienttimetoseehowour2020rulesoperate(Pierce2022).18Thepatentdataweexaminearenotsubjective.ESGratings,ontheotherhand,sufferwidedisparitiesamongproviders.19ThesamefirmhasbeenshowntoreceivewildlydivergentscoresbydifferentratersnotonlyonthecompositemeasureofESG,butalso,morealarmingly,oneachsubcomponent(Berg,Kölbel,andRigobon2019),wheremeasurementcomprisesthelargestsourceofdivergenceamongthesixlargestratingagencies.(Apparently,whetherornotaCEOisalsothechairpersonisdifficulttoassess.)Suchdivergenceandsubjectivitydonotexistwithpatents.EitherafirmfilesonewiththeUnitedStatesPatentandTrademarkOfficeoritdoesnot.Patentseitherciteotherpatentsortheydonot.EventheprescriptionsforthePatentandTrademarkOfficecooperativepatentclassificationforclimatemitigatingtechnologies(theY02series)areveryspecificandmustwithstandthetechnicalscrutinyofapatentofficer.WhereaswithESGratings,afirmcanreceivepraisefromoneproviderandscornfromanother.Forthesereasons,Tindall,Cole,andJavakhadze(2023)informthe18The2020rules,Piercerefersto,aretheincreaseinthresholdsforresubmission—3%,6%,and10%raisedto5%,15%,and25%ofthevote—andthequalificationstoownership—fromaflat$2,000tovariegatedownership:$2,000ownedfor3years,$15,000for2years,and$25,000for1year.19Evenwhenratingagenciesissuesimilarratings,aswithbondratingagencies,theoutcomeofrelianceonthoseratingscanhavedisastrousconsequences,likethefailuresthatgaverisetothe2008globalfinancialcrisis.Byextension,relyingonESGratingsforsubstantialimplementationshouldbeseriouslyquestioned.ClimateChange:Policy,Innovation,andProposals99SECnotonlythatshareholderproposalsservetheirintendedgovernancerole,butalsothedegreetowhichproposalshavetheintendedeffect.Endlesspolitics,cleveraccounting,andpublicrelationsgimmicksareunlikelytoresolvetheclimateissuesfirmsface.Rather,whentheunderlyingeconomicsdisplaypreferenceforclimatemitigatingtechnologies,firm-levelcarbonissuesaremorelikelytofindresolutionandpossiblyassistingthelowcarbonenergytransition.Theviewhereisthatclimate-relatedshareholderproposalsintheUSsince1994haveprovidedaninvaluableforumformaintainingfocusontheeconomicsofinnovation.6.5SupportThresholdsSincetheBenedictineSistersofSanAntoniofirstsponsoredtheirproposal,averagesupportforclimateproposalshasincreasedconsiderably,asshowninpanelAofFigure6.3.Onaverage,shareholderssupportforclimateproposalsdidnotexceed20%until2012.Muchlikeweleanonaccountingreasoning(FASB’sStatementNo.5)forwhatitmeanstobookaliability,wealsoturntoitforwhatanoncontrollingpercentageofsharesmightmean.TheAccountingPrinciplesBoardOpinionNo.18presumesthataninvestorwithover20%ofsharesoutstandingexerts“significantinfluence,”unlessfactsandcircumstancesdictateotherwise.Once20%isbreached,theequitymethodofaccountingmustbeimplemented.Itistheopinionherethat20%means“something”forproposalsupportaswell.Exactlywhat20%means(orevenif20%istheexactfigure),itcannotbesaidwithprecision.Tindall,Cole,andJavakhadze(2023)discoverthatclimate-relatedproposalsspurclimateinnovationsthatareefficientandvaluable.Thesampleinthepapercontainedfewerthan10climateproposalsthatexceeded50%support.Giventhisobservation,thepaperconjecturesthatshareholderproposalswhichgatherlessthanmajorityarestillmeaningfulevenifthey“fail.”ItfindsanecdotalreassuranceinrecentstatementsmadebyShellCEOBenvanBeurden,aboutvotingresults.Managementappearstolistentoshareholder“voice”evenwhenproposalsdonot“win.”InthediscussionoftheResultsfromthe2021AnnualGeneralMeeting,vanBeurdenstatedofaclimateproposalthatgained30%support:“WealsonotetheoutcomeofthevoteonShareholderResolutionnumber21.Wewillseektofullyunderstandthereasonwhyshareholdersvotedastheydid…”(RoyalDutchShelln.d.).Thefollowingyear,vanBeurdenagainpaidhomagetothesameclimateresolution,whichdeclinedinsupportbutstillgarnered20%ofshareholders.“WearealsoencouragedbythereducedsupportforShareholderClimateChangeandClimateFinance100Source:InstitutionalShareholderServices.Figure6.3:AverageandRangeofClimateProposalSupportbyYearPanelA:AverageProposalSupportbyYearAnnualsupport:VoteforPanelB:BoxPlotsofProposalSupportbyYearAnnualsupport:VoteforResolutionnumber21butrecognisethereisstillworktodo.Wewillconsultshareholderstounderstandthesevotes…”Clearly,20%ofthevoteisenoughtogetmanagement’sattention,possiblyenoughtoexertsignificantinfluence.EvenintheUnitedKingdom,wheremajoritysupportlegallyobligatesfirmstoimplementaresolution,shareholderscanhavetheir“voice”heard.IntheUS,wheremajoritysupportremainsprecatory,shareholder“voice”canresonateenoughwithmanagementtoencouragechangeinfirmpolicies,aswedemonstratewithclimateproposalsandclimateinnovations.ClimateChange:Policy,Innovation,andProposals101WithrespecttotheSEC’s2020thresholdchangesnowrequiring5%,15%,and25%forresubmissionandwithrespecttotheunfoldingofclimatechangeproposalssince1994,theinformationinpanelAofFigure6.3suggeststhat,onaverage,shareholdervoicewouldhavebeensilencedlongago.Further,theboxplotsinpanelBofFigure6.3displaytheannualrangeofshareholdersupportforclimateproposals.Theextremes,evenasrecentlyas2017,displaytheproblemofsimplytakinganaverage:fromalmostnosupport(1.3%)toclearmajority(67.3%).Collectively,Figure6.3demonstratesthatshareholdervoicemaytakemoretimetofindconsensusthanthe3yearsallottedforresolutionstoexceed25%supportinordertoberesubmitted.IfShell’svanBeurdenstilllistenstothe20%ofshareholderswhovotedagainsthim,20inthemidstofShell’senergytransition,theauthorsagreewithSECCommissionerPierce’scontentionthattheSECmightwanttorefrainfromchanging14a-8anyfurther,atleastforthetimebeing.21Indeed,the2020amendmentsonlybecameeffectiveatthestartof2022.Herrequesttoallowmoretimeseemsprudentgiventhatadditionalchangesto14a-8forothergroundstoexcludeproposals(especiallyfortheSubstantialImplementationstandardandEssentialElementstestmentionedabove)mightbeobscuredbythe2020changethathavebeeneffectiveforonly1year.TheanecdotalevidenceweprovideforUSclimateproposals,theappropriatedinsightfromnon-USresolutions,andtheborrowedestimationfromFASB,allsuggestthattimemaybeakeyelementtocompellingownersandagentstoferretoutfirminterests,asopposedtoahardthresholdlike25%.6.6ConclusionandPolicyRecommendationsWhenthemicrocosmofinternalfirmpoliticstakeplacethroughtheshareholderproposalmechanismandcollectivelypointsinaconsistentdirection,externalpolicymakerscanmorecomfortablyimplementtheirpolicies,asthedecisionhasbeenmademucheasierthroughmutualconsent.Policymakersneednotcommandandcontrolwhenownershavevoicedtheiropinionsandagentshaveexpressedtheirwillingnesstolisten.Moregenerally,persuasioncanbemorepowerfulthancoercion.AsTindall,Cole,andJavakhadze(2023)demonstrate,suchhasbeenthecaseforshareholder20TheauthorsofthischapterfullyrecognizethevastdifferencesbetweentheUSandtheUnitedKingdomshareholderresolutions(themainonebeingcompulsoryimplementationifmajoritysupport).TheyspeculatethatShell’svanBeurdenisstatingpubliclywhatUSCEOsthinkofproposalsthatgainsignificantsupport.Theycompoundspeculationbyborrowing20%fromFASB.21ForaninterestingdiscussionofthecomplicationswithSubstantialImplementationandEssentialElements,seeMathew(2023).ClimateChangeandClimateFinance102proposalsrelatedtoclimatechangeinencouraginginnovationstobenotonlyclimatemitigatingbutalsoeconomicallyefficient.Theanecdotalevidenceweprovideinthischaptersuggeststhatclimate-relatedproposalsarenottheprovidenceofgadflies.Rather,theTexasSistersmeantseriousbusinessandtheirclimateconcernsprovedtobequitevalid,spurringfirmstoinnovateclimatemitigatingtechnologies.AscanbeseeninthedebateswhichattempttoclarifySubstantialImplementationandEssentialElements,theSEChasbeenplacedinadifficultpositionofdetermininghowtoapplythematthefirmlevel,fairlyanduniformly.Tindall,Cole,andJavakhadze(2023)provideanimprovementoverpriorliteratureonatleastwhattypeoffirmoutcomemightbeabettermeasure:patentsoverESGratings.ThemostspeculativesuggestionisfortheSECtoreconsidersupportthresholds.Thetimetrendofclimateproposalsindicatesthata“propersubjectonaction”mighttakemorethan3yearstoexertsignificantinfluence.Thischapterrecognizesthatathresholdofsupportmustbedrawnatsomepointintime,butitencouragestheSECtocloselymonitorits2020changessuchthatitsintentiontofindagoodbalancebetweenshareholdervoiceandmanagement’swillingnesstolistenresultsinthebestdeploymentoffirmresources.ClimateChange:Policy,Innovation,andProposals103ReferencesBerg,F.,J.F.Kölbel,andR.Rigobon.2019.AggregateConfusion:TheDivergenceofESGRatings.ForthcomingReviewofFinance.http://dx.doi.org/10.2139/ssrn.3438533.Bhattacharya,U.,P.Hsu,X.Tian,andY.Xu.2017.WhatAffectsInnovationMore:PolicyorPolicyUncertainty?JournalofFinancialandQuantitativeAnalysis.52(5).pp.1869–1901.Brannon,Jr.,H.R.,A.C.Daughtry,D.Perry,W.W.Whitaker,andM.Williams.1957.RadiocarbonEvidenceontheDilutionofAtmosphericandOceanicCarbonbyCarbonfromFossilFuels.Eos,TransactionsAmericanGeophysicalUnion.38(5).pp.643–650.Carleton,W.T.,J.M.Nelson,andM.S.Weisbach.1998.TheInfluenceofInstitutionsonCorporateGovernancethroughPrivateNegotiations:EvidencefromTIAA-CREF.TheJournalofFinance.53(4).pp.1335–1362.Cong,L.W.andS.T.Howell.2021.PolicyUncertaintyandInnovation:EvidencefromInitialPublicOfferingInterventionsinChina.ManagementScience.67(11).pp.7238–7261.Cuñat,V.,M.Gine,andM.Guadalupe.2012.TheVoteIsCast:TheEffectofCorporateGovernanceonShareholderValue.TheJournalofFinance.67(5).pp.1943–1977.ExxonMobil.1998.DefinitiveProxyStatement.https://www.sec.gov/Archives/edgar/data/34088/000119312517122538/d182248ddef14a.htm._____.2017.DefinitiveProxyStatement.https://www.sec.gov/Archives/edgar/data/34088/000119312517122538/d182248ddef14a.htm#toc182248_23.FinancialAccountingStandardsBoard(FASB).n.d.SummaryofStatementNo.5.https://www.fasb.org/page/PageContent?pageId=/reference-library/superseded-standards/summary-of-statement-no-5.html&bcpath=tff.Flammer,C.2015.DoesCorporateSocialResponsibilityLeadtoSuperiorFinancialPerformance?ARegressionDiscontinuityApproach.ManagementScience.61(11).pp.2549–2568.ClimateChangeandClimateFinance104Flammer,C.andP.Bansal.2017.DoesaLong-TermOrientationCreateValue?EvidencefromaRegressionDiscontinuity.StrategicManagementJournal.38(9).pp.1827–1847.Gao,H.andJ.Zhang.2019.SOXSection404andCorporateInnovation.JournalofFinancialandQuantitativeAnalysis.54(2).pp.759–787.GibsonDunn.2018.ShareholderProposalDevelopmentsduringthe2018ProxySeason.12July.https://www.gibsondunn.com/wp-content/uploads/2018/07/shareholder-proposal-developments-during-the-2018-proxy-season.pdf.Gillan,S.L.andL.T.Starks.2007.TheEvolutionofShareholderActivismintheUnitedStates.InstitutionalInvestorActivism:HedgeFundsandPrivateEquity,EconomicsandRegulation.Oxford:OxfordUniversityPress.pp.55–73.Jacoby,H.D.,R.G.Prinn,andR.Schmalensee.1997.Report#21.Needed:ARealisticStrategyforGlobalWarming.MassachusettsInstituteofTechnology.http://web.mit.edu/globalchange/www/rpt21.html.Kiernan,P.2021.SECAsksDozensofCompaniesforMoreClimateDisclosures.TheWallStreetJournal.22September.https://www.wsj.com/articles/regulators-ask-dozens-of-companies-for-more-climate-disclosures-11632341672?mod=article_inline.Litvak,K.2007.TheEffectoftheSarbanes-OxleyActonNon-USCompaniesCross-ListedintheUS.JournalofCorporateFinance.13(2–3).pp.195–228._____.2008.TheLong-TermEffectoftheSarbanes-OxleyActonCross-ListingPremia.EuropeanFinancialManagement.14(5).pp.875–920.Mathew,S.J.2023.HowCompaniesShouldApproachShareholderProposalsthisProxySeason.HarvardLawSchoolForumonCorporateGovernance.https://corpgov.law.harvard.edu/2023/01/03/how-companies-should-approach-shareholder-proposals-this-proxy-season/.Olson,B.2017.ExxonShareholdersPressureCompanyonClimateRisks.TheWallStreetJournal.31May.https://www.wsj.com/articles/exxon-shareholders-pressure-company-on-climate-risks-1496250039.ClimateChange:Policy,Innovation,andProposals105Pierce,H.2022.ExclusionPreclusion:StatementontheShareholderProposalsProposal.StatementfromtheSECCommissioner.https://www.sec.gov/news/statement/peirce-statement-shareholder-proposals-proposal-071322.Reuters.2021.Timeline:TheRiseandFallofWirecard,aGermanTechChampion.16March.https://www.reuters.com/article/us-germany-wirecard-inquiry-timeline/timeline-the-rise-and-fall-of-wirecard-a-german-tech-champion-idUSKBN2B811J.Rich,N.2018.LosingEarth:TheDecadeWeAlmostStoppedClimateChange.TheNewYorkTimes.1August.RoyalDutchShell.n.d.ResultofAnnualGeneralMeeting.https://www.shell.com/investors/shareholder-meetings/_jcr_content/root/main/section/simple/list_copy/list_item.multi.stream/1663830795090/e31f2aa8ff0be567ea9577b43011bac4044f0e4e/voting-results-of-the-2021-agm.pdf.SecuritiesandExchangeCommission(SEC).2010.SECIssuesInterpretiveGuidanceonDisclosureRelatedtoBusinessorLegalDevelopmentsRegardingClimateChange.Pressrelease.27January.https://www.sec.gov/news/press/2010/2010-15.htm._____.2020.SECAdoptsAmendmentstoModernizeShareholderProposalRule.Pressrelease.23September.https://www.sec.gov/news/press-release/2020–220._____.2022.SECProposesAmendmentstoShareholderProposalRule.Pressrelease.13July.https://www.sec.gov/news/press-release/2022-121.Tindall,G.,R.Cole,andD.Javakhadze.2023.InnovationRespondstoClimateChangeProposals.WorkingPaper.Weiss,P.2019.ExxonMobilPrevailsinLandmark$1.6BillionTrialOverClimateChangeDisclosures.https://www.paulweiss.com/practices/litigation/litigation/news/exxonmobil-prevails-in-landmark-16-billion-trial-over-climate-change-disclosures?id=30337.Chapter7John(Jianqiu)Bai,YongqiangChu,ChenShen,andChiWanManagingClimateChangeRisks:SeaLevelRiseandMergersandAcquisitions7.1IntroductionAsclimatehaschangedoverthelast4decadessohasawarenessofthesevereconsequencesthatsuchchangescanbring.Mostcompanies,however,“areunderestimatinghowclimate-relatedrisks,suchasextremeweatherandchangingconsumerviewsonenvironmentalissues,couldaffecttheircompanies’bottomlines,andtheyneedtomakeclimateriskassessmentsabiggerpriority”(Broughton2019).Thischapterlooksathowcompaniesengageinmergersandacquisitionstomanageanddiversifyawayfromoneimportantlong-runclimaterisk:thatassociatedwithsealevelrise.1Itdoessofortworeasons:First,theacceleratingriseofsealevelisamongthemostsevereimpactsofclimatechange,withconsensusthatitisaseriousenvironmentalissuethatrisksdisruptinghouseholdandbusinessactivitiesinthelongrun.Hauer,Evans,andMishra(2016)suggestthata1.8meter(roughly6feet)riseinsealevelwouldleaveareaspopulatedby6millionAmericansuninhabitable.Undertheseconditions,businesseswithcommercialpropertiesoroperationsinlow-lyingcoastalareasmightfinditincreasinglydifficulttoensuretheirassets,makingsealevelrisearelevantlong-termbusinessrisk(Balch2016).Second,itisachallengetoforecastariseinsealevels,whichmakesstudyinghowfirmsmanagesuchasignificantyetuncertainriskparticularlyurgentandtimerelevant.1ThischapterisanupdatedversionofthepaperplacedinSSRNon11May2021(https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3739599).107ManagingClimateChangeRisksThechapterpositsthatfirmsexposedtosignificantsealevelrisediversifyawayfromsuchrisksbyacquiringfirmsunlikelytobeaffectedandthatthisactionisrewardedbythemarket.Itconjecturesthat,aftersuchamerger,theinformationenvironmentintheacquiringfirmsimprovesastheydiversifyawayanimportantsourceofforecastuncertainty,thatis,theriskofrisingsealevels.Thechapteralsosuggeststhatthecombinedfirms’environmental,social,andgovernancescoresshouldimprovepost-merger.Inamultistepapproach,thefirstsetofanalysesinvestigateshowexposuretosealevelriseriskaffectsmergerlikelihood.Becausesealevelriseisanuncertainyetsignificantlong-termoperationalrisk,theanalysishypothesizesthatfirmsexposedaremore(less)likelytobecomeacquirers(targets)inamergerdeal.Theevidenceisconsistentwiththishypothesis:relativetoagroupofpotentialacquirers(targets)inthesameindustryandsimilarinsize(aswellasabook-to-marketratio),firmsmoreexposedtosealevelrisearesignificantlymore(less)likelytobeanacquirer(target)inamergerdeal.Whenafirmexposedtotheriskofsealevelriseannouncesthatitisacquiringafirm,itsstockreturnsaresignificantlyhigher(andabnormal)intheannouncementperiod.Thisisconsistentwiththenotionthatthemarketrewardsfirmsfordiversifyingawaysuchrisk.Indeed,theresultsholdaftercontrollingforalargenumberoffirmsandmergerdealcharacteristics.Importantly,thepositiveannouncementeffectconcentratesondealsinwhichtargetfirmsarenotexposedtosealevelriserisk,suggestingitisdrivenbythediversificationofsealevelriserisk.Thepositivereturnisalsomorepronouncedforfirmswithmoreanalystcoverage.Thesefindingsexpandunderstandingofhowenvironmentalandclimatechangerisksinfluencevariousmarketparticipantsandunderlyingassets.Priorstudieshavefoundthatinstitutionalinvestorsconsiderclimateriskanimportantsourceofriskfortheirportfolios,suchasKrueger,Sautner,andStarks(2018).Forinstance,mutualfundinvestorsgravitatetowardfundswithfavorable(low)carbondesignationbytiltingtheirportfoliostowardlowfossilfuelandlowcarbonriskholdings(BoltonandKacperczyk2020).Besides,investorspayapremiumforgreenbonds,whichusetheproceedsforenvironmentalpurposes(Bakeretal.2018).ClimateChangeandClimateFinance108Indeed,thebondmarketsstartedtopriceinsealevelriseriskasearlyas2011(Goldsmith-Pinkhametal.2020).Intherealestatemarket,however,theevidenceissomewhatmixed:whilesomestudiesfindthatrealestatepricesareheavilyinfluencedbysealevelrise(Bernstein,Gustafson,andLewis2019),othersfindminimalpriceimpact(MurfinandSpiegel2020).Acemogluetal.(2016)takeauniquemodelapproachtothecompetingchoicesthatfirmsfacebetweencleananddirtytechnologiesandprovidesempiricalevidencethatsuchchoicesarelargelyinfluencedbytaxesandsubsidies.Bansal,Ochoa,andKiku(2016)findthatequityportfolioswithhighexposuretoclimateriskcarryapositiveriskpremium.Adoptingamorequantitativeapproach,Giglioetal.(2018)estimatelong-rundiscountratesforvaluinginvestmentsinclimatechangeabatement,whileBarnett,Brock,andHansen(2020)highlightthechallengesofmodelingclimate-changeriskduetouncertainty.Onthecorporateside,Jiang,Li,andQian(2020)findfirms’costoflong-termloansincreaseswithsealevelriserisk.Theanalysisinthischapter,meanwhile,providesdirectevidenceofhowfirmsrespondtosealevelriseriskinthemarketforcorporatecontrol.Second,ourstudycontributestothesignificantliteratureonmergersandacquisitions.Empiricalstudiesonmergersandacquisitionslargelyfocusoneitherthedeterminantsofmergersorthesourcesofsynergisticgains.Whilemanyfactorssuchasstockovervaluation(e.g.,ShleiferandVishny2003;Rhodes-KropfandViswanathan2004),economic,regulatory,andtechnologicalshocks(e.g.,Harford2005;MitchellandMulherin1996)leadtomergerwaves,mergers’synergisticgainsrangefrombetterresourceallocationandproductdifferentiation(e.g.,Lichtenbergetal.1987;Healy,Palepu,andRuback1992;McGuckinandNguyen1995;MaksimovicandPhillips2001;Schoar2002;HobergandPhillips2010;Maksimovic,Phillips,andPrabhala2011),interesttaxshields(Devos,Kadapakkam,andKrishnamurthy2009;Fee,Hadlock,andPierce2012),improvementsinproductquality(Sheen2014),toimprovementsinstructuredmanagementpractices(Bai,Jin,andSerfling2022).Thischapter’sanalysiscontributestotheliteraturebyprovidingsystematicevidencethatsealevelriserisksareasignificantfactorthataffectsmergerlikelihoodandthatmarketsvaluemergersthatdiversifyawayfromsuchlong-runrisks.109ManagingClimateChangeRisks7.2LiteratureandHypothesis7.2.1MergerLikelihoodWhywouldthelikelihoodofmergersbecorrelatedwithenvironmentalrisks?Ononehand,previousresearchfindsthatmergersareclusteredbyindustryandbytimeandareoftenmotivatedbyeconomic,regulatory,andtechnologicalshocks(Harford2005).Becauseclimatechangeisgradualandslow,itisreasonabletoexpectmergerdecisionstobeunrelatedtoenvironmentalrisks.Ontheotherhand,environmentalrisksposeauniquechallengefortoday’scompanies.“Investors,analysts,researchfirms,andcompaniesareputtingmoreemphasisonhowclimateissuesrangingfromrisingsealevelstorecordheatwaveswillaffectprofitsandrevenuesintheUnitedStatesandwhatcompaniesaredoingtoaddressthoserisks”(Randall2019).Inthecontextofmanagingrisksassociatedwithrisingsealevel,oneimmediatelyeffectivemethodistoacquirebusinessesingeographiclocationsunaffectedbysuchenvironmentalrisks.Atthesametime,itisexpectedthatbusinesseslocatedinareasseverelyimpactedbyrisingsealevelsaredifficulttosellinthemarketforcorporateassets,astheseenvironmentalrisksaredifficulttodiversifyawayandquitesalientforanypotentialacquirers.Asaresultoftheseconsiderations,onecanexpectamergerlikelytobecorrelatedwiththerisksofsealevelrise.Theanalysisinthischaptersummarizestheaboveargumentsintheirnullandalternativeformsinthefollowinghypotheses:H1:Thelikelihoodofafirmbecominganacquirer(target)inamergerdealisnotcorrelatedwiththefirm’sexposuretotheriskofsealevelrise.H1a:Thelikelihoodofafirmbecominganacquirer(target)inamergerdealispositively(negatively)correlatedwiththefirm’sexposuretotheriskofsealevelrise.H1b:Firmssubjecttosealevelriseriskaremorelikelytoacquirefirmssubjecttonosealevelriserisk.ClimateChangeandClimateFinance1107.2.2CumulativeAbnormalReturnsaroundMergerAnnouncementsFollowingasimilarlogic,ifenvironmentalrisksareslowmovinganddonotaffectfirms’businessstrategiesorday-to-dayoperations,investorsmaynotrewardacquisitionsthatdiversifyawaytheexposuretotheserisks.Ontheotherhand,ifclimatechangeassociatedwithsealevelrisedoesposeseriousoperationalandbusinessrisks,oneshouldexpectthemarkettoviewacquisitionsthatdiversifyawaysuchrisksasvalueimproving.Theanalysisteststhesecompetingpredictionsbyinvestigatingabnormalcumulativereturnsaroundmergerannouncements.Thefollowingsummarizesthesepredictionsinthesecondsetofhypotheses:H2:Thecumulativeabnormalreturnoftheacquiringfirmsaroundmergerannouncementsisnotcorrelatedwiththeexposuretorisksassociatedwiththesealevelrise.H2a:Thecumulativeabnormalreturnoftheacquiringfirmsaroundmergerannouncementsispositivelycorrelatedwiththeexposuretorisksassociatedwiththesealevelrise.7.3EmpiricalMethodologyTheempiricalexerciseproceedsinthreesteps.First,ittestswhetherexposuretosealevelriseriskaffectstheprobabilityofafirmbecominganacquirer(atarget).Tothisend,itrunsconditionallogistic,logistic,andordinaryleastsquares(OLS)regressions.Specifically,itestimatesthefollowingspecification:EventFirmi,m,t=+1SLRRiski,m,t–1+2Xi,t–1+t×s+k(orvm)+eim,t(1)wherei,m,k,t,andsindexfirm,deal,industry,year,andstate,respectively.EventFirmi,m,tequalsoneiffirmiistheacquirer(target)indealm,andzerootherwise.ThekeyindependentvariableSLRRiski,m,t–1isadummyvariableequaltooneiffirmi’sheadquarterswouldbeinundatedifthesealevelrisesby6feet,andzerootherwise.Theanalysisincludesthefollowingfirm-levelcharacteristics(Xi,t–1)measuredinyeart–1toaccountforfirms’observablecharacteristicsonprofitability,financialposition,andotherattributes.111ManagingClimateChangeRisksThesecondsetofanalysesstudieswhetheracquirers’cumulativeabnormalreturn(CAR)aroundacquisitionannouncementsiscorrelatedwiththesealevelriseexposureoftheacquiringfirms.Specifically,itestimatesthefollowingcross-sectionalregression:AcquirerCARi,m,t=+1SLRRiski,m,t–1+2Xi,t–1+2DealCharacterm,t–1+t×s+k+eim,t(2)wherethedependentvariableistheacquirerCARarounddifferentwindowssurroundingthemergerannouncements.AlltheothervariablesaredefinedanalogouslytoEquation(1).7.4SummaryofFindingsTestingthefirstsetofhypotheses(i.e.,H1andH1a)byinvestigatingwhethersealevelriseisanimportantdeterminantofafirmengaginginamerger.Ifsealevelriserisksaresignificantbusinessrisksthatfirmsattempttodiversifyawaythroughacquisitions,itisexpectedthesealevelriserisktobepositivelycorrelatedwithafirm’slikelihoodofbecominganacquirer,andnegativelycorrelatedwithafirm’slikelihoodofbeingatargetfirm.Tooperationalizethesetests,theanalysisestimatesEquation(1)onthetwomatchedsamples:theindustryandsize-matchedandtheindustry,size,andM/Bratiomatchedsamples.Table7.1presentstheresultsoftheseexercises.PanelsAandBpresenttheresultsbasedontheindustryandsize-matchedsampleandindustry,size,andM/Bratio-matchedsamples,respectively.Columns1–3ofpanelApresentthecoefficientestimatesfromtheconditionallogitandlogitmodels,whilecolumns4–7displaytheresultsusingtheOLSregressionmodel.Overall,throughoutvariousempiricalspecifications,itisfoundthatthecoefficientestimatesonsealevelriserisk(Inundated6ft)arepositiveandstatisticallysignificant,suggestingthatfirmswithhighersealevelriseriskaremorelikelytobecomeanacquirer,evenaftercontrollingforavarietyoffirmcharacteristics.Ineconomicsignificance,column1predictsthatifthefirmissubjecttotheinundationrisk,thenthefirmis4.1%morelikelytobecomeanacquirerthanthefirmnotsubjecttotheinundationrisk.Althoughthemagnitudesbecomesmallerincolumns4–7whenthelinearprobabilitymodel(i.e.,OLS)isemployed,thepositiverelationbetweensealevelriseriskandtheprobabilityofbecominganacquirerstayspositiveandeconomicallymeaningful.ClimateChangeandClimateFinance112Table7.1,panelBreportstheresultsontheindustry,size,andM/Bratiomatchedsample.ThefindingsarebroadlyconsistentwiththoseinpanelA.Thecoefficientestimates,aswellastheeconomicsignificance,becomelarger,whichismostlikelyduetothebetter-matchedsamplethatensuresthatthecontrolfirmsandtreatedfirmsarecomparableacrossmoredimensions.Forinstance,column1predictsthatifthefirmissubjecttotheinundationrisk,thefirmis13.1%morelikelytobecomeanacquirerthanthefirmnotsubjecttotheinundationrisk.Theresultsarerobusttofurthercontrolforthecountyfixedeffectsthatabsorbtheimpactofwithin-county,time-invariantvariables.Toexaminewhethersealevelriseiscorrelatedwithfirms’propensitytobecomeatargetinamergerdeal,theanalysisestimatesasimilarsetofmodelstoexaminethelikelihoodofanygivenfirmbecomingatargetandpresentstheseresultsinTable7.2.SimilartoTable7.1,thetablepresentstheresultsestimatedonthetwomatchedsamplesinpanelsAandBseparately.Overall,theresultsshowasignificantnegativerelationshipbetweenfirms’sealevelriseriskasproxiedbyInundated6ftandtheirprobabilityofbecomingatarget.Forinstance,column1ofpanelAshowsanegativeandstatisticallysignificantcoefficientof-0.205onInundated6ft.Byeconomicsignificance,ifthefirmissubjecttotheinundationrisk,thenthefirmis4.7%lesslikelytobecomeatargetthanthefirmsubjecttonoinundationrisk.PanelBofTable7.2repeatstheseexercisesontheindustry,size,andM/BmatchedsampleandshowsanoverallsimilarpatternasinpanelA.Ineconomicsignificance,ifthefirmissubjecttotheinundationrisk,thenthefirmis5.3%lesslikelytobecomeatargetthanthefirmsubjecttonoinundationrisk.Theanalysisnextrefinestheanalysisandexamineswhetherhighsealevelriseriskacquirersaremorelikelytobuylowsealevelriseriskfirms.Itemploysthesamematchingmethodologyasinearliersectionsandforeachacquirer(target),uptofivecontrolacquirersandtargetsarefound.Next,theanalysisfollowsBenaandLi(2014)toconductthefollowingtest:Mergerpairi,jm,t=+1SLRRiski,jm,t–1+2Xi,j,t–1+t×s+k(orvm)+ei,jm,t(3)whereMergerpairi,jm,tequalsoneifthematchingpairistherealmergerdeal,andzerootherwise.SLRRiski,jm,t–1equalsoneiftheacquirer/targetissubjecttosealevelriserisk/nosealevelriserisk.Theanalysisincludesthefirmcharacteristicsofboththeacquirersandthetargets.Italsocontrolsforavarietyoffixedeffects.TheresultsarereportedinTable7.3.113ManagingClimateChangeRisksTable7.1:SeaLevelRiseandLikelihoodofBecominganAcquirerPanelAAcquirerConditionalLogitLogitOLSIndustryandSizeMatched(1)(2)(3)(4)(5)(6)(7)Inundated6ft0.2060.1840.1860.0470.0460.0320.032(0.038)(0.036)(0.106)(0.008)(0.021)(0.006)(0.019)0.0410.0290.029ClusterDealDealZipcodeDealZipcodeDealZipcodeFixedeffectsDeal,StateState,Year,IndustryState,Year,IndustryDeal,State×YearDeal,State×YearIndustry,State×YearIndustry,State×YearControlvariablesYesYesYesYesYesYesYesNo.ofobservations91,823100,273100,27399,55999,559100,364100,364R-squared0.1380.1400.0610.062PseudoR-squared0.0870.0320.032PanelBAcquirerConditionalLogitLogitOLSIndustry,Size,andM/BMatched(1)(2)(3)(4)(5)(6)(7)Inundated6ft0.5860.5420.5570.0810.0820.0770.080(0.056)(0.055)(0.247)(0.009)(0.042)(0.008)(0.037)0.1310.0560.058ClusterDealDealZipcodeDealZipcodeDealZipcodeFixedeffectsDeal,StateState,Year,IndustryState,Year,IndustryDeal,State×YearDeal,State×YearIndustry,State×YearIndustry,State×YearControlvariablesYesYesYesYesYesYesYesNo.ofobservations80,13283,17883,17883,05783,05783,29383,293R-squared0.1170.1180.0860.087PseudoR-squared0.0680.0510.051M/B=market-to-book,OLS=ordinaryleastsquares.Notes:Thistablereportscoefficientestimatesfromconditionallogit,logit,andOLSmodelsinequation(1).Thedependentvariableisequaltoonefortheacquirer,andzeroforthematchedacquirersthatformthecontrolgroup.ThekeyindependentvariableisInundated6ft,adummyvariableequaltooneifthefirm’sheadquarterswouldbeinundatedifthesealevelriseby6feet,andzerootherwise.PanelApresentsthebaselinespecificationfortheindustryandsize-matchedsample.PanelBpresentsthebaselinespecificationfortheindustry,size,andM/Bratiomatchedsample.Allspecificationsincludefixedeffectsthatarelistedatthebottomofthetable.Robuststandarderrors(clusteredatthedealorzipcodelevel)arereportedinparentheses;,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Theanalysisreportsthemarginaleffectsbelowtherobuststandarderrorincolumns1,2,and3.Source:Authors.ClimateChangeandClimateFinance114Table7.2:SeaLevelRiseandLikelihoodofBecomingaTargetPanelATargetConditionalLogitLogitOLSIndustryandSizeMatched(1)(2)(3)(4)(5)(6)(7)Inundated6ft–0.205–0.252–0.250–0.044–0.054–0.037–0.046(0.122)(0.122)(0.160)(0.023)(0.029)(0.019)(0.025)–0.047–0.039–0.039TargetcontrolvariablesYesYesYesYesYesYesYesClusterDealDealZipcodeDealZipcodeDealZipcodeFixedeffectsDeal,StateState,Year,IndustryState,Year,IndustryDeal,State×YearDeal,State×YearIndustry,State×YearIndustry,State×YearNo.ofobservations8,0929,1809,1809,0499,0499,1839,183R-squared0.2180.2170.1450.147PseudoR-squared0.0440.0390.039PanelBTargetConditionalLogitLogitOLSIndustry,Size,andM/BMatched(1)(2)(3)(4)(5)(6)(7)Inundated6ft–0.609–0.513–0.511–0.061–0.060–0.054–0.054(0.194)(0.200)(0.264)(0.021)(0.027)(0.021)(0.030)–0.053–0.049–0.048TargetcontrolvariablesYesYesYesYesYesYesYesClusterDealDealZipcodeDealZipcodeDealZipcodeFixedeffectsDeal,StateState,Year,IndustryState,Year,IndustryDeal,State×YearDeal,State×YearIndustry,State×YearIndustry,State×YearNo.ofobservations7,8898,9508,9509,0879,0879,0999,099R-squared0.1350.1360.1680.168PseudoR-squared0.1040.0870.086M/B=market-to-book,OLS=ordinaryleastsquares.Notes:Thistablereportscoefficientestimatesfromconditionallogit,logit,andOLSmodelsinequation(1).Thedependentvariableisequaltooneforthetarget,andzeroforthematchedtargetsthatformthecontrolgroup.ThekeyindependentvariableisInundated6ft,adummyvariableequaltooneifthefirm’sheadquarterswouldbeinundatedifthesealevelrisebysixfeet,andzerootherwise.PanelApresentsthebaselinespecificationfortheindustryandsize-matchedsample.PanelBpresentsthebaselinespecificationfortheindustry,size,andM/Bratiomatchedsample.Allspecificationsincludefixedeffectsthatarelistedatthebottomofthetable.Robuststandarderrors(clusteredatthedealorzipcodelevel)arereportedinparentheses;,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Theanalysisreportsthemarginaleffectsbelowtherobuststandarderrorincolumns1,2,and3.Source:Authors.115ManagingClimateChangeRisksTable7.3:SeaLevelRiseandMergerPairPanelAPairConditionalLogitLogitOLSSizeandIndustryMatched(1)(2)(3)(4)(5)(6)(7)Sealevelrise0.2060.1180.1190.0300.0310.0240.025(0.117)(0.059)(0.067)(0.018)(0.021)(0.012)(0.013)0.0400.0220.022AcquirercontrolYesYesYesYesYesYesYesTargetcontrolYesYesYesYesYesYesYesClusterDealDealZipDealZipDealZipFixedeffectsDeal,StateState,Year,IndustryState,Year,IndustryDeal,State×YearDeal,State×YearIndustry,State×YearIndustry,State×YearNo.ofobservations12,30813,43213,35713,10913,03113,16613,091R-squared0.1620.1630.0860.088PseudoR-squared0.0520.0180.019PanelBPairConditionalLogitLogitOLSSize,Industry,andM/BMatched(1)(2)(3)(4)(5)(6)(7)Sealevelrise0.4540.2740.2860.0470.0470.0330.034(0.202)(0.127)(0.162)(0.024)(0.031)(0.014)(0.016)0.1020.0280.029AcquirercontrolYesYesYesYesYesYesYesTargetcontrolYesYesYesYesYesYesYesClusterDealDealZipDealZipDealZipFixedeffectsDeal,StateState,Year,IndustryState,Year,IndustryDeal,State×YearDeal,State×YearIndustry,State×YearIndustry,State×YearNo.ofobservations8,5629,3339,2739,2619,1969,2709,206R-squared0.1620.1630.0990.100PseudoR-squared0.0740.0420.042M/B=market-to-book,OLS=ordinaryleastsquares.Notes:Thistablereportscoefficientestimatesfromconditionallogit,logit,andOLSmodelsinequation(3).Thedependentvariableisequaltoonefortherealmergerdeal,andzeroforthematcheddeal.ThekeyindependentvariableisSLRRiski,jm,t–1equalsoneiftheacquirer/targetissubjecttosealevelriserisk/nosealevelriserisk.PanelApresentsthebaselinespecificationfortheindustryandsize-matchedsample.PanelBpresentsthebaselinespecificationfortheindustry,size,andM/Bratiomatchedsample.Allspecificationsincludefixedeffectsthatarelistedatthebottomofthetable.Robuststandarderrors(clusteredatthedealorzipcodelevel)arereportedinparentheses;,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Theanalysisreportsthemarginaleffectsbelowtherobuststandarderrorincolumns1,2,and3.Source:Authors.ClimateChangeandClimateFinance116Usingvariousempiricalspecifications,theanalysisfindsthatthecoefficientestimatesonSLRRiski,jm,t–1arepositiveandstatisticallysignificant,suggestingthatfirmswithsealevelriseriskareindeedmorelikelytoacquirefirmssubjecttonosealevelriserisk,evenaftercontrollingforavarietyoffirmcharacteristicsofboththeacquirersandthetargets.Theestimateincolumn1ofpanelAsuggeststhatifthefirmissubjecttotheinundationrisk,thefirmis4.0%morelikelytoacquireafirmsubjecttonoinundationrisk.Althoughthemagnitudesbecomesmallerincolumns4–7whenthelinearprobabilitymodel(i.e.,OLS)isemployed,thepositiverelationshipbetweentheSLRRiski,jm,t–1andtheprobabilityofamergerstayspositiveandeconomicallymeaningful.PanelBreportstheresultsofthesametestbyusingtheindustry,size,andM/Bmatchedsample.Thissectioninvestigateshowthemarketrespondstomergerannouncementsbyacquirerswithhighexposuretosealevelrisebeforethemerger.Cumulativeabnormalreturns(CAR)aroundthemergerannouncementperiodsprovideacleanestimationofthemarket’sreceptionofthenewsannouncementandtheunderlyingwealtheffects(LiandPrabhala2007).Ifsealevelriseindeedposesasignificantbusinessrisk,themarketisexpectedtoreactpositivelytoacquisitionannouncementsthatreducesuchrisks.Totestthisconjecture,theanalysisestimatesequation(2),inwhichthedependentvariableistheacquirerannouncement-periodcumulativeabnormalreturnaroundvariouswindows,andthemainindependentvariableistheacquirer’ssealevelriserisk.Itfocusesonseveraleventwindowsstartingfrom3daysbeforetheacquisitionannouncementto3daysafter.Thelongestwindowofexaminationis(-3,+3)whiletheshortestwindowis(-1,+1).Toestimatethecumulativeannouncementreturn,theanalysisfirstusestheFamaandFrench(1993)threefactorsmodelanddailystockreturnsintheestimationwindowof(−255,−46)toestimatethefactorloadings,whicharethenappliedtoreturnsduringtheeventwindowtoestimatetheannouncementCARs.Becausethestockreturnanalysesusethesampleofactualacquisitionannouncements,wehaveadifferentsamplesizethantheoneusedintheanalysisoftheprobabilityofamerger.TheresultsarepresentedinTable7.4.ItisfoundthatthecoefficientestimatesofInundated6ftarepositiveandstatisticallysignificantincolumns1–9.ThecoefficientestimateonInundated6ftincolumn1suggeststhatacquirerswhoseheadquarterswouldbeinundatedifthesealevelrisesby6feethas0.531%higherCARsthanotheracquirersovera2-daywindowaroundthe117ManagingClimateChangeRisksannouncement.Also,thecoefficientestimatesonInundated6ftincreasewiththedaysoftheeventwindowoftheCARs.Overall,thisevidenceisconsistentwithH2a,suggestingthatthemarketrewardsacquirersthatdiversifyawayfromtheirsealevelriseriskthroughacquisitions.Table7.4:MarketReaction—Acquirers’AnnouncementPeriodReturnsCARs[-1,+1][-1,+2][-1,+3][-2,+1][-2,+3][-3,+1][-3,+1][-3,+2][-3,+3](1)(2)(3)(4)(5)(6)(7)(8)(9)Inundated6ft0.4940.6540.7300.6720.8280.9250.6470.8060.900(0.292)(0.317)(0.330)(0.297)(0.308)(0.320)(0.323)(0.327)(0.340)Ln(dealvalue)0.4930.4940.4900.5340.5330.5290.5830.5780.570(0.058)(0.063)(0.066)(0.061)(0.066)(0.068)(0.063)(0.067)(0.070)Allcashdeal0.4160.4000.3740.2700.2620.2300.2070.1920.161(0.121)(0.134)(0.144)(0.129)(0.141)(0.149)(0.140)(0.151)(0.159)Diversifydeal0.1320.0110.0080.1620.0490.0390.1520.0350.023(0.134)(0.150)(0.162)(0.147)(0.163)(0.174)(0.161)(0.175)(0.187)ClusterZipZipZipZipZipZipZipZipZipFixedeffectsIndustry,State×YearIndustry,State×YearIndustry,State×YearIndustry,State×YearIndustry,State×YearIndustry,State×YearIndustry,State×YearIndustry,State×YearIndustry,State×YearNo.ofobservations18,64518,64518,64518,64518,64518,64518,64518,64518,645R-squared0.0990.0940.0900.0960.0920.0880.0950.0930.088CARs=cumulativeabnormalreturns,OLS=ordinaryleastsquares,R&D=researchanddevelopment,ROA=returnonassets.Notes:ThistablereportscoefficientestimatesforOLSregressionsinequation(2)foracquirers.WeusetheFamaandFrench(1993)threefactorsmodelanddailystockreturnsinthewindow(–255,–46)toestimatethedealannouncementCARs.WeusetheCenterforResearchinSecurityPricesvalue-weightedindexasthebenchmarkportfolio.ThekeyindependentvariableisInundated6ft,adummyvariableequaltooneifthefirm’sheadquarterswouldbeinundatedifthesealevelriseby6feet,andzerootherwise.ThedealCharacteristicsincludeLn(Dealvalue),Allcashdeal,andDiversifydeal.EventfirmcharacteristicsareFirmsize,Market-to-book(M/B),Leverage,Dividendpayer,Ln(TotalSales),ROA,R&D,Capex,Quickratio,Non-debttaxshield,andCashflowvolatility.Allspecificationsincludefixedeffectsthatarelistedatthebottomofthetable.Robuststandarderrors(clusteredattheziplevel)arereportedinparentheses;,,anddenotesignificanceatthe10%,5%,and1%levels,respectively.Source:Authors.ClimateChangeandClimateFinance1187.5ConclusionEffectivemanagementofenvironmentalriskshasbecomecentraltothelong-termsustainabilityandsuccessofmodernbusinesses.Whiletherearemanytypesofenvironmentalrisks,theinundationrisksassociatedwithsealevelrisethatarebothuncertainandsignificantposeauniquechallengeforfirms.Thechapterdevelopsandteststhehypothesisthatfirmsmanagethesealevelriseriskthroughacquisitions.Usingacomprehensivesampleofpubliclytradedfirmsbetween1986and2017,theanalysisfindsthat,inthecross-section,firmsexposedtohighsealevelriseriskhaveahigherprobabilityofbecomingacquirersbutasignificantlylowerprobabilityofbecomingtargets.Also,itfindsthatthemarketrewardsacquisitionsbyfirmswithhighsealevelriseriskexposure,asasignificantandpositiverelationshipisobservedbetweentheacquirers’cumulativeannouncementreturnandpre-mergersealevelriserisk.Itisalsofoundthatthispositiverelationismorepronouncedforfirmswithhigheranalystcoverage.Finally,theanalysisfindsthatsea-level-rise-inducedmergerstendtocompletefaster,andthatpost-merger,thecombinedfirmexperiencesagreaterincreaseinanalystcoverage;forecastprecision;andenvironmental,social,andgovernancescorewhentheacquiringfirmhasahighsealevelriseexposurebeforethemerger.Whiletheresultsprovidethefirstsystematicevidenceofhowenvironmentalrisksassociatedwithsealevelrisesshapeandinfluencefirmbehaviorinthemarketforcorporatecontrol,manyotheraspectsofsuchinteractionremainunexplored.Adeeperunderstandingofhowdifferenttypesofenvironmentalrisksdifferentiallyaffectfirms’investment,financing,andoperationalpoliciesremainsafruitfulareaforfutureresearch.119ManagingClimateChangeRisksReferencesAcemoglu,D.,U.Akcigit,D.Hanley,andW.Kerr.2016.TransitiontoCleanTechnology.JournalofPoliticalEconomy.124(1).pp.52–104.Bai,J.,W.Jin,andM.Serfling.2022.ManagementPracticesandMergersandAcquisitions.ManagementScience.68(3).pp.2141–2165.Baker,M.,D.Bergstresser,G.Serafeim,andJ.Wurgler.2018.FinancingtheResponsetoClimateChange:ThePricingandOwnershipofUSGreenBonds.NBERWorkingPaper.No.w25194.NationalBureauofEconomicResearch.Balch,O.2016.Sea-LevelRises:WhyFloodingIstheNextBigBusinessRisk.TheGuardian.18March.Bansal,R.,M.Ochoa,andD.Kiku.2016.ClimateChangeandGrowthRisks.NBERWorkingPaper.No.w23009.NationalBureauofEconomicResearch.Barnett,M.,W.Brock,andL.P.Hansen.2020.PricingUncertaintyInducedbyClimateChange.TheReviewofFinancialStudies.33(3).pp.1024–1066.Bena,J.andK.Li.2014.CorporateInnovationsandMergersandAcquisitions.TheJournalofFinance.69(5).pp.1923–1960.Bernstein,A.,M.T.Gustafson,andR.Lewis.2019.DisasterontheHorizon:ThePriceEffectofSea-LevelRise.JournalofFinancialEconomics.134(2).pp.253–272.Bolton,P.andM.Kacperczyk.2020.DoInvestorsCareAboutCarbonRisk?NBERWorkingPaper.No.w26968.NationalBureauofEconomicResearch.Broughton,K.2019.CFOsAreUnderestimatingtheFinancialRisksofClimateChange,ExecutivesSay.WallStreetJournal.11June.https://www.wsj.com/articles/cfos-are-underestimating-the-financial-risks-of-climate-change-executives-say-11560276836.Devos,E.,P.R.Kadapakkam,andS.Krishnamurthy.2009.HowDoMergersCreateValue?AComparisonofTaxes,MarketPower,andEfficiencyImprovementsAsExplanationsforSynergies.TheReviewofFinancialStudies.22(3).pp.1179–1211.ClimateChangeandClimateFinance120Fama,E.F.andK.R.French.1993.CommonRiskFactorsintheReturnsonStocksandBonds.JournalofFinancialEconomics.33(1).pp.3–56.Fee,C.E.,C.J.Hadlock,andJ.R.Pierce.2012.WhatHappensinAcquisitions?EvidencefromBrandOwnershipChangesandAdvertisingInvestment.JournalofCorporateFinance.18(3).pp.584–597.Giglio,S.,M.Maggiori,J.Stroebel,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igure8.1:SustainableInvestingintheUnitedStates,1995–2020,,,,,,,,,Totalassets(billion)ESGincorporationOverlappingstrategiesShareholderadvocacyTraditionalistsviewriskasunfavorable.TheCambridgedictionarydefinesriskas“exposingtohazardordanger.”AnimproveddescriptionofriskisgivenbytheChinesesymbolfor“crisis,”whichinthefirstpartrefersto“danger”andthesecondto“opportunity,”makingriskacombinationofdangerandopportunity(Roggi,Damodaran,andGarvey2012).Soriskmanagementisreducingexposuretodownsideriskandmaximizingexposuretoupsidepotential(Roggi,Damodaran,andGarvey2012).Economistshavelongrecognizedthatinvestorsconsiderdownsideriskandupsidegainsdifferently,showingmoresensitivitytodownsidelossesthanupsidegainsandthereforedemandingapremiumforholdingassetsthatcovarywiththemarketwhenitdeclines(Ang,Chen,andXing2006).AlthoughithasbeenestablishedthatESGcanserveasariskreductionmechanism,deliberationcontinuesastowhetherESGcreatesupsidepotentialforinvestorswhileprotectingagainstdownsiderisk.Thisstudythustakesacontemporaryrisk-takingperspectiveonESGtoexaminewhetherESGactivitiesaffectdownsideandupsideriskdifferently.Throughriskmanagementandstakeholdertheory,theanalysisexplainstherelationshipbetweenESGandfirmrisk(separatedintoitsdownsideandupsidecomponents).Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks125Fromthetraditionalriskmanagementperspective,companiespayattentiontothoseactivitiesthatarelikelytocausedamageandtakeinitiativestominimizefinancialexposure.Forexample,firmsinvolvethemselvesinsociallyandenvironmentallyresponsiblepracticestolegitimizetheiractionsandtoavoidfines,penalties,orreputationaldamage(Godfrey2005;KytleandRuggie2005).Theanalysisherearguesthatasariskmanagementstrategy,ESGperformanceisexpectedtoreduceoverallfirmrisk.Further,stakeholdertheoryrationalizesthatESGactivitiesreducefinancialexposurebydevelopinghealthyrelationswithstakeholders.Thisstrongbondmotivatesstakeholderstoplaytheirroleinfirmsuccesswiththeresourcestheyown(Freeman1984,2010).Thus,companieswithhighESGfacelesslikelihoodofboycotts,badmouthing,orscandals,whichcandecreasedownsiderisk.Italsohelpsfirmsdevelophealthyrelationshipswiththefinancialcommunityandgovernment(McGuire,Sundgren,andSchneeweis1988),lessencapitalconstraints(Cheng,Ioannou,andSerafeim2014),buildgoodwill(CornellandShapiro1987),improvethecompany’sattractivenessasanemployer,andretainaskilledworkforce(GreeningandTurban2000).Thisallincreasesupsidepotential.Itmayhappenthatcompanyinsiderswillinglycarryoutsociallyresponsiblepractices,whosecostsaregreaterthanbenefitstoreceiverecognitionorappreciation.Thisadditionalcostoverbenefitstranslatestolowerreturns(BarneaandRubin2005).Therefore,wearguethatESGactivitiesoffirms,havinghealthyrelationshipswithstakeholders,maynotonlylowerdownsideriskbutalsoincreaseordecreasetheupsidegainsforinvestors(Figure8.2).ESG=environmental,social,andgovernance.Source:Authors.Figure8.2:Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisksDownsideriskScenarioESGactivitiesmayreducedownsideriskbutincreaseupsideriskScenarioESGactivitiesmayreducebothdownsideriskandupsiderisk–evevUpsidegainClimateChangeandClimateFinance1268.2GapsintheAcademicLiteraturePreviousacademicresearchontheESGandfirmriskrelationshipreportsmixedresults.ForoverallESGandfirmrisk,themajorityofstudiesshowanegativerelationship(e.g.,Albuquerque,Koskinen,andZhang2019;LoofandStephan2019;Boubakeretal.2020);andBecchetti,Ciciretti,andHasan(2015)findapositiveresult,whileothersreportnorelationship(e.g.,Sassen,Hinze,andHardeck2016).Likewise,theliteraturehasdrawnunclearconclusionsabouttherelationshipbetweenindividualESGpillars(EandS)andfirmrisk.1Theseinconsistentfindingsmaybeduetodifferencesinmethodologicalapproaches(Gillan,Koch,andStarks2021).Mostimportantly,theearlierclassificationoffirmriskintosystematicandidiosyncraticriskislessintuitiveforinvestorsbecauseitfailstodifferentiatebetweenthepositiveandnegativedeviationofreturns.Hence,dividingfirmriskintoitsdownsideandupsidefluctuationsmayaccuratelycaptureinvestors’riskpreferences(Harlow1991).Inarecentreview,Gillan,Koch,andStarks(2021)notethatamongallESG-firmriskrelatedstudies,onlytwostudies(Hoepneretal.2018;Ilhan,Sautner,andVilkov2020)haveuseddownsiderisk:Hoepneretal.(2018)testtheimpactofESGshareholderengagementondownsideriskwhileIlhan,Sautner,andVilkov(2020)examinetheinfluenceofcarbonemissionsontailrisk.TheanalysishereextendsthisstreamofliteraturebyexaminingforthefirsttimetheeffectofESGactivitiesonfirmrisk,whichisdividedintodownsideandupsiderisks.8.3ResearchMethod8.3.1DataandSampleTheinitialsampleincludes5,511firm-yearobservationsthatcompriseallS&P500companieswhoseESGdataareavailableintheRefinitivdatabase1Forinstance,Bouslah,Kryzanowski,andM’Zali(2013)findapositiverelationshipbetweenenvironmental(E)andfirmriskforS&P500firmsbutanegativelinkbetweenthetwofornon-S&P500firms.Contradictoryfindingsarealsoobservedforthesocial(S)pillar,whereBouslah,Kryzanowski,andM’Zali(2013)highlightanegativeaswellasnorelationwithfirmriskfordifferentdimensionsofsocialperformance,whileLu(2016)findsaninverselinkagebetweenSandfirmrisk.Thegovernance(G)pillarhasalsobeenfoundtohavepositive(e.g.,FerreiraandLaux2007),negative(e.g.,Bouslah,Kryzanowski,andM’Zali2013),ornorelation(e.g.,Sassen,Hinze,andHardeck2016)withfirmrisk.Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks127for2008–2020.FirmcharacteristicsandstockpricedataarealsosourcedfromtheRefinitivdatabase.Theanalysisexcludesfinancialfirmsbecauserisk-takingmaydifferforfinancial(suchasbanks)andnonfinancialfirms.Asafinalsample,theanalysisretains4,451firm-yearobservationsforallfirmsconditionedupontheavailabilityofdataforallvariables.Allthecontinuousvariablesare“winsorised”2at1stand99thpercentiles.8.3.2MeasuringEnvironmental,Social,andGovernancePerformanceTheanalysisusestheESGscoreprovidedbyRefinitivtomeasuretheESGperformancefollowingrecentESGstudies(e.g.,Dingetal.2021;andShiandVeenstra2021).AsshowninFigure8.3,thescorecapturesfirm-levelESGinformationonmorethan630measures,whicharethengroupedinto10differentcategories,namelyemissions,resourceuse,innovation(environmentalcategories);humanrights,productresponsibility,community,workforce(social),management,corporatesocialresponsibilitystrategy,andshareholders(governance).Thesecategoriesarefurtherformulatedintothreeindividualpillars—environmental,social,andgovernance—thatultimatelyformulateanoverallESGscorewhichrangesfrom0(poorperformance)to100(excellentperformance).2Winsorizationisastatistcialprocedureusedtolimittheextremevaluesinthedatatoreducetheundueinfluenceofoutliersontheregressionestimates.CSR=corporatesocialresponsibility;ESG=environmental,social,andgovernance.Source:Refinitivdatabase,2022(accessed15January2023).Figure8.3:RefinitivEnvironmental,Social,andGovernanceScoreEnvironmentalResourceuseEmissionsInnovationManagementShareholdersCSRstrategyWorkforceHumanrightsCommunityProductresponsibilitySocialGovernancefromcompanypublicdisclosureESGscorescalculatedusingsubsetofmetricsESGScoreGOVscoreSOCscoreENVscoreESGmeasurescollectedandcalculatedClimateChangeandClimateFinance128Table8.1showstheincreasingtrendintheaveragevalueofoverallESGanditsindividualpillarsfrom2008to2020.OverallESGscoremeanwas45%in2008,reaching60.5%in2020.Amongtheindividualpillars,theE(S)scorewasatitslowestof35%(46.7%)in2008.However,companiesstartedtorecognizetheimportanceofbeinginvolvedinenvironmentally(socially)friendlypractices,whichresultedinthehighestE(S)scoreof56.3%(65.5%),in2020.Further,thesamplefirmshaveaveragegovernanceperformanceofabove50%inallyears.ThiswaslikelyduetotheintroductionoftheSarbanes-OxleyActin2002.Cohen,Krishnamoorthy,andWright(2010)alsofoundasolidpost-actcorporategovernanceenvironment.Overall,theincreaseinESGperformancemaybecreditedtotheintroductionofPrinciplesoftheResponsibleInvestmentin2006,whichisbasedonareport“WhoCaresWins,”whichmentionedthatincorporatingESGissuesintocapitalmarketsgeneratessustainablemarkets,resultsingoodbusinessperformance,andleadstopositivesocietaloutcomes(TheGlobalCompact2005).Table8.1:Environmental,Social,andGovernanceScoresbyYearYearNESGESG200824345.0235.0446.6651.29200933647.0538.3848.6152.45201034948.6740.9750.1752.88201135649.7442.2651.5853.27201235950.3243.5752.0453.28201335450.8443.3953.0453.66201437451.3244.4153.2853.62201539853.3045.0954.8357.32201640455.7146.7457.7659.17201741357.1549.3359.5259.30201841458.6252.0861.1659.47201940260.8054.8963.6461.0120205460.4856.3065.5356.36E=environment;ESG=environmental,social,andgovernance;G=governance;N=numberofobservations;S=social.Source:Authors.8.3.3MeasuringFirmRiskTheanalysismeasuresfirmriskusingthreeproxies:totalrisk,downsiderisk,andupsiderisk,followingAli,Liu,andSu(2022).Inthefirstmeasure,totalriskdepictstheoverallvariationinstockreturns.FollowingpreviousEnvironmental,Social,andGovernancePerformanceandDownsideandUpsideRisks129studies,suchasAlbuquerqueetal.(2020)andCholletandSandwidi(2018),totalrisk(TR)ismeasuredbytheannualizedstandarddeviationofdailystockreturns.Dailystockreturnsforeachfinancialyeararecalculatedusingthefollowingformulaforcontinuouslycompoundedreturns:Rit=ln()(1)wherePt–1andPtrefertotheclosingpricesforanytwosuccessiveperiodstandt–1,Ritdenotesdailystockreturns,andlnisthenaturallogarithm.Firmriskmeasuredthroughstockreturnvolatilitydoesnotdistinguishthepositiveandnegativedeviation,makingthismeasurelesshelpfulforinvestors.Separatingfirmriskintodownsideandupsidefluctuationscapturesinvestors’riskpreferences(Harlow1991).Therefore,thesecondproxyisdownsiderisk,whichmeasuresthepossiblelossesoveraspecificperiodatagivenconfidencelevel(Ali,Liu,andSu2022).Theanalysismeasuresdownsiderisk(DR)usingconditionalvalueatrisk,theaveragelossthatincursfortheworstpossiblecasesoveragiventimeperiod,calculatedasfollows:DR=(2)whereRijisthedailyreturnsforfirmiinyeart;VARitisthe5thpercentilevalueofdailyreturnsatthe95%confidencelevel(lefttail);nisthenumberofdailyreturnsbelowVARit.Tofacilitateinterpretation,thevalueofDRistakenaspositiveintheempiricalanalysis.Thethirdmeasureisupsiderisk,whichcapturesthepossiblegainsoveraspecifictimehorizonatagivenconfidencelevel.Itismeasuredlikedownsiderisk,withthemaindifferencebeingthatupsideriskisestimatedusingtherighttail(gains)ofstockreturns,whereasthedownsideriskshowsthelefttail(losses).Theanalysismeasuresupsiderisk(UR)usingconditionalvalueatrisk.Itistheaveragegainthatincursforthebestpossiblecasesoveragiventimeperiod.UPiscalculatedasfollows:UR=(3)whereRijisthedailyreturnsforfirmiinyeart;UPitisthe5thpercentilevalueofdailyreturnsatthe95%confidencelevel(righttail);nisthenumberofdailyreturnsaboveUPit.PtPt–1nj=1Rij/nifRij<–VARitnj=1Rij/nifRij>+UPitClimateChangeandClimateFinance1308.3.4EstimationModelTotesttheeffectofESGonfirmrisk,theanalysisdevelopstheregressionEquation(4)asfollows:RISKit=0+1ESGit+2SIZEit+3LEVit+4R&Dit+5PROFit+6CASHit+7LIQit+8CAPXit+9SALESGit+j+t+uit(4)wheresubscriptidenotesindividualfirms(i=1,2,3…505)andtreferstothetime(t=2008,2009,…,2020),denotesthecoefficientstobeestimatedanduitistheerrorterm.Toaccountforindustry-wideandyearfluctuationsinfirmrisk,theanalysisaddedyear-fixedeffects(t),andindustry-fixedeffects(j)inallspecifications.Riskitiseithertotalrisk(TR),upsiderisk(UR),ordownsiderisk(DR)andESGitiseitheroverallscore(ESG)orindividualpillars(E,S).3Toconservespace,definitionsofcontrolvariablesareoutlinedinTable8.2.Table8.2:VariableDefinitionsVariable(Notation)DefinitionsEnvironmental,social,andgovernance(ESG)AcomprehensivescoreofcompanyESGperformance,whichisbasedonreportedinformationrelatedtoitsindividualpillars(E,S,G).Environmental(E)Environmentalpillar(E)reflectsthecompany’sperformancerelatedtoemissionreduction,resourceuse,andgreeninnovation.Social(S)Socialpillar(S)collectstheinformationwhetherthefirmpromotedhumanrights,workedoncommunitydevelopment,consideredthewelfareofworkforce,andfulfilledtheproductresponsibilitiesforcustomers.Totalrisk(TR)AnnualizedstandarddeviationofdailystockreturnsDownsiderisk(DR)Conditionalvalueatrisk(VAR):Anaverageofthe5%extremelossesifVARmeasuredatthe95%confidencelevelUpsiderisk(UR)Conditionalupsidepotential:Anaverageofthe5%bestreturnsifVARmeasuredatthe95%confidencelevelFirmsize(SIZE)NaturallogarithmoftotalassetsoffirmProfitability(PROF)RatioofnetincomedividedbytotalassetsLeverage(LEV)TheratiooffirmtotaldebtdividedbyitstotalassetsLiquidity(LIQ)RatioofcurrentassetstocurrentliabilitiesCapitalexpenditures(CAPX)RatiooftotalcapitalexpendituresdividedbytotalassetsResearchandDevelopmentintensity(R&D)RatiooftotalR&DexpensesdividedbytotalassetsCashHolding(CASH)Cashandshort-terminvestment/totalassetsSalesGrowth(SALESG)Salesrevenuedividedbyprioryearsalesrevenueminusone,multipliedby100Source:Authors.3TheanalysisexcludesGfactorfromtheregressionmodelbecausetherelationshipofGfactorwithdownsideandupsideriskshasalreadybeenexaminedinAli,Liu,andSu(2022).Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks1318.4EmpiricalResultsandDiscussion8.4.1DescriptiveStatisticsTable8.3providesthedescriptivestatisticsforallvariablesconsistingofrisk-takingmeasures,ESGvariables,andfirmcharacteristicsinPanelsA,B,andC,respectively.First,panelAofTable8.3showsthatmeanTRis1.82%andDRandURhavemeansof4.17%and4.06%,respectively.InpanelBofTable8.3,ESGhasameanvalueof52.96%,whereasmeanE,S,andGare45.39%,55.01%,and55.90%,respectively.Amongthethreepillars,Ehasthelowestmeanvalue.TheaverageESGscorereportedbyHarjotoandLaksmana(2018)fortheUSsamplefirmswas27.20%,whichissubstantiallylowerthanouraverageESGscoreof52.97%.ThisdifferencecanbeattributedtotheirESGdatasourceofMSCIKLDandsampleperiodfrom1998to2011.AccordingtoWong,Table8.3:DescriptiveStatisticsNMeanStd.Dev.p25Medianp75minmaxPanelA:FirmRiskVariablesTR4,4561.8150.851.241.5882.1210.786.171DR4,4504.172.092.793.644.931.6315.12UR4,4504.061.992.723.514.771.6614.30PanelB:ESGVariablesESG4,45652.9619.6237.9354.8168.8711.0088.61E4,45545.3928.7319.7350.0670.410.0092.36S4,45555.0121.3037.6655.7071.6811.7994.67G4,45655.9021.9939.6658.6373.506.2293.73PanelC:ControlVariablesLIQ4,4561.861.241.071.492.240.377.52SIZE4,45616.411.2515.4916.4217.2912.7120.52CASH4,4560.140.150.030.090.200.000.67CAPX4,4564.774.001.913.556.510.0022.25SALESG4,4568.1415.920.596.0812.86–35.9888.96PROF4,4568.317.004.357.6711.92–19.3231.05LEV4,45628.5917.6716.2527.5238.520.0090.34R&D4,4560.030.050.000.000.040.000.28Cash=cashholding;CAPX=capitalexpenditures;DR=downsiderisk;E=environment;ESG=environmental,social,andgovernance;G=governance;LEV=leverage;LIQ=liquidity;PROF=profitability;R&D=researchanddevelopmentintensity;S=social;SALESG=salesgrowth;SIZE=firmsize;TR=totalrisk;UR=upsiderisk.Notes:Thistabledisplaysthestatisticaldescriptionincludingnumberofobservations(N),mean,standarddeviation(std.dev.),firstquartile(p25),median,thirdquartile(p75),minimum(min)andmaximum(max)valuesof4,456firmyearobservationsforallthevariables.SeeTable8.1forvariabledetails.Source:Authors.ClimateChangeandClimateFinance132Brackley,andPetroy(2019),ThomsonReuters,MSCIKLD,Sustainalytics,andBloombergareamongthetop-fourESGratingproviders.However,theirmeasurementframeworkssignificantlydiffer,whichleadstodiscrepanciesintheirESGratings/scores(Widyawati2020).PanelCofTable8.3presentsthecontrolvariableswheremeanliquidity(LIQ)is1.86%,indicatingthatthefirm’sabilitytocovercurrentliabilitiesfromcurrentassetswhilemeancashholding(CASH)is0.14%showingthatsamplefirmskeeplesscashandshort-terminvestment.Meanfirmsize(SIZE)is16.41andillustratesthatsamplefirmshaveaveragetotalassetsof$16.41million.Thecapitalexpenditureratio(CAPX)is4.77onaverageandprofitability(PROF)rangesfromlossesof19.32%togainsof31.05%.Further,themeanvalueof28.59%forleverage(LEV)highlightsthefinancialhealthofcompanies.ItwasinterestingtonotethatmorethanhalfofthefirmsdidnotengageinR&Dactivities,asthemedianvalueofR&Dintensity(R&D)iszero.ThisfigureisconsistentwithpriorstudiesandimpliesthatR&Ddistributionishighlyright-skewed(Kothari,Laguerre,andLeone2002).TheanalysisreplacedmissingR&DexpenditurevaluestocalculateR&DintensityfollowingthesuggestionofKohandReeb(2015).8.4.2MultivariateRegressionTable8.4presentstheresultsofthepooledOLSregressionestimatedusingEquation(4),whereESGisaproxyforESGperformance,andTR,DR,andURaremeasuresoffirmrisk.TheresultsforTR,DR,andURarereportedincolumns1to3.Year-fixedeffectsandindustry-fixedeffectsarecontrolledTable8.4:Environmental,Social,andGovernanceandFirmRisk(1)TR(2)DR(3)URESG–0.00338–0.00676–0.00781(–3.29)(–2.68)(–3.46)ControlsYesYesYesYearYesYesYesIndustryYesYesYesConstant4.69710.7111.16(13.22)(13.15)(13.77)N4,4514,4454,445Adj.R20.6320.5920.632DR=downsiderisk;ESG=environmental,social,andgovernance;TR=totalrisk;UR=upsiderisk.Notes:Thistableshowstheresultsofpooledordinaryleastsquares(OLS)betweenESGandtotalfirmrisk(TR),downsiderisk(DR),andupsiderisk(UR).Thet-statisticsinparenthesesarebasedonrobuststandarderrors.Superscripts,,indicatestatisticalsignificanceat1%,5%,and10%levels,respectively.SeeTable8.2forvariabledetails.Source:Authors.Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks133for,inregressions.Thet-statisticsarecalculatedbasedonrobuststandarderrors.Equation(4)iswellfittedasF-statisticisstatisticallysignificant,andadjustedR-squareis63.2%,59.2%,and63.2%forTR,DR,andUR,respectively.Overall,theresultsshowthatESGhasanegativeinfluenceonfirmriskastheESGcoefficientisnegativeandstatisticallysignificantatthe5%levelforTR.ThisimpliesthathighESGperformancedecreasestheoverallriskinfirms.ThesefindingsareconsistentwithJoandNa(2012)andHarjotoandLaksmana(2018),whouseMSCIKLDforESG.Likewise,thecoefficientonESGperformanceisnegativeandsignificantatleastthe5%levelforDRandUR.TheseresultsshowthatreducingfirmriskthroughhighESGperformanceisrelatedtodownsideriskandupsidepotential.Hoepneretal.(2018)providecorroborativeevidencethatESGshareholdersengagementreducesdownsiderisk.However,theanalysisdoesnotfindevidenceforanincreaseinupsidereward.Itmaybethatcompaniesaredoinggoodbutnotdoingwell,wheremanagerscarryoutsociallyresponsibleactivitiestoreceiverecognitionorappreciationforbeingsociallyresponsible.Iftheseactivitiesarenotcost-effective,thentheexcesscostoverbenefitsisrevealedthroughlowershareholderreturns(StatmanandGlushkov2009).ItalsosuggeststhatESGinvestorsmaybehappytoacceptlowerrealizedreturnsforafirm’scompliancewithsocialnorms(HongandKacperczyk2009)asfarastheycanreducerisk.AnotherreasonfornotfindingsupportforanincreaseinupsiderewardcanbethatthishighESGperformancemaysavethefirmfromgreaterexposuretoriskwhileholdingthefundamentaltrade-offbetweenriskandreturn(Lööf,Sahamkhadam,andStephan2022).TheanalysisalsocalculatesthemarginaleffectsofEandStoseewhichofthetwopillarsisdrivingtheresultsforthedifferentfirmriskmeasures.AsseeninTable8.5,theSpillar’smarginaleffectproportion(%ME)isgreaterthanEforallfirmriskmeasures.ThisindicatesthatmostofthenegativeimpactofESGonfirmriskisattributedtothesocialdimensionofESG.DumitrescuandZakriya(2021)providearationaleforwhythissocialdimensionmattersbyarguingthatsocialinitiativesaremainlyaimedatprimarystakeholders(suchasemployeesandcustomers),andthemarketandinvestorscaneasilyassesstheircostsandbenefits.Also,firmsandtheirmanagershavethemostpowerovertheseprimarystakeholders.Incomparison,environmentalinitiativeshavelong-termorientationsandarechallengingforinvestorstounderstand.Sincethewindowofanalysisisovertheshorttomediumterm,itmaybewhyESGanditspillarsreducedownsideriskbutnotincreaseupsidereturn,andtheimpactsaredrivenbysocialconcerns.ClimateChangeandClimateFinance1348.5ConclusionandPolicyImplicationsThisstudyexamineswhetheroverallESGanditspillarsaffectdownsideandupsideriskdifferently.Intuitively,highESGperformanceshouldreducedownsideriskandincreaseupsidegainsatthesametime.Lossaversionbehaviorandconcernforpersonalbenefitsmayengageconservativestrategiesthatreducedownsideriskatthecostofupsidegains.ItwouldseemthatthisanalysisisthefirsttountanglethedifferentialimpactofESGondownsideandupsiderisks.Usingasampleof4,456USfirm-yearobservationsfor2008–2020,thepooledOLSestimationshowsthatESG(overall/pillars),measuredbyThomsonReutersESG(overall/pillars)scoresinpercentage,lowerrisktakinginfirmsintermsoftotalrisk,downside,andupsiderisk.ThisfindinghasimplicationsforregulatorswhodesignregulationsanddisclosurerelatingtoESGactivities.ThestudysuggeststhatESGactivitiescanbeadevicetominimizeunanticipatedlossesbutmaynotbeaseffectivetoimprovethelikelihoodofunanticipatedgains.Fromabroaderregulatoryperspective,thesefindingsimplythatESG-relatedregulationsshouldbedesignedsothatfirmsadoptingESGactivitiescannotonlyprotectinvestorsfromdownsiderisk,butalsoprovideanopportunitywithsignificantupsidepotential.Therefore,thestudycallsforESGregulationsthataimtominimizeTable8.5:MarginalEffectsofEnvironmentandSocialonFirmRisk(1)TR(2)DR(3)URESGME–0.00338–0.00676–0.00781p-value0.0010.0070.001%ME–0.285–0.162–0.192EME–0.00147–0.00229–0.00443p-value0.0000.0250.000%ME–0.124–0.055–0.109SME–0.00191–0.00384–0.00462p-value0.0000.0050.000%ME–0.161–0.092–0.114DR=downsiderisk;E=environment;ESG=environmental,social,andgovernance;S=social;TR=totalrisk;UR=upsiderisk.Notes:Thetableshowsthemarginaleffects(ME)frompooledordinaryleastsquares(OLS)showninTables8.3and8.4.TheMErepresentsabilityofESG,E,andStopredictfirmriskmeasures(column1tocolumn3).Thepercentagemarginaleffect(%ME)iscomputedas100(ME/meanofdependentvariable).EachsetofME,p-value,and%MErepresentsoneregression.SeeTable8.1forvariabledetails.Source:Authors.Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks135thecostandmaximizethebenefitsofadoptingESGactivitiesforfirms.Inpractice,thiscanbeachievedthroughanappropriatebalancebetweenpenalizingsociallyirresponsiblefirms(lawsuits)andrewardingsociallyresponsiblefirms(subsidies).Specifically,forenvironmentalactivities,policiesshouldbeintroducedtoencouragefirmstoinvestinenvironmentalactivities,includingbettermonitoringbyclimateagenciesonoutputsfromtheseactivitiessuchasreducingcarbonemissionsandinvestmentinrenewableenergy.Sincethereisnostandardizedframeworkforclimatechangerelateddisclosurewhichaddressesenvironmentalrisksandopportunities,arecommendationistoencouragedisclosureundertheTaskForceonClimate-RelatedFinancialDisclosuresframework,ormakedisclosuresmandatory,aseconomiessuchasSwitzerland;theUnitedKingdom;HongKong,China;Japan;Singapore;andNewZealand;andmembersoftheEuropeanUnionhavedone.TheTaskForceonClimate-RelatedFinancialDisclosures’levelsongovernance,riskmanagement,strategyandmetricsandtargetscanhighlightrisksandopportunitiesinclimatechange,allowingmanagerstobetterunderstandtheimpactonthefirmandprovidebetterinformationforinvestorsandotherstakeholders.Bettermonitoringofcarbonemissions,includingpoliciestohelpfirmsinrecordkeepingandmanagementofcarbonemissionreductiontargetscanbeencouragedandsupportedthroughgovernmentfundingandgrantschemes.Forsocialpoliciesinparticular,policiescanbeintroducedtorequirebetterdisclosureofsocialactivitiesandtheidentificationofmodernslaveryrisksinoperationsandsupplychains.Inmodernslaverydisclosureofrisksandactions,legislationcanbeintroducedforfirms,especiallylargefirms,topreparemodernslaverydisclosurestatementsashasbeendoneinAustraliaandtheUnitedKingdom,toidentifyandaddresstheserisks.Suchlegislationisespeciallybeneficialtohigh-riskcountriesengaginginconflictmineralsandtextiles.Othersocialactivities,suchasemployeetrainingschemes,canbeintroducedviagrantsandotherfundingschemes,andawardscanbeestablishedforfirmsthatprioritizeemployeewelfare.Whilelessattentionispaidtosocialperformanceinmanycountries,withthefocusworldwideonenvironmentalperformance,thestudyhereshowsthatfirmsshouldalsopayparticularattentiontotheirsocialperformance,andpoliciesandregulationscanbelaunchedtosupporttheseactivities.ClimateChangeandClimateFinance136Suchenvironmentalandsocialpoliciesshouldnotbedesignedtoincreasecompliancecosts,createatickboxmentality,orpromotegreenwashingbehavior,whichprovideinvestorswithprotectionfromdownsideriskatthecostofupsidegains.Instead,thesepoliciesshouldbedesignedtominimizecompliancecostsandnourishaculturewherefirms“walkthetalk.”Theyshouldencouragegenuineengagementinenvironmentalandsocialactivitiestoprotecttheplanetandpeople,whichisultimatelyfavoredbythemarket.Thiswouldrewardinvestorswithreduceddownsideriskandincreasedupsidepotential.Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks137ReferencesAlbuquerque,R.,Y.Koskinen,S.Yang,andC.Zhang.2020.ResiliencyofEnvironmentalandSocialStocks:AnAnalysisoftheExogenousCOVID-19MarketCrash.TheReviewofCorporateFinanceStudies.9(3).pp.593–621.Albuquerque,R.,Y.Koskinen,andC.Zhang.2019.CorporateSocialResponsibilityandFirmRisk:TheoryandEmpiricalEvidence.ManagementScience.65(10).pp.4451–4469.Ali,S.,B.Liu,andJ.J.Su.2022.DoesCorporateGovernanceHaveaDifferentialEffectonDownsideandUpsideRisk?JournalofBusinessFinanceandAccounting.49(9–10).pp.1642–1695.Ang,A.,J.Chen,andY.Xing.2006.DownsideRisk.ReviewofFinancialStudies.19(4).pp.1191–1239.Barnea,A.andA.Rubin.2005.CorporateSocialResponsibilityasaConflictBetweenOwners,SocialPerformanceMetricsConference.HaasCenterforResponsibleBusiness.Becchetti,L.,R.Ciciretti,andI.Hasan.2015.CorporateSocialResponsibility,StakeholderRisk,andIdiosyncraticVola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4.Shi,W.andK.Veenstra.2021.TheModeratingEffectofCulturalValuesontheRelationshipBetweenCorporateSocialPerformanceandFirmPerformance.JournalofBusinessEthics.174(1).pp.89–107.Statman,M.andD.Glushkov.2009.TheWagesofSocialResponsibility.FinancialAnalystsJournal.65(4).pp.33–46.Environmental,Social,andGovernancePerformanceandDownsideandUpsideRisks141USSIF.2020.ReportonUSSustainable,ResponsibleandImpactInvestingTrends.Washington,DC.https://www.ussif.org/files/Trends%20Report%202020%20Executive%20Summary.pdf.Widyawati,L.2020.MeasurementConcernsandAgreementofEnvironmentalSocialGovernanceRatings.AccountingandFinance.61(S1).pp.1589–1623.Wong,C.,A.Brackley,andE.Petroy.2019.RatetheRaters2019:ExpertViewsonESGRatings.TheSustainabilityInstitutebyERM.https://www.sustainability.com/globalassets/sustainability.com/thinking/pdfs/sa-ratetheraters-2019-1.pdf.ChapterMarkHumphery-Jenner,SumanBanerjee,andVikramNandaWhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?99.1IntroductionCompanydirectorsandinstitutionalinvestorsoftenfacepressuretopursueenvironmentalobjectivesfromthemedia,policymakers,orcommentators.Itisnotalwaysfromshareholdersorinvestors.Someinvestorshaveaclear“impact,”“environmental,”or“social”mandate.However,otherstandardinvestorsareoftenpresentedwithabarrageofenvironmental,social,andgovernance(ESG)pressure.WhatthenshouldtheydowiththisandhowshouldtheyevaluateESGinthecontextoftheirportfolios?ESG,sustainability,andclimateinitiativeshavebeencontroversialinbusiness.Environmentalimpactsaresometimesperceivedas“longterm”andrelevanttoshort-termdecision-making(Kirk2022).Theimmediatefinancialimpactofpollutioncanbeopaque.Thereisacompetencedeficitinindustry(Schumacher2022).Thisisexacerbatedbyacottageindustryofcourses,whicharenotnecessarilytaughtbysubjectmatterexperts.Hyperboliclanguageworsenstheseconcerns(Kirk2022).Thiscancauseageneraldistrustofso-called“ESGexperts.”Thus,CEOshavereportedlybecomereticenttowadeintocontroversialorhot-buttonpoliticalissues(Kowitt2023;Rosenbaum2022).Investorsarethusinadifficultposition.AbsentaclearESGmandate,howshouldtheyconsiderESGfactors?AreESGindexesrelevant?Whatcantheyreasonablyaskofficersanddirectorstodo?Andwhatfactorsmightinfluencecorporateperformance?WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?143Thischapterconsidersenvironmental,social,andgovernancefactorswithinthecontextofinvestment.ThechapterdiscusseshowinvestorsmightconsiderESGinvestors.ItfirstdiscussesESGindexes,theproblemstherewith,andwhatinvestorsmustdoaboutESGfactorswithinaportfolio.Thechapterthenconsiderswhatofficersanddirectorsareobligatedtodo.Andthus,whatinvestorscanreasonablyexpectfromofficersanddirectors.ItcloseswithwaysESGfactorscaninfluencecorporateperformanceandtheassociatedevidence.9.2HowDoEnvironmental,Social,andGovernanceFactorsFitintoaPortfolio?InstitutionalinvestorsoftenfacepressuretoconsiderESG-relateinformation.Someofthispressuremightbefrominvestors.However,outsidepartiesmightalsopressureinvestors.Thisbegsthequestionofwhatpreciselyshouldfundmanagersdo:shouldtheyconsiderESGfactors,especiallyenvironmental?9.2.1TheGeneralPrinciple:WhatShouldFundManagersDo?Fundmanagers—andinstitutionalinvestors—oftenfacesignificantexternalpressure.However,theissueisthenwhetherthisshouldinfluencetheirinvestmentdecisions.Theanswerdependsonthefundmanager’sinvestmentmandate.Theinvestmentmandatetellsfundmanagerswhatfactorsshouldguidetheirinvestmentdecisions.IfthemandatecontainsanESGimpactorenvironmentalfocus,thenthefundmanagermustfocusonthosefactors.Iftheinvestmentmandateissilentonthesefactors,thefundmanagershouldonlyconsiderfinancialconsiderations,suchasriskandreturn.Suchafundcannotchoosetodirectinvestors’fundstoenvironmentalandsocialinitiatives.Rather,thefundmustinvestcapitalfollowingtheirinvestors’wishes.However,ESGfactorscanberelevanttothosefinancialconsiderations.ESGconsiderationscanbeimportantforfinanciallyfocusedfunds,withsomenuance.Thisincludeshowtoframeenvironmental,social,andgovernancefactors:shouldtheybegroupedtogetherorconsideredseparately?Shouldthemanageruseanindexorshouldthemanagermodelcashflows?IfusinganESGindex,whatarethedangersandissueswithusingsuchanindex?Eachofthesefactorsisconsideredbelow.ClimateChangeandClimateFinance1449.2.2BeCarefulCombiningEnvironmental,Social,andGovernanceFactorsFundmanagersareoftenlabeledas“ESG”funds.ESGindexprovidersoftenprovideasingleESGscore,inadditiontooverallratingsforE,S,andGindividually.However,theconstituentparts:E,S,andGaredifferent.Thisisimportantbecausefactorsthatmaximizeonecomponentneednotbenefitanyother.Governanceisaparadigmexample.Traditionally,“governance”hasreferredtocorporategovernance.However,somemighttrytoredefineittosuittheirowngoals.Goodcorporategovernanceinvolvescomplyingwithrelevantlegalobligations,whichoftenincludemaximizingshareholdervalue.Thisisoftenalegalrequirementratherthananoption.1Disdainingshareholderwealthmaximizationdoesnotchangedirectors’legalobligations.Thus,ifenvironmentalgoalsundermineshareholderwealth,managersoughtnotpursuethemasthiswouldviolatetheirlegalobligationstoshareholders.9.2.3Environmental,Social,andGovernanceIndexesCanBeArbitraryandBuryNuanceESGindexeshaveissueseveniftheyareappropriatetouseforafund.Asindicated,ESGindexesarbitrarilygroupE,S,andGintooneindex.Thesefactorscanhavedifferentimplicationsforcompanyperformance.However,ESGindexeshaveadditionalproblems.ESGindexescandiffersignificantlyinwhattheymeasureandhowtheymeasureit(Berg,Kölbel,andRigobon2022).Toseethis,onemustconsiderhowESGindexesarecreated.ESGindexescreatesubindexesforeachofE,S,andG.Eachofthesesubindexesisbasedonindicators.Forexample,“G”mightbebasedonthenumberofanti-takeoverprovisions,CEOage,tenure,andcompensationstructure(forexample).However,theseindicatorsmightdifferbetweenratingagencies.Further,theymightmeasurethesameconcept(i.e.,compensationstructure)differently(i.e.,itcouldbetotalcompensation,thepercentageofbonus,thecompensationequityintensity,oritsdelta).Next,whenconstructingsubindexes(andoverallESGscores),indexprovidersmustweighttheseindicators.But,theseweightingsmightdiffer.Therefore,indexesmightdifferduetoindexprovidersusingdifferentdatatomeasuredifferentconcepts,whichtheyweightdifferently.1Forexample,seeCorporationsAct2001(Cth)Section181.http://classic.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s181.html.WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?145TheseconstructiondifferencescanleadtosignificantdeviationsbetweenESGindexes.Berg,Kölbel,andRigobon(2022)analyzesixmajorESGindexes:Sustainalytics,S&PGlobal,Moody’s,KLD,Refinitiv,andMSCI.Theyanalyzewhethertheindexesdifferinscope(i.e.,thetypesofthingsmeasured),measurement(i.e.,theindicatorsused),andweight(i.e.,howtheindexesweightthefactors).Theyfindalowcorrelationbetweenindexesandnotethat56%ofthedivergenceisduetomeasurementdifferencesand38%duetoscopedifferences.Thatis,theindexesmeasuredifferentthingsanddosousingdifferentindicators.Despitethis,theindexespresentthemselvesasmeasuringthesameunderlyingidea.ThereneednotbeaproblemwithESGindexesdiffering.However,thereareproblemsifESGindexespurporttocoverthesameconcept,buttheydosodifferentlyandproducedifferentresults.Forexample,iftheindexprovidersprovidea“governancestrength”score,butthatscoreisbasedondifferentfactors,analystsmustthendeterminewhichscore(ifany)iscorrect.ThisimpliesthattherewouldbeaconstructvalidityissueinoneormoreESGindexes.Howthenwouldananalyst—oracompany—resolvetheproblemswithESGindexes?Theclearsolutionistofocusonunderlyingfactorsthathaveacleardemonstratedrelationshipwithcorporateperformance(ortheinvestor’sspecificgoal).Analystsmustthenincorporatetheseconsiderationsintoinvestmentdecisions,and/orfinancialmodeling,ratherthandelegatingdecision-makingtoanESGindexprovider(e.g.,Edmans2023).9.2.4Environmental,Social,andGovernanceFactorsNeedNotImprovePerformanceInvestorsmustalsoconsiderwhetherahighESGindex—orsubindex—scoreimprovesreturns.IfESG(orenvironmental)indexesarenotassociatedwithhigherreturns,thenconstructingaportfoliobasedonthemcouldlowerrisk-adjustedperformance.Inturn,thiswouldimplythatinvestorsmustmodelthespecificcashflow—andrisk—implicationsoffirms’environmentalpolicies.TheevidencesuggeststhathigherESGindexscorescouldbenegativelyrelatedtoreturns.Avramovetal.(2022)analyzesixmajorESGindexes.TheyexplorewhetherahigherESGscoreisassociatedwithhigherreturns,andwhetherthisisespeciallythecaseiftheESGscoresaremoreconsistent.ThisconnectswiththenotionthatESGscoresmightdiffersignificantlybetweenproviders(Berg,Kölbel,andRigobon2022).Thus,thefirm’sESGClimateChangeandClimateFinance146(orenvironmental)strengthcouldbeindoubt.Further,themarketmightbelesscertainaboutwhetherthefirmhasstrongESGcredentials.Avramovetal.(2022)findthathigherESGscoresarenegativelyrelatedtostockreturns.ThisisespeciallythecaseifthereismorecertaintyaboutthoseESGscores.Similarly,HartzmarkandSussman(2019,Table8)showthat“highersustainability”mutualfundsunderperform“lowersustainability”funds.ThenegativerelationshipbetweenESGindexes(andsubindexes)andreturnshasimplicationsforinvestors.First,ifinvestorsinvestinhighESGcompaniestheycannotalwaysexpectthecompanytogeneratehigherreturns.Second,thelowerreturnsmaysuggest—butneednot—alowercostofcapital.Thatis,themarketdoesnotdemandashighareturnfromthehigh-ESGcompany,duetoithavinglowerrisk;andthus,iswillingtopaymore.Inturn,thisreducestherealizedreturns.Third,lowerstockreturnsmightimplythatthemarkethaserroneouslyoverpricedthecompany(drivingdownreturns).Thisisconsistentwithevidencethatinvestorsaresusceptibletogreenwashing,poorlyvaluethecostsofimpact,andoverpayforperceivedimpact(Heebetal.2023).Suchoverpaymentwouldmanifestinpoorfuturereturns.9.2.5ConsiderHowEnvironmental,Social,andGovernanceFitsintoPortfolioConstructionPortfoliomanagerssometimesimposeESGrequirements—or“constraints”—ontheirportfolios.TheymightdothisbyrequiringtheirportfoliotohaveanESGindex(orsubindex)aboveacertainlevel.Alternatively,theymightscreenoutcompaniesthattheydeemtobeuninvestable.The“portfolioconstraint”approachcanbeappropriateiftheinvestmentmandaterequiresthatthefundavoidspecificcompaniesormaintainanESG—orenvironment—scoreaboveacertainlevel.Forexample,supposeaninvestoraimstomaximizethereturnperunitofrisksubjecttotherequirementthattheportfolio’s“environment”scorebeacertainlevel(E).Here,ifonehasnpotentialstocks,onewouldhaven×1vectorsofweights(w),expectedreturns(r),andenvironmentscores(e).Onewouldalsohaveacovariancematrix().Theportfoliooptimizationapproachwouldthenbe:maxwTrws.t.wTw=wTe=EWhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?147Theportfolioconstraintapproachcanhavecosts.Ingeneral,itismathematicallyimpossibleforaconstrainedportfoliotogenerateahigherreturnperunitofriskthananunconstrainedportfolio.Thisisbecauseanunconstrainedportfoliocanconsiderthefullinvestmentuniverse.Itwillmathematicallyeliminateundesirablecompaniesastheywouldhavepoorrisk-adjustedreturns.Forexample,ifcoalcompaniesweretounderperform,anunconstrainedportfoliowouldeliminatethem.However,notall”undesirable”companieswillunderperformintheportfolio.And,aconstrainedportfoliowouldremovethemfromconsideration.Therearesomesituationsinwhichportfolioconstraintscanbenon-negative.Someconstraintsmightneverbebinding.Asindicated,ifcoalminingweretoendandcoalminersarebadinvestmentsinallcases,theywouldneverhavebeeninanunconstrainedportfolio.Further,constraintsmightenableinvestorstoamass—oruse—specificexpertise.Ideally,thisshouldalignwithareaswhereclientswantexposureand/orwouldappreciatepureplaycompanies.Forexample,aregion-specificfundmightfocusresourcesondevelopingexpertiseinthatspecificlocation.Thisreducestheinformationasymmetrythefundmightotherwiseface.Inturn,thiscanmakethefund’sreturnandriskpredictionsmoreaccurateandimprovethefund’sperformance.Whatthenaboutenvironmentalconstraints?Doeseliminating“undesirable”companiesor“polluting”companiesenablefundstoamassmoreexpertise?Or,putdifferently,doesonlyinvestingin“clean”companiesenablethefirmtodevelopadditionalexpertise?Theanswerwoulddependonhowthatisdefined:iftheinvestoronlyinvestedinfirmswithanenvironmentalindexscoreaboveacertainlevel,thatwouldnotconnoteexpertise.Thatwouldconnotedelegationtoanindexprovider.Iftheinvestoronlyinvestsinrenewables,thatcancreateexpertiseand/orgiveinvestorspureplayexposurethattheymightvalue.Anexamplehelpstoillustratethis.Consideraportfoliothatisconstrainedtoonlyincludecompanieswhosenamesstartwith“M.”If“M”companiesalwaysoutperformed,thisportfolioshouldperformsimilarlytoanunconstrainedportfolioandtheconstraintshouldnotbebinding.However,ifcompaniesstartingwith“Z”sometimesoutperform“M”inaportfolio,thentheconstrainedportfoliowillunderperform.Thisanalogyappliesintheenvironmentalcontext.Ifcleancompaniesalwaysoutperform,thentheconstrainedportfolioshouldperformsimilarlytoarationallyconstructedunconstrainedone.Indeed,itcouldoutperformdueClimateChangeandClimateFinance148tothepossibilitythatunconstrainedportfoliomanagersmighterroneouslybelievecleancompanieswillunderperformor“sin”companieswilloutperform.However,ifsomesincompanieswouldoutperformthecleanonesinaportfolio,thentheconstrainedportfoliowillunderperform.Theconstrainedportfolioapproachthushasissues.Itcanconveyadvantagesinspecificsituations.Theseincludewhereinvestorswantaspecific(cf.vague)exposure,theportfoliocanconveygenuineexpertise,and/orcanmitigatevalue-relevantinformationasymmetry.However,iftheenvironmentalconstraintisarbitraryormerelycullscompaniesbasedonenvironmentalscoresorindustries,theconstrainedportfoliowilloftenunderperform.9.2.6WhattoDoaboutEnvironmental,Social,andGovernance?Thisdiscussionhasclearimplicationsforportfoliomanagers:theyshouldnotdelegatedecision-makingtoESGindexprovidersoradvocates.ThisflowsfromthenegativerelationshipbetweenreturnsandESGindexes(and,potentially,subindexes).ItalsoisduetoconstructvalidityissuesinESGindexes.Fundmanagersshouldstartwiththeirinvestmentmemorandum.Theinvestmentmandateisthefundmanager’scontractwithitsclients.IftheinvestmentmandatehasanESGobjective,thenthefundmanagershouldanalyzewhetherspecificinvestmentssupportthatobjective.GiventhatESGindexes(andsubindexes)oftendisagreewitheachother,fundmanagerscannotblindlyrelyonsuchindexestomakeESG-relateddecisions.ESGcanberelevanttoportfolioreturns.Iftheinvestmentmandaterequiresthefundmanagertomaximizeperformancemetrics,ESGandenvironmentalconcernscanstillberelevant.However,here,fundmanagersmustnotgeneralizeorassumethatESGimprovesreturns.Rather,fundmanagersmustmodelthespecificimpactofthesefactorsonriskandreturns.Insodoing,ESGandenvironmentalfactorsbecomemerelyaninputintomodelingwhatisrelevanttotheportfolio.Whatthenisthenatureofthisinput?Thefundmanagercanexplicitlymodeltheimpactofthefactoronthefirm’scashflowsandrisks.Thisincludesincorporatingthosefactorsinfinancialmodelingand/orscenarioanalysis.Somefactorsareamenabletothis.Forexample,ananalystcouldmodeltheimpactofcarbontaxesorotherregulatoryinterventionsbasedonhowWhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?149pollutingthecompanyis.Somefactorsarenotreadilyamenabletothis.Forexample,whatisthespecificcashflowimpactofacorporategovernanceattribute.Forthesefactors,investorsshouldconsidertheprecisemechanismofactionthroughwhichthefactormightinfluenceperformance.And,theymustthenanalyzethecostsofimprovingthatfactor(oreliminatingit)asisrelevant.Thischapterdiscussesfactorsthattheliteratureshowsinfluencecorporateperformance.9.3WhatMustOfficersandDirectorsConsider?InvestorsandmanagersmustalsoconsiderwhetherthereisabusinesscaseforconsideringESGfactors.Thestartingpointforthisistoconsiderwhetherofficersanddirectorsshouldevenconsiderenvironmentalandsocialfactors.Afterall,officersanddirectorsmustcomplywiththeirlegalobligationsregardlessoftheirpersonalobjectives.Officersanddirectorsmustcomplywiththeirlegalobligations.Whatthismeansvariesacrossjurisdiction.Thismay—butneednot—involveconsideringenvironmental(orESG)factors.Inallcases,suchdecisionsmustbeevidencebasedandquantified.ThissectionfocusesontheAnglo-Americanapproachtocorporategovernance.And,here,ESGandenvironmentalfactorsareimportanttoconsiderbutonlytotheextenttheymaximizeshareholderwealth.DirectorstypicallyowetwooverarchingdutiesintheUnitedStates(US):adutyofcareandadutyofloyalty(Skadden2020).Thesearedutiestotheshareholders.Theirprecisenaturevariesacrossstates.Australiahassimilardirectors’duties.InAustralia,directorsaresubjecttoadutyofcare,adutytoactforaproperpurposeandinthebestinterestsofthecorporation,andadutynottomisuseinformation,ortheirposition,toobtainanimproperbenefitortoharmthecorporation.Somecountriesrequiredirectorstoconsideroutsidestakeholders.ThisisnotthecaseintheUSorAustralia.Indeed,Australiaconsideredwideningdirectors’dutiesandrejectedamendingtheformercorporationslawtoexpandsuchduties(SenateStandingCommitteeonLegalandConstitutionalAffairs1989).And,despitebeingpreviouslyconsidered,Australia’sCorporationsAct2001didnotincludeexpandeddirectors’duties.ThequestionthenbecomeshowenvironmentalandESGconsiderationscaninfluencedirectors’decision-making.Thisinturninfluenceswhatinvestorscanreasonablyexpectofficersanddirectorstodo.ClimateChangeandClimateFinance1509.3.1TheDutyofLoyaltyOfficersanddirectorsoweadutyofloyaltytoacompany;andthus,theshareholders.Ifdirectorsviolatethisdutytheypotentiallyriskasecuritiesclassactionoraderivativelitigation.Thesederivativelitigationsinvolveshareholderssuingthedirectorsforwrongsdonetothecompany.Thus,ifdirectorsactabovetheirauthorityandmisusecompanyfundsforpersonalreasons,shareholderscouldsuethedirectortorecoverdamages.Thedutyofloyaltyimpactswhether—andtowhatextent—officersanddirectorsshouldconsidersocialandenvironmentalissues.Thedutyrequiresdirectorstoactin“goodfaith,”inthe“bestinterestsofthecorporation,”and“foraproperpurpose.”ThislanguageiscodifiedinAustralia,2andsimilarlanguageexistsintheUScaselawand/orstatute.Ingeneral,thebestinterestsofthecorporationinvolvemaximizingcorporatevalueand/orshareholderwealth.Thenextissueiswhetherofficersanddirectorsshouldactforshort-termorlong-termshareholders.Thesegroupscanhavedisparateinterests(Fried2015).Thiscanbeespeciallythecasesinceinvestorsmightunderappreciatelongdated,hard-to-value,orriskyinvestments(Martin2012).However,the“short-term”vs“long-term”divideisoftenadistinctionwithoutadifference.Activistsoftenraiseconcernsaboutmyopiainrelationtodividendpaymentsorrepurchases,whichinvolveapresent-daycashdistribution.Suchdistributionstautologicallyreducethecashavailableforinvestment.However,thisisbeneficial.Therearewell-documentedagencyconflictsof“excess”freecashflow(Jensen1986),orcashholdings(Harford1999).Here,managerswithaccesstolargeamountsofcapitalmakeincreasinglyself-interestedinvestments,consumeexcessperquisites,orsimplyshirk.Theymightalsopursuesuboptimalinvestments,eithermotivatedbyself-interestora“moneychasingdeals”problem(seeanalogouslyDillerandKaserer2009).Thus,distributingcashtoshareholders—onlysomeofwhommightholdshort-term—benefitsthecorporationandlong-termshareholders(Edmans2017;PwC2019).2CorporationsAct2001(Cth)Section181statesthatofficersanddirectorsmustact“ingoodfaithinthebestinterestsofthecorporation”and“foraproperpurpose.”WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?151Actingingoodfaithforshort-termshareholderswillordinarilybenefitlong-termshareholders,andviceversa.Usually,thefirm’sstockpriceshouldreflectthepresentvalueofallfutureexpectedcashflows.Thus,ifcapitalisfreelyavailable,corporationsshouldpursueallvalue-creatingprojects,regardlessofwhethertheyareshortorlongterm.Capitalrationingcanforceashort-termfocus.However,evenhere,wemustnotethatafirmwillonlygettofocusonthelongtermifitcansurvivetheshortterm.Andthus,amanageractingin“goodfaith”to“properly”benefitshort-termshareholdersshouldalsobenefitlong-termshareholders,andviceversa.Environmentalandsocialfactorscanfitintothedutyofloyalty.Firmsmustgenerallycomplywithenvironmentalandsocialregulationsinordertocontinueasagoingconcern.Forexample,strongerworkplacelawsisassociatedwithfeweraccidents(Banerjeeetal.2022a).Theycanfacenegativepublicityfromsafetyorenvironmentalincidents.Satisfiedworkerscanbemoreproductive,therebyimprovingcorporateperformance(BoustanifarandKangforthcoming).Thus,environmentalandsocialconsiderationsmay,butneednotautomatically,squarewithsatisfyingthedutyofloyalty.9.3.2TheDutyofCareDirectorsandofficersoweadutyofcaretothecompany.Thisrequiresdirectorsandofficerstoexercisethelevelofcareandskillthatwouldbeexpectedofadirectorinthecompany’scircumstances.Thedutyofcarewouldgenerallyrequireofficersanddirectorstoturntheirmindstoenvironmentalandsocialfactors.Thedutyofcareimpliesthatdirectorsshouldconsiderfactorsthatmightimpactthefirm’saccesstocapitalandthecostthereof.Itwouldbeimprudenttoignorecapitalrequirements.Sustainabilitymayinfluencethefirm’scostofequity(NgandRezaee2015),andcostofdebt(Eichholtzetal.2019;Jung,Herbohn,andClarkson2018),dependingonthecompany’sspecificcircumstances.Workerwell-beingcanboostproductivity,whichcouldimprovecorporateperformance(BoustanifarandKangforthcoming).Therefore,officersanddirectorsmustconsiderenvironmentalandsocialfactors;however,theymustdosointhecontextofmaximizingcorporatevalue.Insomelocations,thedutyofcaremightberelativelymootduetothe“businessjudgmentrule.”Dependingonthejurisdiction,makingagenuinebusinessjudgmentissufficienttosatisfythisduty.Thus,instatessuchasClimateChangeandClimateFinance152Delaware,itwouldberelativelystraightforwardfordirectorstoarguethattheysatisfiedthedutyofcare.However,inotherlocations,3directorsmightalsoneedtoshowtheyrationallybelievedthedecisionwasinthecompanies’bestinterests,thejudgmentismadeingoodfaithandforaproperpurpose,andthedirectorshadnomaterialpersonalinterestinthedecision.Thedutyofcarealsoimpliesthatofficersanddirectorsmustconsiderthefinancialcostsofenvironmentalandsocialconsiderations.Inthiscontext,actingwith“care”or“skill”involvesfocusingthat“care”and“skill”onthecorporation’sinterests.Forexample,itismostlyirrelevantwhethertheofficersanddirectorsexercise“care”whendecidingthecolorschemefortheirpersonaloffices.Rather,thedutyfocusesondirectingthatcareandskilltowardimprovingcorporatevalue,whichisinherentinhowthedutyofcaresitsalongsidethedutyofloyalty.Therefore,ifthedirectorenablesESGconsiderationstounderminereturns,thentheyarenotacting“withcare”or“withskill”intherelevantsense.Similarly,iftheofficersanddirectorsfailtoconsiderESG’sfinancialimplications,theywillalsonotactwithcareorskill.Thisimpliesthatfinancialconsiderationsaretobetheoverarchingguidewhendecidingwhethertopursueenvironmentalandsocialinitiatives.9.3.3HowAreTheseDutiesRelevanttoEnvironmental,Social,andGovernanceInvesting?Officers’anddirectors’dutiesdirectlyinfluencehowinvestorsmightengagewithmanagersonESG-relatedtopics.Thesedutiescircumscribedirectors’behaviors.Aninvestor—ESGmandateornot—cannotexpectanofficerordirectortoactcontrarytotheduties.Investorscannotexpectofficersanddirectorstopursueenvironmentalorsocialinitiativesthatundermineshareholderreturns.Thishasseveralcorollaries.First,officersanddirectorsactforallshareholders,notmerelythelargestortheloudestshareholder.Thishascreatedsomeshareholderconflictsinwhichenvironmentally-focusedinvestorsattempttoexertinfluenceoverofficersanddirectors(Humphery-Jenner2022a).Second,whenengagingwithmanagersoverESG-issues,investorsmustdosothroughafinanciallensandmustunderstandmanagers’objectivefunctionandduties.Thefollowingsectiondiscussessomeofthefactorsthathavebeendocumentedtobeassociatedwithperformance.3Forexample,seeCorporationsAct2001(Cth)Section180(2).WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?1539.4HowMightEnvironmentalFactorsImpactBusiness?Theissueisthenhowenvironmentalfactorsmightimpactcorporateperformance.Whetherandhowthesefactorsarerelevantdependsonthenatureoftheportfolio.Iftheportfoliohasanexplicitenvironmentalorsustainabilitymandate,thiswillcircumscribethenatureoftheinvestments.Iftheportfolio’sobjectiveistomaximizeperformancemetrics,thefundmanagermustconsidertheimpactofenvironmentalfactorsonriskandreturn.Thatis,theyshouldconsiderenvironmentalandsocialfactorsmuchliketheywouldanyothercorporatecharacteristic.Theliteraturecontainssomeinterestingfindingsonhowenvironmentalandsocialfactorsmayenhance,orpotentiallyworsen,corporateperformance.Andthefindingspointtowardhowinvestorsmightanalyzeenvironmentalandsocialfactorswhenconstructingaportfolio,orhowofficersanddirectorsmighttargetexpendituretoincreaseshareholderwealth.Someofthesefactorscouldbespecificallyincorporatedintocashflowmodels.Forotherfactors,investorsshouldidentifytheclearmechanism-of-actionthroughwhichthefactorinfluencesreturnsandestablishthelikelycosts(ifany)andbenefitsassociatedwithpursuingsuchafactor.9.4.1HowEnvironmentalFactorsCanInfluencePerformanceEnvironmentalconsiderationscaninfluencecorporateperformance.However,investorsmustconsiderthespecificmechanismofactionthroughwhichtheyareallegedtodoso.Andinvestorsmustconsiderenvironmentalinitiativesonacase-by-casebasisratherthanovergeneralizing.Takeacoalpowerplant,forexample.Coal-firedpowerplantsaredecreasinglypopularandwillhaveafinitelife.Attheendofthatlife,therearealsocashflows.Thepowerplantmighthavesomesalvagevalue.But,conversely,theownermightneedtoengageinenvironmentalrectificationwork.Duringitslife,thecoalpowerplantwillgeneraterevenues.Theserevenuesmightdecreaseovertime.Environmentaltaxesmaybutneednotreducethatrevenue.Whetherthisisthecasewilldependonmyriadpoliticalandeconomicconsiderations.Thus,howdoesaninvestorevaluatethecoal-firedpowerplant?ClimateChangeandClimateFinance154Theinvestormustconsidertwooverarchingfactorsforthecoalpowerplant.First,investorsmustforecastthereturns.Thisincludesforecastingthepowerplant’susefullifeandlikelyrevenues.Second,investorsmustanalyzethe“costofcapital.”Thisistherateofreturnthataninvestorwoulddemandinordertoinvestinsuchaproject.Investorswouldalsobenefitfromundertakingascenarioanalysistodeterminetheasset’sperformanceinpossiblefuturestatesoftheworldandtheprobabilitythereof.Foranon-ESGinvestor,theinvestmentdecisionturnsonthesefactors.Environmentalperformancecaninfluencefirms’costofcapital:thisincludesboththecostofdebtandthecostofequity.Environmentalfactorscaninfluencetheseindifferentways.Lendershavereportedlybecomeconcernedaboutsocialpressurewhenlendingto“polluters.”Theyhavealsobecomeconcernedaboutbusinessriskstopollutingcompanies.Forexample,alenderwouldworryaboutriskstothatcoalpowerplant’sfuturecashflows.Therefore,Eichholtzetal.(2019)findthatUS-basedrealestateinvestmenttrusts’(REITs)borrowingcostsarelowerformoreenvironmentallyfriendlybuildings.AndREITswithagreaterproportionofenvironmentallyfriendlybuildingshavealowercorporatecostofdebt.Environmentalfactorscanalsoinfluencefirms’costofequity.Theimpliedcostofequityistherateofreturnthatshareholdersrequiretobewillingtoinvestinafirm.Betterenvironmentalperformanceisassociatedwithalowerimpliedcostofequity(Gupta2018;YangandYulianto2022).Thisappearstoconcentrateinfirmsinanenvironmentallysensitiveindustryandforfirmswithagreaterassociatedriskexposure.Further,firmswithhigherESGindexes—whichoftenheavilyfeatureenvironmentalmatters—havelowerrealizedstockreturns(Avramovetal.2022),whichisconsistentwithsuchfirmshavingalowercostofequity(butwhichcouldalsosuggestsuchfirmssimplyunderperformed).Thelowercostofequitycouldbeduetoseveralfactors.First,ifenvironmentalrisksmakecashflowsmorevolatileorincreaseregulatoryrisks,thenfirmsthatmitigatesuchriskscouldbe“safer.”Thiswouldcausealowercostofequity.Second,theriseofESG-focusedfundscouldcreatemoredemandforgreen-lookingcompanies.Inturn,thiscouldcreateeithermoredemandforsuchfirms’stockissuancesand/ormoredemandandsupportforthosefirms’stocksinthesecondarymarket.Third,investorsseeminglyunderestimatethecostsand/oroverestimatethebenefitsofenvironmentalinitiatives(Heebetal.2023).Inturn,thiscouldsupportpricesandlowertheimpliedcostofequitywhilealsoriskinglong-rununderperformance.WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?155Environmentalconsiderationscanberelevanttofirms’cashflows.However,investorsmustassesswhethersuchabenefitisquantifiable,realistic,andoffsetsthecost.Forexample,apollutermightfacegreaterregulatoryrisk.Thiscouldimpactcashflows.Somecustomersmightbeconcernedabouttheenvironmentalcredentialsoftheirsupplychains.Corporations(andthusinvestors)shouldconsiderwhetheritisnecessarytopreemptivelyimproveenvironmentalperformancetoreducetheriskofclimate-relatedtaxesandpenalties.Companiesmightalsolooktoenvironmentalinitiativesforcashflowbenefits.Forexample,OccidentalPetroleum—mostknownforitsoiloperations—generatesrevenuesfromcarboncapturetechnology(Valle2022).MawsonInfrastructure—mostknownforcryptocurrencymining—generatesrevenuesfromcarboncreditsandheavilyemphasizesenvironmentalinitiativesinitsinvestordocumentation(MawsonInfrastructureGroup2022).Therefore,investorsmustalsoconsiderwhetherenvironmentalinitiativescangeneraterevenueratherthanmerelyincurcosts.Environmentalfactorscanalsohaveanindirecteffect.Workersdislikeworkinginpollutedenvironments.Thus,corporationsmightneedtopaymoretoconvinceemployeestoworkinlocationswithpoorairquality(Banerjeeetal.2022b).Further,giventhatemployeesatisfactioncanimproveperformance(BoustanifarandKangforthcoming),corporationsmightconsiderhowtosupporttheirlocalenvironment.Inturn,thiscouldincreaseemployeeproductivityandlowerlaborcosts.Theforegoingenvironmentalfactorscaninfluencetheinvestmentcase:environmentalconsiderationscaninfluencefirms’costofcapital,cashflows,andtheriskthereof.However,corporationsandinvestorsmustscrutinizetheseinitiativesonacase-by-casebasisandallsuchbenefitsshouldbeclearlyquantified.Investorsshouldbecautioustoavoidgreenwashing,ortokeninitiatives,whichmightcostmoney,trickinattentiveinvestors,andmightultimatelyyieldlimitedfinancialupside.9.4.2HowSpecificSocialFactorsCanInfluenceCorporatePerformanceSocial-relatedfactorscaninfluencecorporateperformance.Thiscanariseinseveralways.However,investorsandshareholdersmustalwaysscrutinizewhetherclaimedbenefitsareevidence-backedandquantifiable.ClimateChangeandClimateFinance156Afrequentclaimisthatsocialinitiativesmightconveypublicrelationsbenefits(LiangandVansteenkiste2020).Thismay,butneednot,bethecase.Forexample,inthecontextofdisasterrelief,corporatephilanthropycanoftenhavelimitedcommercialbenefit.However,ityieldsgreatergainsforfirmsinneedofimageenhancement,oraroundhighprofileattention-grabbingdisasterswithgreatermediacoverage.Corporatephilanthropymightalsoimprovestaffmorale(Rice2022).However,corporationsshouldbecautiousofpolarizingorcontentiousissues,whichmightincreasestaffdivisionoraggravatestaffmembers.Corporationsmustalsoensurethatanysuchactionsareseenas“authentic,”ratherthanperformative,condescending,fake(Garg2022).Thus,shareholdersandinvestorsmustanalyzewhetherthereissuchabenefit,whetheritoutweighstheexpenditure,andwhetherthesocialinitiativerisksalienatingacorporatemarketsegment.Themarketmightunderappreciatethewealth-effectsofemployeehappiness.BoustanifarandKang(forthcoming)arguethatsatisfiedemployeesaremoreproductiveandassociatedwithloweremployeeturnover.Theyhighlightthatthemarketmightoveremphasizethecostsofemployee-satisfactioninitiativesandunderemphasizethebenefits.Therefore,aslongasemployeewelfareremainsunderappreciated,investorsmightearnabnormalreturnsbyinvestingin(atleastmoderately)employee-friendlycompanies.Workplaceaccidentsareoftenassociatedwithworsecorporateperformance.Thiscanstemfromseveralfactors.Accidentsareoftenassociatedwithsignificantfines,lostlaborhours,andreducedmorale.Workplaceaccidentscanalsotriggergreaterregulatoryscrutinyorunionactivity.Accidentratescanalsobeassociatedwithworsetrainingandreducedproductivity.Therefore,investorsmightconsiderfirms’workplacesafetypracticesandthegovernancestructuresinplacethatmightinfluenceworkplaceaccidents(Banerjeeetal.2022a).Suchaccident-reductionstepscouldultimatelyimprovecorporatevalue.However,investorsshouldscrutinizesuchactivitiesonacase-by-casebasis.Socialfactorsneednotalwaysimproveperformanceandinvestorsshouldscrutinizethem.Executivesmightgain“utility”fromdoing“good”acts.Thismightencouragethemtoengageinphilanthropiccauses,especiallythosewithwhichtheyhaveapersonalconnection.However,executivesmightexperienceallthe“benefits”ofhelpingthesecauseswhileshareholdersbearthecosts.Thiscandriveself-interestedphilanthropicactivities,whichbenefitexecutivesbutthatdonotbenefitshareholders(MasulisandReza2015).Therefore,shareholdersandinvestorsmustcriticallyanalyzeanyphilanthropicorsocialinitiativesthatcompaniespropose.WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?1579.4.3DoNotForgetCorporateGovernance!Strongcorporategovernancetautologicallyisapositive.The“G”in“ESG”pertainstocorporategovernance.Itisseparateanddistinctfromsocialandenvironmentalconsiderations.Strengtheningcorporategovernanceinvolvesaligningmanagers’objectivesandactionswiththoseofshareholders.Thus,anyattempttoenhancesuchanalignmentisanattempttobenefitshareholders.CorporategovernanceisoftenneglectedwheninvestorsrefertoESG.Corporategovernanceisabroadtopic.However,therearesomegeneralfactorstoconsider.Investorsmustconsiderwhethertheboardofdirectorsisappropriate.Forexample,amoreindependentboardofdirectorscanhelprestrainCEOsthatareeitheroverconfident(Banerjeeetal.2015),orotherwisepowerful(Humphery-Jenneretal.2022).IndependentdirectorsarealsomorelikelytodisciplineunderperformingCEOsfortheirpoorperformance(GuoandMasulis2015).However,independentdirectorsmightlackfirm-specificknowledgeormightbepoorlyincentivized.Thus,independentdirectorsmightbecomedistractedandfocustheirtimeoncompaniesthattheydeemtobe“moreimportant”(Liuetal.2020).Thus,itisimportanttohaveanappropriatenumberofsufficientlyskilledandmotivatedindependentdirectorswhilealsodrawinginsightsfromexecutivedirectors.Executivecompensationpracticesareimportantconsiderations.Whenanalyzingexecutivecompensation,investorsshouldnotdelegatedecision-makingtoESGindexes,whichcanburynuance.Ingeneral,incentive-basedcompensationisdesirable:thishelpstobetteralignexecutives’incentiveswithshareholders’objectives.However,theappropriatenatureofthatcompensationcandependontheCEO’sbehavioralattributes(Humphery-Jenneretal.2016)andthebroaderregulatoryenvironment(Humphery-Jenneretal.2021).Further,compensationlevelsandstructurescanbetheresultofacomplextrade-offwithotherfactors.Forexample,firmsmightadjustcompensationinordertoconvinceaCEOtoworkinamorepollutedenvironment(Banerjeeetal.2022b).Thenatureofthefirm’ssharescanalsobeimportant.Thiscanincludewhetherthefirmhasadualclasssharestructure.Dual-classstructuresprovideanunevendistributionofvotingpowerinfavorofaspecificgroupofshareholders.Thisarrangementallowsthedominantshareholdersandtheirconnectedinsiderstoreaptheprivatebenefitsofcontrol.Withinthisframework,theycanpursueinvestmentsandexpensesdrivenbyself-interest,enjoyingoutsizedbenefitswhileavoidingthefullcostsofsuchoutlays.ClimateChangeandClimateFinance158Dualclasssharestructuresaretypicallyassociatedwithworsecorporateperformance,buthigherCEOcompensation(Masulis,Wang,andXie2009).TheyhavecreatedissuesattechcompaniessuchasSnap(Humphery-Jenner2017),andMeta(Humphery-Jenner2022b).Potentialinvestorsshouldalsoconsiderthecompany’sbroadergovernanceattributes.Thisincludesthepresenceofanti-takeoverprovisions.Suchprovisionsaregenerallyassociatedwithworsecorporateperformanceasthey“entrench”managersandenablethemtoresistdisciplinaryacquisitions(Harford,Humphery-Jenner,andPowell2012;Masulis,Wang,andXie2007).Anti-takeoverprovisionsincludestructuressuchaspoisonpills,whichenabletargetstodiluteputativeacquirers,stymieingatakeoverattempt.Thesecansometimesbenefityoungerormoreinnovativecompaniesbyenablingmanagerstofocusonlong-termvaluecreationwithoutworryingabout“opportunistic”takeoverbids(Humphery-Jenner2014;Johnsonetal.2022).However,thebenefitsdiminishforlargerincumbentfirms(Humphery-JennerandPowell2011).Thus,investorsshouldconsiderwhetherthefirmhassuchprovisionsinplace,andtheextenttowhichmanagersmightunilaterallyadoptsuchprovisionsinamannerthatharmsshareholders.Thenatureoftheotherinvestorscanalsosignificantlyinfluencecorporategovernance.Institutionalandactivistinvestorscanoftenengagewithfirms’managers(McCahery,Sautner,andStarks2016).Thiscaninvolvedirectinteractionswiththemanager,whichcanhelpencouragemanagerstoactconsistentwithshareholders’bestinterests.Further,beingabletocrediblythreatentosellsharescandisciplinemanagersexante(EdmansandManso2011;Gallagher,Gardner,andSwan2013).Therefore,investorsmightconsiderthenatureoftheotherinvestorsinthecompany.ThisincludesanalyzingwhethertheotherinvestorshavesimilarESGobjectives.Theforegoingfactorsaresomeofthegovernanceattributesinvestorsmightconsider.GovernanceisanimportantpartofESGinvestingandisvitaltoensuringthatmanagersactinshareholders’bestinterests.Indeed—bothFTXandAdanihavetoutedtheirESGcredentials—butbothFTXandAdanihavebeenthesubjectofmajorgovernancescandals.WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?1599.5WhatShouldInvestorsDoaboutEnvironmental,Social,andGovernance?Thequestionisthenhowinvestorsmightconsiderenvironmental,social,andgovernancefactorsintheirportfolioconstruction.Ifinvestorshaveaspecificimpact,social,orenvironmentalobjective,theyshouldactaccordingtothatobjective.Iftheinvestors’investmentmandateistomaximizeshareholderwealth,thenESGfactorscanberelevanttotheextentthattheyareconsistentwiththatmandate.WhenconsideringESGfactors,investorsshouldbecautious.TheyshouldnotethatE,S,andGaredifferent.Theyhavedifferentimplicationsandinfluencecashflowsandrisksdifferently.ESGindexesthatcombinethesefactorsriskbecominga“blackbox.”ThisisclearfromtherelativelylowcorrelationbetweentheESGindexes.HighESGindexesalsoneednotbeassociatedwithbetterperformance.Andanaïveapproachofsimplyrequiringtheportfolio’sESGindextobeaboveaspecificlevel,orscreeningoutfirmswithESGindexesbelowalevel,couldharmreturns.Investorsmustalsoconsidertheappropriateroleofthefirm’sofficersanddirectors.Theofficersanddirectorsactforallshareholdersandmustcomplywiththeirlegalobligations.Therefore,theycannotmerelyactforthemostaggressiveshareholderoreventhelargestshareholder.Theymustalsocomplywiththeirduties,whicharegenerallytomaximizeshareholderwealth.Therefore,anyimpact-relatedpressuremustbewithinthecontextofwhatofficersanddirectorsarelegallyallowedtodo.Attemptingtopushdirectorstoactcontrarytotheirdutiesisliabletoresultinperformativecorporateactions.Whenconsideringenvironmentalandsocialfactors,investorsshouldconsiderspecificwaysinwhichtheycaninfluencefirms’cashflowsandreturns.Forexample,bettercorporategovernanceisassociatedwithbettercorporateperformancebecausebettergovernanceisfocusedonaligningshareholders’andexecutives’actions.Environmentalperformancecanreducefirms’costofcapitalandmightreducecashflowrisk.Bettersocialperformancemay—butneednot—enhanceemployeewelfare,whichcanimprovereturns.Theoverallapproachshouldbequantitative.WhenassessingspecificESGindexes,orESGfactors,investorsshouldbesuretoquantifytheirimpactratherthanrelyingongeneralizationsorheuristics.Theliteratureindicatesthatinvestorsaresusceptibletounscrupulousgreenwashingandmightoverpayforimpact.Thus,investorsshould,overall,specificallymodelhowfactorsmightinfluencecashflowsandrisks,and/orestablishaclearmechanismofactionthroughwhichthefactormightimproveperformance.ClimateChangeandClimateFinance160ReferencesAvramov,D.,S.Cheng,A.Lioui,andA.Tarelli.2022.SustainableInvestingwithESGRatingUncertainty.JournalofFinancialEconomics.145(2).pp.642–664.https://doi.org/10.1016/j.jfineco.2021.09.009.Banerjee,S.,M.Humphery-Jenner,P.Jain,andV.K.Nanda.2022a.SafetyFirst!OverconfidentCEOSandReducedWorkplaceAccidents.UNSWBusinessSchoolResearchPaper.Banerjee,S.,M.Humphery-Jenner,andV.Nanda.2015.RestrainingOverconfidentCEOsthroughImprovedGovernance:EvidencefromtheSarbanes-OxleyAct.ReviewofFinancialStudies.28(10).pp.2812–2858.Banerjee,S.,M.Humphery-Jenner,V.Nanda,andX.Zhang.2022b.LocationMatters:TheImpactofLocalAirQualityonCEOCompensation.UniversityofNewSouthWales(UNSW)BusinessSchoolResearchPaper.Berg,F.,J.Kölbel,andR.Rigobon.2022.AggregateConfusion:TheDivergenceofESGRatings.ReviewofFinance.26(6).pp.1315–1344.https://doi.org/10.1093/rof/rfac033.Boustanifar,H.andY.D.Kang.2022.EmployeeSatisfactionandLong-RunStockReturns,1984–2020.FinancialAnalystsJournal.78(3).pp.129–151.https://doi.org/10.1080/0015198X.2022.2074241.Diller,C.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anlearnaboutsustainableinvestingfromrecentdevelopmentsinprivatecapitalmarkets,whatchallengesmaylieahead,andhowpolicymakerscanhelptoovercomethesechallenges.SustainablePrivateCapitalMarkets16710.2SustainableInvesting:TheCaseofPrivateEquityAsubstantialpartoftheprivatemarketlandscape,theprivateequityindustryconstitutesasignificantpartoftheeconomy.In2021,theindustrycontrolledover$4.5trillioninassetsundermanagement.Privateequityfirmstypicallyraisefundsfrominstitutionalinvestorssuchaspensionfunds,endowments,andwealthyindividuals,andthenusethatcapitaltoacquirecontrollingstakesincompaniesortofundmanagementbuyoutsofpubliclytradedcompanies.Thegoalofprivateequityisusuallytoimprovetheperformanceofthecompaniestheyinvestinandthenselltheirstakesataprofit.However,thereiswidespreadperceptionamongthegeneralpublicthatprivateequityinvestments,orownershipbyprivateequityfirms,areheavilyfocusedonshort-termprofitsprincipallyattheexpenseofstakeholdervalue.Forexample,USSenatorElizabethWarrenfamouslyaccusedtheprivateequityindustryof“buyingcompanies,loadingthemupwithdebt,andthenextractingvaluefromthem…attheexpenseofworkersandtheirfamilies,aswellascommunitiesandsmallbusinesses”andthatprivateequityfirmsare“simplynotgoodforAmerica.”2Asprivateequityfundswhosefuturefundflowshavehistoricallybeenprincipallydependentontheirfinancialperformance(KaplanandSchoar2005),thisisacritiquepotentiallynotwithoutmerit.Ontheotherhand,itispossiblethattheESGpreferencesofinvestorsinprivateequity,namelylargeinstitutions,caninfluenceprivateequityfirmstobemorecommittedtosustainability.Thelargestclassofinvestors(i.e.,limitedpartners)inprivateequity,amongthempensionfundsandsovereignwealthfunds,areincreasinglyconcernedaboutESG-relatedissuesincludingsystem-leveleffectsofclimatechangeandinequality(Ecclesetal.2022).Forexample,severalDutchpensionfundsnowgradeandrankgeneralpartners(ortheprivateequityfirms)basedonkeyperformanceindicatorsrelatedtoESGissues.Giventheeconomicimportanceoftheprivateequityindustry,publicconcernsabouttheindustry,andincreasinginvestorpressureforhigherESGstandards,itisimportanttoanalyzeandunderstandtheimplicationsofprivateequityinvestmentsforsustainability.Recently,academicresearchersstartedtosystematicallyexaminewhetherprivateequityownershipreallyhurtsstakeholdervalues.Theevidencetodateprovidesuniqueinsights.2SeeSenatorWarren’swebsiteathttps://www.warren.senate.gov/.ClimateChangeandClimateFinance168Ontheenvironmentalfront,Bellon(2022)studiestheeffectsofprivateequityownershiponcorporatepollution.Thestudyfindsthatprivateequity-backedfirmsreducepollution,onlywhensuchfirmsfacehigherenvironmentalregulatoryriskorpoliticalrisk.Ontheotherhand,firmsthatdonotfacesuchrisksconverselyincreasetheirpollutionafterbeingownedbyprivateequityfirms.Thesefindingsshedimportantlightonwhetherprivateequityfirmspromotesustainabilitygenuinelyforthesakeofstakeholdervalues.Thisdoesnotseemtobethecase.Rather,theresultsareconsistentwithprivateequityinvestorsprimarilyseekingfinancialreturns,andonlyensuringsustainabilitywhenfailingtodosomaycostsignificantshareholdervalueduetoregulatoryenforcement.Alongsocialdimensions,Lambertetal.(2021)studychangesinemployeesatisfactionaroundleveragedbuyouttransactions.Whilethetypeofdealsvariessubstantially,theauthorsdocumentanoveralldeclineinemployeesatisfactionafteraleveragedbuyoutdeal.Theresultsseemtoindicatethatprivateequityfirmsarenotprimarilyinterestedinimprovingthewelfareofemployeeswhentheytargetportfoliofirms.Fang,Goldman,andRoulet(2022)examinepaygapswithinprivateequityportfoliofirmsandshowthatleveragedbuyouttargetfirmsexperienceareductioninwithin-firmwageinequalitybetweenmenandwomen,managersandnon-managers,andolderandyoungeremployees.Whileonthesurfacethisseemstosuggestthatprivateequityfirmspromoteequality,additionalanalysisinthestudyconveysamorenuancedmessage.Muchofthereductionininequalityisinfactdrivenbyachangeinemployeecomposition,where“expensive”employeesinthehighpaycategories(suchasoldermeninmanagerialpositions)arereplacedwithcheaperandyoungerones.Moreover,theauthorsshowthattheseseparatedexpensiveemployeeshadbeenpaidmorebeforethebuyoutthansimilaremployeesatotherfirmsandhaveworsecareeroutcomesafterthedeal.Therefore,thekeyfindingsofthestudyareconsistentwithprivateequityfirms“cuttingfat”inmismanagedcompaniesandimprovingtheiroperationalefficiency.Thecommonthreadacrossthesestudiesisthatprivateequityinvestments,byfocusingonimprovingshareholdervalue,alsobenefitsomestakeholdersundercertaincircumstancesthataligntheirincentives.However,thereisnoevidenceyetthatprivateequityfirmswouldpromotesustainabilityasapriorityinandofitself.Animportantpolicyimplicationoftheserecentfindingsisthatifstakeholdervalueprotectionisanimportantsocietalobjective,incentivestructuresneedtobedesignedtoalignthefinancialSustainablePrivateCapitalMarkets169incentivesofprivatemarketinvestorswithsuchstakeholder-orientedgoals.Inparticular,Bellon(2022)highlightstherolethatregulationscanplayinsettingupincentivessuchthataprofitmaximizinginvestorlikeaprivateequityfirmcanalsoensurethatcertainexternalities,suchasthoseofpollution,areinternalized.10.3TransparencyandDisclosureofSustainabilityinPrivateMarketsAnincreasinglyimportantissuerelatedtocorporateincentivesandtheroleofregulationinsustainabilityishowmuchinformationcompaniesshouldberequiredtodiscloseregardingtheirsustainablepractices.TherehasbeenageneralpushformoretransparentcorporatedisclosureabouttheirESGfootprints(Ilhanetal.2023;IoannouandSerafeim2019).Forexample,inMarch2022,theUSSecuritiesandExchangeCommissionproposedrulechangesthatwouldrequirecompaniestoincludeclimate-relateddisclosuresintheirfinancialstatements,includingdisclosureoffirms’greenhousegasemissions,amongothermaterialinformation.3Thisdemandfortransparencyofcorporatesustainabilityisnotlimitedtopublicmarkets.Notably,skepticismhasbeengrowingaroundthevalidityofsustainability-relatedclausesandcommitmentsthatarepurportedlyreflectedinanincreasingnumberofprivatelynegotiatedcontracts—suchassustainability-linkedloans(Kimetal.2022)—forwhichdetailedinformationistypicallynotavailabletotheoutsidestakeholdersorthegeneralpublic.Thisconcernhasopenedthedoortoapotentialdebateoverwhethertoimplementpoliciesthatrequireacertainlevelofpublictransparencyonsustainabilityinprivatecontracts.However,itisnotimmediatelyobviousthatdisclosure-relatedpoliciesshouldbetakenthatfar,giventhatcontractualdetailsinmostprivatecontractsarebytheirnaturenotrequiredtobedisclosedtopartiesoutsideofthecontract.Thequestionofwhatdisclosureshouldberequiredinprivatecontractsultimatelyboilsdowntowhetherthereisapotentialconflictofinterestorinfringementonotherstakeholders’intereststhatarisesfromthecontract.Whenitcomestosustainability-linkedcontracts,afewimportantreasonsforsuchconflictsmightbeofconcern,whichareultimatelyrelatedtofirmincentives.3SeeclimateriskdisclosureguidelinesproposedbytheSecuritiesandExchangeCommissionathttps://www.sec.gov/news/press-release/2022–46.ClimateChangeandClimateFinance170Chiefamongthesereasonsisthatsuchcontractscanbeandareoftenusedassignalingmechanismswherebythecontractingparties(e.g.,corporations)mighthaveincentivestoimpressoutsidestakeholdersthattheyareESG-consciousorsociallyresponsiblealongsomedimensions.Itisthennotunreasonabletoviewoutsidestakeholdersalsoaspartiesofinterest,astheESGcommitmentssignaledbytheprivatecontractmayaffecttheirdecisionsaboutthecompanyascustomers,investors,orpotentialemployees.Withlimitedpublicdisclosure,theasymmetryofinformationinthegenuinenessoftheESGcommitmentmayleadtoadverseselectionproblemsbecausefirmscouldmakeemptypromisesofsustainability,inotherwords,engageinformsofgreenwashing.Thefactthatprivatecontractsareoftenrelationship-drivencouldexacerbatethisproblem.Forexample,relationshipbankingmayfostermutuallybeneficialgreenwashingarrangementsinsustainability-linkedlendingbetweenborrowersandlendersattheexpenseofotherstakeholders.WhilelendingrelationshipsmightfacilitatemoreeffectivetailoringandmonitoringofESGcommitmentsspecifictotheborrower,theycanmakeitsubstantiallyeasierforbankstofalselylabeltherevolvingcreditlinesoftheirexistingrelationshipborrowers’assustainability-linkedloanswhentheyreneworrollovertheseloansinthespiritofgreenwashing.10.4TransparencyandDisclosure:TheCaseofSustainability-LinkedLoansAsseenabove,acaseinpointfortheissueoftransparencyanddisclosureisthemarketforsustainability-linkedloans,whichhasgrownexponentiallyfrom$3billionin2017toroughly$600billionin2021(Figure10.1).Sustainability-linkedloansaregeneralpurposecorporatesyndicatedloansthattieloanpricingtermstotheESGperformanceoftheborrowingfirm.TheseloansarealsocalledESG-linkedloans.Theloanspreadsarepeggedexplicitlytokeyperformanceindicatorsincorporatingsustainabilitygoals.TheseindicatorsmaybeESGscoresassignedtoborrowersbyexternalratingagencies(e.g.,MSCIorSustainalytics)orspecificmeasuressuchasgreenhousegasemissionsorgenderequality.Theproceedsfromsustainability-linkedloanscanbeusedtofundgeneraloperationswithoutbeingtiedtogreenprojects.Incontrast,theconventionallyavailableinstrumentsforgreenfinancing(e.g.,greenbonds)requirethatthecapitalraisedbeusedonlyforspecificsustainableprojects(e.g.,renewablepowerplants,energy-efficientbuildings).SustainablePrivateCapitalMarkets171Inresponsetothegrowthoftheseloansintoperhapsthemostimportantsustainableprivatefinancingmarket,otherstudieshaveemergedtoinvestigateitsnature(Kimetal.2022;CaskeyandChang2022;Du,Harford,andShin2022;Dursun-deNeef,Ongena,andTsonkova2022;LoumiotiandSerafeim2022).Thefirstofthesestudies,Kimetal.(2022)payparticularattentiontotheavailabilityofpublicinformationonthesustainability-linkedcontractfeaturesoftheseloansandrelatestheleveloftransparencytopotentialgreenwashingincentivesonthepartofborrowersandlenders.Thefollowingdiscussesthisstudy’simplicationsforsustainabilitydisclosureinprivatemarkets.Amidtherapiddevelopmentofthissustainability-linkedprivatefinancingmarket,practitionersandthegeneralpublicaresignificantlyconcernedthatitisdifficulttoverifyESGloanlabelsorassesstherealimpactofsustainability-linkedloansindiscipliningborrowersonsustainabilityissues.4TogaugethecredibilityofESGcommitmentssignifiedbytheissuanceofsustainability-linkedloans,investorsmustrelyonpubliclydisclosedinformationaboutthecontractualdetails,suchaswhatthespecifickeyperformanceindicatorsareandhowtheyaretiedtotheloanterms.Thesustainability-linkedloanprinciples,developedbyaworkingpartyconsistingofrepresentativesfromleadingfinancialinstitutions,provideguidelinestoborrowersaboutdisclosuresandreportsthatneedtobemadeavailabletolenders.However,intheabsenceofregulationsorpublicdisclosurerequirementsintheemergingESGlendingmarket,thisinformationisvoluntarilyandselectivelydisclosedbyborrowersandlenderstothelargerpublic.Practitionerscommonlycriticizethelimitedavailabilityofthisinformation,makingitdifficultforinvestors4SeeBloomberg2020,2021a,and2021b.Figure10.1:Sustainability-LinkedLoanIssuancebillionSource:RefinitivDealScan.ClimateChangeandClimateFinance172andotherstakeholdersofthefirmtoverifythevalidityofESGloanlabelsandnavigatetheopaquemarket.Thelackofdetailorqualityofsuchdisclosuresisinturnskepticallyviewedasanindicationofgreenwashing.Itisthereforeimportanttoexaminethequalityofkeyperformanceindicatorinformationdisclosuresinsustainability-linkedloans.Kimetal.(2022)classifysustainability-linkedloansforwhichthereisnopublicinformationabouttheindicatorsorhowtheyaretiedtoloantermsas“lowpublicinformation”(LPI)loans.“Highpublicinformation”(HPI)loansarethosewithloantermslinkedtosomemetricofESGperformance(e.g.,CO2emissionspertonneoftransportedcargopernauticalmile,percentofwomeninworkforce,Sustainalyticsscore).Thestudyfindsthatthedisclosurequalityofsustainability-linkedloansisgenerallypoor.Roughlyhalfofthesustainability-linkedloansinthesampleareclassifiedasLPIloans(i.e.,510LPIloansvs.617HPIloans).ThelargefractionofLPIloansisrathersurprisinggivenhowgenerousthestudyisinclassifyingloansasHPIloans(i.e.,itlooselyclassifiesthemassuch,aslongastheyhavesomeinformationontheESG-relatedkeyperformanceindicators).EvenamongHPIsustainability-linkedloansthatdisclosesuchindicators,firmsasymmetricallydisclosetherewards(i.e.,morelikelytodisclose,or22%ofHPIloans)andpenalties(i.e.,lesslikelytodisclose,or13%ofHPIloans)tobeappliedtoloanspreadsconditionalonESGperformance.Kimetal.(2022)arguethatborrowersaremorelikelytorefrainfrompubliclydisclosinginformationonsustainabilityfeaturesoftheirESG-linkedloancontractswhenthesustainabilityfeatureshaveno“bite,”i.e.,whenkeyperformanceindicatortargetsarenotambitiousenoughorwhenthepenaltyfornotmeetingthetargetsisnotfinanciallymaterial.Insuchcases,borrowersaimtobenefitfromtheESGlabelwhileneverintendingtodevoteresourcestowardimprovingtheirESGprofile.Putdifferently,theyengageingreenwashing.Toempiricallyassesswhetherthelackofdisclosureinsustainability-linkedloansisapotentialmanifestationofgreenwashingandthereforeshouldbeimprovedthroughpolicy,thisstudyexamineshowborrowerESGperformanceisrelatedtotheissuanceofESGloanswithhighorlowpublicinformationavailability.Kimetal.(2022)investigatethisissueusingfirm-levelESGscoresfromtheRefinitivAsset4database.55Acknowledgingrecentconcernsaboutthesubjectivenatureandinconsistencyofsomethird-partyESGscores(Berg,Fabisik,andSautner2021;Berg,Koelbel,andRigobon2022),thestudyherefurtheranalyzescomponentsofAsset4scoresthatareplausiblymoreobjective(e.g.,emissions,resourceusage,etc.),andfindssimilarresults.SustainablePrivateCapitalMarkets173ThestudyfindsthatbothborrowersandlendersofESGloanshavesignificantlyhigherexanteESGscoresthanthoseofmatchednon-ESGloans,consistentwithfirmsthatfacegreaterscrutinyfromstakeholdersissuingsustainability-linkedloans.6Ifsustainability-linkedloanscrediblysignalcommitmenttoESG-friendlypractices,onewouldexpectthesuperiorexanteESGprofilestoimproveoratleastpersistaftersustainability-linkedloanissuance.Ontheotherhand,adeteriorationofESGperformanceexpostcouldindicategreenwashingaroundsustainability-linkedloanissuance.Consistentwiththelatter,thestudyherefindsthatborrowers’ESGprofilesdeteriorateaftersustainability-linkedloanissuance.Tofurtherdelineatewhethertheexpostwithin-firmdeteriorationinESGperformanceisconsistentwithgreenwashing,thestudyexploitsthecross-sectionalheterogeneityacrosssustainability-linkedloansintheavailabilityofpublicinformationabouthowtheloantermsaretiedtospecifickeyperformanceindicators.Figure10.2,whichplotscoefficientsfromdynamicdifference-in-differencesregressions,paintsaninterestingpicture.HPIsustainability-linkedloansarenotassociatedwithpost-issuancedeclineinborrowerESGscores.Suchborrowers,whohavehighESGscorestobeginwith,continuetomaintaintheirsuperiorESGscores.Ontheotherhand,consistentwithagreenwashinghypothesis,thisstudyfinds6TheresultsarealsoconsistentwithrecentfindingsthatborrowersandlenderswithsimilarlyhighESGratingstendtoformlendingrelationships(KacperczykandPeydró2022;HoustonandShan2022).Figure10.2:BorrowerEnvironmental,Social,andGovernancePerformancearoundSustainability-LinkedLoanIssuanceSource:Kimetal.(2022).–––––––HighpublicinformationLowpublicinformationClimateChangeandClimateFinance174asharpdeteriorationinESGperformancefollowingtheissuanceofLPIsustainability-linkedloans.Thisindicatesaformofgreenwashinginwhichcompaniesentersustainability-linkedloansthathavelaxloantermswhenitcomestopunishmentformissingsustainabilitytargetsorloansthatlayoutunambitioustargetstobeginwithandchoosenottopublicizethisinformation.Takentogether,thestudyherefindsthatESGloanissuanceitselfhasnopositiveimpactonexpostborrowerESGperformance,butinfactisfollowedbywithin-borrowerdeteriorationinESGperformance.ThisexpostdeteriorationisdrivenbyLPIsustainability-linkedloanswithlittleinformationavailableabouttheirkeyperformanceindicators,raisingconcernsaboutgreenwashinginalargesegmentofthemarket.ThereisnodeteriorationinESGscoresfollowingtheissuanceofHPIloans,suggestinggreatercommitmentstohighESGstandardsamongsuchborrowers.Theanalysisalsoshowsthatshareholders—outsidestakeholdersfromtheperspectiveoftheloancontracts—expresstheirconcernsaboutgreenwashing,wherebypublicstockmarketreactionsarepositiveforHPIsustainability-linkedloans(i.e.,onlywhenthereisenoughinformationaldetailaboutthesustainability-linkedaspectoftheloancontract)butnegligibleornegativeforLPIloans.Itseemsthatmoretransparentdisclosurewouldbeawelcomedevelopmentfortheevolutionofthesustainability-linkedloanmarketasapillarofsustainableprivatecontracts.10.5ConclusionandPolicyGuidelinesStakeholdersincreasinglydemandtransparencyincorporateESGpolicies.Whilemuchacademicresearchhaslookedatpubliccapitalmarkets,muchlessworkisavailableonprivatecapitalmarkets.Earlyresearchthusfarsuggeststhatprivateequityfirmscanhaveapositiveimpactonthesustainabilityoftheirportfoliofirms’businesses,butonlyiftheirprofit-maximizationincentivesarealignedwithstakeholdervalues.Rulesandregulationsmayplayanimportantroleinhelpingcompaniesandinvestorsinternalizeexternalities.Onepotentialandhotlydebatedregulationisrequiringsustainability-relateddisclosures.Eveninprivatecapitalmarkets,suchrulescouldmakesensewhencompanieshaveincentivestoengageingreenwashing.Mountingstakeholderpressuredoesindeedgivefirmsthisincentive.Inthecorporatesyndicatedloanmarket,wheresustainability-linkedloanshaveproliferatedinrecentyears,suchincentivesarepervasive.ThisisapparentSustainablePrivateCapitalMarkets175inthepoorqualitywithwhichcompaniesdisclosethesustainability-linkedcontractualfeaturesoftheseloanstothegeneralpublic.Notonlyisthisinformationoftenunavailablepublicly,butitispresentedselectivelyevenwhenitisavailable.Moreimportantly,borrowingcompanieswhodonotmakethecontractualinformationpublictendtoperformworseonESG-relatedperformancemetricsaftertheytakeoutsustainability-linkedloans.Thisindicatesthatsustainability-linkedcontractualfeaturesareinplaceasasignalingdevicetoaffectstakeholderdecisionswithoutfollowingthroughonconcreteandambitiouscommitments.Overall,theearlyevidencethusfarbuildsareasonablecaseforadvancingpolicydiscussionstodesignandimplementregulationstoalignshareholder-orientedcorporateincentiveswithstakeholdervalues.Rulesrequiringthetransparencyofpurportedsustainabilitycommitmentsseemareasonablestartingpoint.ClimateChangeandClimateFinance176ReferencesAlbuquerque,R.,Y.Koskinen,S.Yang,andC.Zhang.2020.ResiliencyofEnvironmentalandSocialStocks:AnAnalysisoftheExogenousCOVID-19MarketCrash.TheReviewofCorporateFinanceStudies.9(3).pp.593–621.Baker,M.,D.Bergstresser,G.Serafeim,andJ.Wurgler.2022.ThePricingandOwnershipofUSGreenBonds.AnnualReviewofFinancialEconomics.14.pp.415–437.Bartram,S.,K.Hou,andS.Kim.2022.RealEffectsofClimatePolicy:FinancialConstraintsandSpillovers.JournalofFinancialEconomics.143(2).pp.668–696.Bellon,A.2022.DoesPrivateEquityOwnershipMakeFirmsCleaner?TheRoleofEnvironmentalLiabilityRisks.Workingpaper.Berg,F.,K.Fabisik,andZ.Sautner.2021.IsHistoryRepeatingItself?The(Un)PredictablePastofESGRatings.Workingpaper.Berg,F.,J.Koelbel,andR.Rigobon.2022.AggregateConfusion:TheDivergenceofESGRatings.ReviewofFinance.26(6).pp.1315–1344.Bloomberg.2020.LeveragedLoanMarket’sESGPushOffersWindowintoOpaqueDeals.3February._____.2021a.WallStreet’sESGLoansChargeCorporateAmericaLittleforMissedGoals.8September._____.2021b.EthicalLabelIsHardtoVerifyinSecretiveWorldofESGLoans.22June.Caskey,J.andW-H.Chang.2022.DoESG-LinkedLoansEnhancetheCredibilityofESGDisclosures?Workingpaper.Döttling,R.andS.Kim.2022.SustainabilityPreferencesUnderStress:EvidencefromCOVID-19.JournalofFinancialandQuantitativeAnalysis.pp.1–39.https://doi.org/10.1017/S0022109022001296.SustainablePrivateCapitalMarkets177Du,K.,J.Harford,andD.Shin.2022.WhoBenefitsfromSustainability-LinkedLoans?Workingpaper.Dursun-deNeef,O.,S.Ongena,andG.Tsonkova.2022.GreenversusSustainableLoans:theImpactonFirms’ESGPerformance.Workingpaper.Eccles,R.G.,V.Shandal,D.Young,andB.Montgomery.2022.PrivateEquityShouldTaketheLeadinSustainability.HarvardBusinessReview.July–August2022.Fang,L.H.,J.Goldman,andA.Roulet.2023.PrivateEquityandPayGapsInsidetheFirm.Workingpaper.Flammer,C.2021.CorporateGreenBonds.JournalofFinancialEconomics.142(2).pp.499–516.GibsonBrandon,R.,S.Glossner,P.Krueger,P.Matos,andT.Steffen.2022.DoResponsibleInvestorsInvestResp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ialStabilityandGreeningPoliciesbyCentralBanks181impactofextreme-weathereventsonacountry’sfiscalandmacroeconomicindicators,apartfromcontributingtofinancialandpoliticalinstability,andabalanceofpaymentsimpactthroughchangesininternationaltradeandfinanceflows(Volzetal.2020).3Againstthisbackdrop,climatechangehasemergedasapolicyareaforcentralbanks.In2015,thethen-BankofEnglandGovernorMarkCarneygavealandmarkspeechoutliningtheexposureoftheUnitedKingdom’sinsurancesectortotheincreasingfrequencyofclimaterisks.Hearguedthatpolicymakersareunabletotakedecisiveandsignificantactiononclimatechangeastheyfacea“tragedyofthehorizon,”i.e.,aninabilitytoenvisagetheadverseconsequencesofclimatechangeduringtheirlifetimeortermofoffice(Carney2015).Hearticulatedtherisksposedbyclimatechangetofinancialandmacroeconomicstability,therebynecessitatingamoreprominentroleforcentralbanksinmitigatingtheserisksgiventheirrequisiteexpertiseandnuancedskills.Inmorerecentyears,centralbanksinEurope,Asia,andelsewherehaveincreasinglybecomecognizantofthesystemicrisksthatclimatechangeposestofinancialstability.Inaddition,centralbankshavebeenproactiveinformingacoalitiontocoordinateandconductresearchon“greenfinance,”4calledtheNetworkforGreeningtheFinancialSystem.Stepstowardpromoting“greenfinance”havealsobeentakenbyemerginganddevelopingcountries,includingBangladesh,Brazil,thePeople’sRepublicofChina,India,Indonesia,andSingapore.Thechapterreviewstherisksposedbyclimatechangetofinancialstability.Itthenlooksatcentralbankresponsestomitigatetheseclimate-relatedfinancialrisksandtheimplementationor“greening”ofprudentialpolicies,includingtheunevendiffusionofthesepoliciesacrosscountriesandthevariouspolicytoolsbeingusedorconsidered.ThechapterempiricallyexaminesthecharacteristicsoftheeconomieswheregreenprudentialpoliciesareadoptedandconcludeswithpolicyimplicationsforAsia.3Forinstance,a2020reportbyADBattributesahigherriskpremiumofaround155basispointsonsovereignbondyieldsduetothegreatervulnerabilityofAssociationofSoutheastAsianNations(ASEAN)economiestoclimatechange(Volzetal.2020).4Greenfinance,orthegreeningoffinance,broadlyencompassesanimpetustofinancinggearedtowardnonfossilfuelorclimate-friendlysectors,enablingasmoothtransitiontoalow-carboneconomy.ClimateChangeandClimateFinance18211.2ImpactofClimateChangeonFinancialStabilityClimatechangeimpactsfinancialstabilityprimarilythroughphysicalriskandtransitionrisk,5whichinturnexacerbatesvariousfinancialriskstofirms.First,a“physicalrisk”arisesfromtheadverseimpactsofextreme-weathereventsandthemoregradualriseinglobaltemperaturesandsealevelsonthebalancesheetsoffirmsandhouseholds(Dafermos,Nikolaidi,andGalanis2018;Molico2019).Onthefinancialside,risksinthisregardarelikelytoarise,forinstance,withininsurancecompanieswheretheunprecedentedscaleofcatastrophiclossesunleashedbyclimateeventswouldsendinsuranceclaimssoaring.Sinceinsurancecompaniesarehighlyintegratedwithintheoverallfinancialsystem,adeclineintheirprofitabilityand/orincreasedoperationalriskislikelytopresentasourceofsystemicriskforoverallfinancialstability(Tooze2019).Second,a“transitionrisk”isposedbythecurrenteconomicarchitecture,whichstillreliespredominantlyonfossilfuelsforenergysupplyandproduction.Anunexpectedshift,oranexpectedbutunplanned-forshiftinthecurrentcarbonemissionstandards,precipitatinga“hardlanding”fromahigh-carbontolow-carbonemittingeconomy(SchoenmakerandVanTilburg2016),canpromptanabruptmoveawayfromfossilfuelsandcarbon-intensiveproductionmethods,whichinturnwillresultinsupplysideshocksandasubsequentneedforcentralbankintervention(Batten,Sowerbutts,andTanaka2016).Suchanunexpectedshiftislikelyforprivateinvestmentincarbon-intensivesectors,becauseresearchhasdemonstratedthatcommercialandprivateinvestmentiscurrentlynotverysensitivetotherealityofglobalcarbonemissionreductionagreements(Amelietal.2020;Morgan2020).Othersourcesoftransitionriskarepolicychangesthatpenalizebrowninvestments,technologicalbreakthroughsthatfurtherthecaseofgreenenergyproductionmethods,andlarge-scaleshiftsinconsumerpreferencestowardmoreenvironment-friendlytechnologiesandproducts(Gaboretal.2019).Campiglio(2016)arguesthatcentralbankscanfacilitatethisshiftawayfromcarbonintensivetolow-carbonstandards,especiallyinemergingeconomies,byincentivizingcommercialbankstofundthelatterprojectsthroughdirectedlending,differentialreserverequirements,andmacroprudentialpolicies.5Referenceisalsosometimesmadeto“liabilityrisks,”whicharisespecificallyforfinancialentitiessuchasinsuranceagenciesandbusinesses,duetothe“uncertaintysurroundingpotentialfinanciallossesandcompensationclaimsstemmingfromvariousdamagescausedbyclimatechange-relatednaturalhazards”(DikauandVolz2018).Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks183Physicalandtransitionrisksaresomewhatnegativelycorrelated.Agradualtransitionfromahigh-carbontolow-carboneconomycanminimizetransitionrisksbutcanexacerbatephysicalrisks,owingtothelongerperiodoftransition,whichwillbecorrelatedwithanincreaseinextremeclimateevents(Table11.1,bottom-rightandbottom-leftcolumns).Ontheotherhand,asuddenshiftfromacarbon-intensivetoanenvironment-consciouseconomicarchitecturecanlowerphysicalrisksatthecostofimposingheftytransitioncostsoneconomicagents,includingprivatefirmsinfossilfuel-intensivesectors,banks,insuranceandreinsuranceagencies,andalliedplayers.Thiscouldoccurbytriggeringamassiverealignmentinassetvaluationswhichdonotcurrentlyfullyreflectclimate-associatedrisks(Kyriakopoulou,Chye,andThio2020;PointnerandRitzberger-Grünwald2019),aso-called“hardlanding”fromahigh-carbontolow-carboneconomy(Table11.1,top-leftcolumn).Inthiscontext,thejoboffinancialsupervisorsandcentralbanksistodesignpoliciestopreparefora“soft-landing”fromahigh-carbontolow-carboneconomyinthemediumterm(Table11.1,top-rightcolumn).Boththeseclimate-relatedriskscouldexacerbatefinancialriskstofirms,includingcreditrisk,marketrisk,liquidityrisk,operational,reputational,andsystemicrisk(Gruenewald2020;PointnerandRitzberger-Grünwald2019).Sincetheserisksareencounteredattheindividualfirm-level,microprudentialinstruments,suchasdifferentialcapitalconservationbuffersandvariousliquiditycoverageratios(D’OrazioandPopoyan2019;GoodhartandPerotti2013)canminimizesuchrisks.However,microprudentialpoliciestargetingrisksassociatedwithindividualfinancialinstitutionsareinadequatetodealwiththesystem-widethreatsposedbyclimate-relatedfinancialrisks.Fromasystem-wideperspective,higherphysicalandtransitionrisksarisingfromtheinabilityoffinancialinstitutionstoadequatelyaccountforclimaticrisksintheirriskframeworkandshort-termisminassetallocationtobrownversusgreensectorscanraisetheprobabilityofdefaultandwrite-offsofbrownassets.Thiscanaggravateoverallfinancialinstabilityandsystemicrisk.Similarly,abruptandmessydecarbonizationcancauselarge-scalecorrectionsinassetpricesandleadto“strandedassets,”whichcoulddestabilizetheentirefinancialsector.ClimateChangeandClimateFinance184Table11.1:ScenariosofInterconnectedPhysicalandTransitionRisksBasedonDegreeandTimingofCorrectiveResponsesStrengthofResponseSTRONGWEAKTimingofResponseEARLYHardlandingLimitphysicalrisk,butcausehightransitionriskSoftlandingLimit,butnoteliminate,bothphysicalandtransitionrisksDELAYEDToolittletoolateBothhighphysicalandtransitionriskHothouseearthExtremelyelevatedlevelsofphysicalriskassociatedwithconsiderabletransitionrisksSource:ByauthorsbasedonGruenewald(2020).11.3RoleofCentralBanksandGreenPrudentialPoliciesCentralbanksshouldbekeyactorsinmitigatingtheadverseimpactsofclimate-relatedfinancialrisksonthefinancialsystem.Likewise,theyarekeyactorsinfacilitatingasmoothtransitiontoadecarbonizednet-zerocarboneconomy,inlinewiththegloballyagreedConferenceoftheParties(COP)21ParisAgreement,andmorerecently,theCOP28meetingsinEgypt.Centralbankresponsestoclimatechangecanbecategorizedbasedontheirpolicymotivesforinterventioninfinancialmarkets.Conceptually,IsabelSchnabel,memberoftheExecutiveBoardoftheEuropeanCentralBank(ECB),envisagescentralbankresponsesasfallingintotwocategories—market-fixingormarket-shaping(Kyriakopoulou,Chye,andThio2020;Schnabel2020).Inmarket-fixingpolicies,centralbanksworkattheperipheriesofthemarkettofixtheinformationasymmetrysurroundingthecarbonpricingofassets.Thiscouldbeaccomplishedbycreatinggreentaxonomiesandencouragingclimate-relateddisclosuresbyprivatefirms.Market-shapingpoliciesaremoreproactiveandinvolvetheincorporationofclimateobjectivesintothesettingofmonetaryandprudentialpoliciesbycentralbankstodirectlyinfluencecreditallocationtogreenvs.brownsectors6(Gruenewald2020).6Othercentralbankresponsesincludeincorporatinggreenprinciplesintothemanagementoftheirownassetportfolios,operations,andforeignreserves(OMFIF2019),whichdonotunambiguouslyfallintoeitheroftheabovetwocategoriesbuthaveformedakeyaspectofcentralbanks’responsetoclimatechange.Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks185Baer,Campiglio,andDeyris(2021)proposeasomewhatdifferentyetcomplementaryclassificationoffinancialpolicies’motivesasprudentialorpromotional.Theyarguethatwhilepromotionalpoliciesareaimedatfacilitatingthetransitiontoalow-carboneconomy,theyarepremisedonamarket-shapingapproach.Ontheotherhand,policieswithaprudentialmotiveareaimedatidentifying,monitoring,andmitigatingtheriskstofinancialstabilityarisingfromclimatechange.Analternativeclassificationofcentralbankresponsestoclimatechangecanfocusonwhetherthepoliciesundertakenarepreventiveormitigative.Inthiscontext,policiestopreemptandminimizetheadverseeffectsofclimatechangeonfinancialstability—includingthecreationofgreentaxonomies,disclosures,calibrationofriskweights,etc.—canbetermedpreventive.Incontrast,ex-postcentralbankpolicies,implementedaftertherealizationofclimate-relatedfinancialrisks—suchastacklingofstrandedassetsandnonperformingloans—canbeclassifiedasmitigative.Disagreementsarerifeinthecentralbankingpolicydomainandacademiaaboutthe“correct”roleforcentralbanksintacklingclimatechange,withconcernsarticulatedparticularlyaboutthe“greening”ofmonetaryandmacroprudentialpolicies(BrunnermeierandLandau2020;Cochrane2020;Honohan2019).DikauandVolz(2021)analyzecentralbankmandatesusingtheInternationalMonetaryFund’s(IMF)CentralBankLegislativeDatabasetoassessthedejuresupportforcentralbanksincorporatingclimate-relatedrisksintotheirpolicyframeworksandresponses.Theyfindthat52%ofcentralbanksintheir135-countrydatabaseexplicitlyorimplicitlyincludesustainablegrowthasapolicyobjective.7Thus,alittlelessthanhalf(48%)ofcentralbanksintheirsampledonothavedejuresupportperseforpromotinggreenfinance,butsomeofthemstillhavetakenpolicymeasurestoaddressclimaterisk.Theauthorsarguethatitisimperativeforcentralbankstotakeaccountofclimate-relatedfinancialrisksregardlessoftheirlegalmandateinsofarasitimpedesoraffectstheattainmentofothercentralbankpolicyobjectivesofpricestability,growth,andfinancialstability.Similarly,asurveyof18centralbanksinAsiaandthePacificrevealsconsiderabledefactosupportamongthecentralbankingcommunitytointroducepoliciesforpromotinggreenfinanceandmitigatingclimaticriskstothefinancialsystem(Durrani,Rosmin,andVolz2020).7Ofthis52%,12%ofcentralbanksexplicitlyhavesustainablegrowthasapolicyobjective,whiletheother40%haveabroaderandvaguermandateofsupportingtheirgovernments’respectivepolicypriorities.Thelargeproportionofthesecentralbanksbelongtoemergingmarketsanddevelopingcountries(DikauandVolz2021).ClimateChangeandClimateFinance186Advocatesofgreencentralbankingarguethatthecurrenteconomicarchitectureisimplicitlybiasedagainstgreenfundingoptions,particularlyduetotheBaselIIImacroprudentialregulationswhichwereformulatedafterthe2008globalfinancialcrisis.BaselIIInormsassignhigherriskweightstogreensectorfinancingsincetheirgestationperiodislonger,greentechnologyisstillnotmainstreamed,andprojectcompletionissubjecttohigheruncertaintycomparedtotraditionalfossilfuel“brown”sectors(Gruenewald2020;Schnabel2020).Thus,reversingthisimplicitbiasbypromotinggreenfinanceandincorporatingclimaticrisksintoassetpricestofacilitatefullpricediscoveryisjustlevelingtheplayingfield.However,theimpactofwadingintotheclimatechangedebateontheindependenceofotherwisetechnocraticandneutrallyperceivedcentralbanks,aswellasquestionsontheseverityofclimaticriskperceptionsthemselves,areposedascounterargumentstothisclaim(Cochrane2020;Honohan2019).Theresponsetothesechargesisalsodividedsharplyalonggeopoliticalandideologicallines.ECBstronglysupportsanactivistroleforcentralbankstoincludeclimate-sensitivepoliciesintocentralbankmandates,becauseclimatechangeposesadirectrisktopricestabilitythroughlargepriceandoutputshocksaffectedbyclimate-relatedphysicalrisks.However,theUnitedStatesFederalReserveendorsestheviewthatsuchpoliciesaretheterritoryofelectedpolicymakers(BrunnermeierandLandau2020;Randow2020;Schnabel2020).Asianeconomieshavelargelybeen“nonvocal”inthesepolicydiscussions.Theyhave,however,implementedvoluntaryormandatorypoliciesincorporatinggreencriteriaintotheircreditallocation,riskdisclosure,andmacroprudentialpolicies,tomitigatetheimpactofclimate-relatedfinancialrisks.Thiscouldbepartlybecausetheircentralbankmandatesarenotpremisedonpricestabilityalone,butalsoincludesupportingthedesignandimplementationofthegovernment’seconomicpolicies.Thisisabroadmandatewhichisabletoincorporateclimate-relatedriskstofinancialstability(DikauandRyan-Collins2017)withoutmuchcontroversyorambiguityaboutthescopeandappropriatenessofcentralbankpolicymakingintheseareas.Againstthisbackdrop,theNetworkforGreeningtheFinancialSystemlaysoutsixrecommendationsforpolicymakers,centralbanks,andfinancialinstitutionstomitigatetheimpactofclimate-relatedfinancialrisksonfinancialstability.Theseare“(i)integratingclimate-relatedrisksintofinancialstabilitymonitoringandmicrosupervision,(ii)integratingsustainabilityfactorsintoown-portfoliomanagement,(iii)bridgingthedatagaps,(iv)buildingClimate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks187awarenessandintellectualcapacityandencouragingtechnicalassistanceandknowledgesharing,(v)achievingrobustandinternationallyconsistentclimateandenvironment-relateddisclosures,and(vi)supportingthedevelopmentofataxonomyofeconomicactivities”(NGFS2019,4).Microprudentialregulationhasincreasinglybecomeamajorcomponentofcentralbanks’toolkitsinrespondingtoclimate-relatedfinancialrisks.Greenmicroprudentialpoliciesfocusontheincorporationofenvironmentalandsocialsafeguardsbyindividualfinancialentitiestoensuretheirresiliencetoclimaticrisks.Attheminimum,thisinvolvessupervisionandclimatedisclosuresbyindividualfirms.Incontrast,greenmacroprudentialpolicyissimultaneouslyconcernedwiththepreservationoffinancialstabilitywhiletryingtominimizeclimaticriskstothefinancialsystemandenablingasmoothtransitiontoalow-carboneconomybypromotinggreenfinance.Thesepoliciesaremoresuitedtocombatsystemicrisksarisingfromtheinterconnectedandsynergisticnatureoffinancialfirms(IMF-FSB-BIS2016).Tomitigateclimate-relatedfinancialrisks,somecommonlyusedand/ordiscussedgreenmacroprudentialtoolsincludecountercyclicalcapitalbuffers,differentialequitymarginrequirements,differentialriskweightsforassetsbasedontheircarboncontent,andclimate-relatedstresstesting(DikauandRyan-Collins2017;SchoenmakerandVanTilburg2016).However,anargumentagainsttheuseofgreenprudentialpoliciesisthatfinancialandclimate-relatedrisksarenotperfectlycorrelated.Moreover,therelationshipbetweenclimatechangeandfinancialstabilityisnotunidirectional.Afewfinancialpoliciescalibratedtowardaclimateobjectivecanalsohaveunintendedconsequencesandcanendupexacerbatingfinancialinstability(Restoy2021;Schydlowsky2020).Forinstance,proposalstoartificiallyreduceriskweightsoncapitaldevotedtogreensectorsbyintroducingagreensupportingfactor(GSF)couldendupbackfiring.Althoughsuchapolicycouldincentivize/nudgefinancialinstitutionstoincreasetheircapitalexposurestogreensectors,agreensupportingfactordoesnotnecessarilyprovideacompleteaccountofthefinancialviabilityand/orcreditworthinessofgreenprojects.Ifthesegreenprojectssubsequentlyturnouttobeunprofitableand/orunviable(evidencedbycontemporaryconcernsofagreenbubbleandgreenwashingbyfirms),theensuingvolumeofnonperformingassetscouldexacerbatecredit/liquidityrisktofinancialentitiesandendupworseningfinancialstability.ClimateChangeandClimateFinance188Themostwidelydiscussedand/orimplementedgreenpoliciesacrosscountriesareclimate-relateddisclosurerequirementsforlistedcompaniesandfinancialinstitutions(currentlyunderdiscussionorimplementedin27jurisdictions),followedbytheinclusionofbroadlyencompassing“greenfinancialprinciples”infinancialregulators’operations.Developingeconomies,inparticular,havelargelyresortedtocreditallocationpolicies(lendingrequirementsanddifferentiatedreserverequirements)toachievesustainabilitygoals.Forinstance,different“equitymarginrequirements”forgreenversusbrownassets(whichisakintodifferentialcapitalconservationbuffers)aremandatoryinBangladesh(DikauandRyan-Collins2017),thePeople’sRepublicofChina(Durranietal.2020),andLebanon(D’OrazioandPopoyan2019),whiletheseareinthediscussionphaseinEurope(D’OrazioandPopoyan2019).VariantsofprioritysectorlendingareevidentinIndiaandBangladesh.8Climate-relatedstresstesting,ontheotherhand,ismandatoryinmanydevelopinganddevelopedeconomiesincludingBrazil;HongKong,China;Japan;Singapore;theUnitedKingdom;andinsomeEuropeaneconomies(Kyriakopoulou,Chye,andThio2020).Variousothereconomiesareactivelyconsideringproposalstoincludeclimate-relatedrisksintheirriskassessmentframeworks(D’OrazioandPopoyan2019).Enhanceddisclosurerequirementsappeartobewitnessingthemostactivityattheinternationallevelandthroughcross-countrycollaboration.TheTaskForceonClimate-RelatedFinancialDisclosuresledbytheFinancialStabilityBoardandatechnicalworkinggroupformedbytheEuropeanCommissionhaveadoptedaconsultativeandcollaborativeapproachtolaydowncommonstandardsforclimateriskdisclosuresbyprivatefinancialfirms.AmongemergingeconomiesinAsiaandLatinAmerica,Bangladesh,Brazil,thePeople’sRepublicofChina,Indonesia,andSingaporealsohavesuchdisclosurerequirementsinplaceforfinancialentities(DikauandRyan-Collins2017;Durrani,Rosmin,andVolz2020).8Bangladeshrequiresbankstoextendminimum5%oftheirloanportfoliotowardgreenactivities.Indiaincludedcredittorenewablesectorsunderitslong-standingPrioritySectorLendingscheme,whichmandatesbankstolendupto40%oftheirtotalloanportfoliotospecifiedsectors(Durrani,Rosmin,andVolz2020).Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks18911.4Empirics11.4.1MethodologyAlthoughtheintroductionofgreenprudentialmeasuresacrosscountriesisarecentphenomenonanditseffectivenessinmitigatingclimate-relatedfinancialriskscanonlybejudgedovertime,hereweexplorethequestionofwhatfactorsdeterminethelikelihoodofadoptionofgreenprudentialregulationsbycentralbanks.9Inparticular,weexaminewhethercountriesthataremorevulnerabletoclimatechangetendtobemorelikelyadoptersofgreenprudentialpolicies,hypothesizingapositivecorrelationbetweenthetwovariables.Aprobitmodelisemployedforanalysissincethedependentvariable—theimpositionofgreenprudentialpolicies—isabivariatedummy.Thebaselineconsidersasimplebivariateregressionestimatingtheeffectofclimatevulnerabilityofcountriesontheirlikelihoodofimplementinggreenprudentialpolicies.Themodelspecificationisasfollows:GMIi=f(Xi)(1)whereGMIiisabinarydummyindicatingwhetheranygreenprudentialpolicyisimplementedincountryiin2018(datadiscussedinnextsection);f(.)isafunctionandXirepresentsavectorofvariablesthatdeterminetheimpositionofgreenprudentialregulations.TheanalysisincludestheClimateVulnerabilityIndexbyPaun,Acton,andChan(2018)inthebaselinemodelasthemaindeterminant(independentvariable).Itadoptsaspecific-to-generalapproachinassessingthedeterminantsofimpositionofgreenprudentialregulations,startingbyonlyincludingclimaterisk-relatedindicatorsinthebaselineusingaprobitmodel.Havingestablishedthebaseline,theanalysisthenconjecturesthatacountrywhichhaspreviouslyimposedmacroprudentialpolicyinstrumentsingeneralismorelikelytoadoptgreenprudentialpractices.10Accordingly,theanalysisincludesanaggregatemacroprudentialpolicyindexinaprevious9PartsofthissectiondrawonCheng,Gupta,andRajan(2022).10Itislikelythatcountriesthatarealreadyfamiliarwithandhaveusedprudentialpolicytoolsinthepreviousyeararemorelikelytoimplement“green”prudentialpolicies,sincetheyonlyrequirearecalibrationtoincorporategreencriteria.ClimateChangeandClimateFinance190yeartocapturehowintensivelycountrieshaveengagedinprudentialmeasuresoverall.TheanalysisusestheMacroprudentialIndexcompiledbyCerutti,Claessens,andLaeven(2017)basedontheIMFsurveyontheGlobalMacroprudentialPolicyInstrumentsdatabase.Followingthat,theanalysisfurtherincludesaproxyforinstitutionalcapacityusingtheindicator“potentialtorespondtoclimaterisks”fromPaun,Acton,andChan(2018)tocapturetheoverallinstitutionalcapacityofacountry.Ithypothesizesthatgiventhesamevulnerabilitytoclimaterisks,thegreatertheinstitutionalcapacityofaneconomy,thelesslikelyitis(relatively)toimposegreenprudentialmeasures.Therefore,wegenerateinteractiontermsbetweenthethreeclimateriskindexesandthepotentialtorespondtoclimaterisksandincludetheminthemodeltotestwhetheracountrywithhigherinstitutionalcapacityislesslikelytoimplementgreenprudentialregulation,everythingelsebeingequal.11.4.2DataThedependentvariableisabivariatedummygeneratedbasedontheGreenMacroprudentialIndex(GMI)developedbyD’OrazioandPopoyan(2019),whichgivesthestatusofadoptionofgreenprudentialpolicies—underdiscussion,voluntary,ormandatory—by56countriesfor2018.11Thisdatasetsurveysexistinggreenprudentialregulationsandinstrumentsbydocumentingofficialcentralbankandfinancialinstitutionreports.TheGMIconstructedbytheauthorshasthreecategoriesandtakesvaluesfromzerototwo.Itequalszerowhenthemeasuresareunderdiscussion,indicatingthatcountriesarediscussingthepossibilityofintroducinggreenprudentialregulation;itequalsonewhencountrieshavedevelopedavoluntarygreenregulation;anditequalstwowhencountrieshaveadoptedagreenprudentialregulationwhichismandatoryinnature.Wemakeuseofthisclassificationbutdefineacountryashavingadoptedgreenprudentialpoliciesnomatterifitisvoluntaryormandatory.Hence,abinarydummyvariableindicatinggreenregulationadoptionisgeneratedanditequalsonewhentheGMIiseitherequaltooneortwoandzerowhentheGMIequalszero.11Fromtheinitialdatabaseof56countriesbyD’OrazioandPopoyan(2019),thesamplesizefortheprobitregressionsis41countries,because8countriesinthedatasethadmissingvaluesforstatusofimplementationofgreenprudentialpolicies,leaving48countrieswithvaluesforthedependentvariable,and7thatwerenotoverlappingwiththeHSBCClimateRisksIndexdataset,thekeyindependentvariable.Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks191Thekeyindependentvariableofinterestisthevulnerabilityofacountrytoclimaticrisks.ThismeasureisoperationalizedthroughanindexcreatedbasedontheClimateVulnerabilityIndexdevelopedbyTheHongkongandShanghaiBankingCorporationLimited(HSBC).TheFragilePlanetReportbyHSBCranks67countriesonthebasisoftheirvulnerabilitytoclimatechangebyprimarilyfocusingontheperiodbetween2006and2016(andinsomecasesgoingbackto1995suchasthelevelandchangeintemperatures)(Paun,Acton,andChan2018).Itassessescountriesbasedonboththephysicalrisksposedtothembyclimatechange,includingagreaterfrequencyofextremeweather-relatedeventsaswellastherisksinvolvedintransitioningtoalow-carboneconomy,whichisafunctionofadequatepublicandprivateinvestmentinrenewableenergyinitiatives.Italsoincludestheavailabilityofinnovativetechnologytoharnessenergyfromwater,hydrogen,andotherreplenishablesources,aswellasthepolicyarchitectureandcapacitythatexiststofacilitateandpromotethedecarbonizationoftheeconomy.Acountry’soverallrankisdeterminedbyanequalweightagegiventofoursubindexesofclimaterisks:“(1)physicalimpacts;(2)sensitivitytoextremeweatherevents;(3)energytransitionrisks;and(4)acountry’spotentialtorespondtoclimatechange,coveringfinancialresourcesandnationalgovernanceindicators”(Paun,Acton,andChan2018).12Alowercountryscorebasedonthesefourmeasurescorrespondstoahighervulnerabilityofthecountrytoclimaterisks.13Forthestatisticalanalysis,anewclimateriskindexisdevelopedbyaggregatingthefirsttwosubindexesintheHSBCreportmeasuringphysicalimpactsandsensitivitytoextremeweatherevents,assigninga50%weighttoeachofthesensitivityscoreandphysicalimpactsscore.Theaggregatescoreisthenreversedbysubtractingthevaluefrom10forinterpretation(sincealowerinitialscoreimpliesahighervulnerabilitytoclimaterisksandscoresacrossallfourHSBCsubindexesrangefrom0to10).TheanalysisalsousesthefourthsubindexinPaun,Acton,andChan(2018)separatelyasaproxyforinstitutionalcapacity.Thisindexdescribeshowwellcountriesareplacedtorespondtothephysicalandtransitionrisksfromclimatechange.Theindicatorcapturesacountry’sfinancialsoundness,includingitsgrossdomesticproductpercapita,publicdebt,sovereignwealthfundsandcapitalcosts,aswellasthestrengthofitsinstitutions,includingruleoflaw,corruption,inequality,andtertiaryeducation.12Formoredetailsonthecompositionoftheeachofsubindexes,refertoAnnexTableA.1onp.197.13Thesurveyfindingsreporttwointerestingtrends—thatcountriesinSouthAsiaandSoutheastAsiaaremostvulnerabletoclimatechange;andthatdevelopedcountriesingeneralarelessvulnerabletoclimateshocksthandevelopingcountries.ClimateChangeandClimateFinance192Forproxyingconventionalmacroprudentialpolicy,theanalysisusestheMacroprudentialIndexcompiledbyCerutti,Claessens,andLaeven(2017)basedontheIMFsurveyonGlobalMacroprudentialPolicyInstrumentsdatabase.Inthisdatabase,therearetwobroadtypesofmacroprudentialmeasures.Thefirsttypeconsistsoftwoinstrumentsthattargetborrowers,whichspecificallyincludecapsontheloan-to-value(LTV)ratioandlimitstothedebt-to-income(DTI)ratio.Thesecondtypeconsistsof10otherinstrumentsthatfocusonfinancialinstitutions(lenders).These12macroprudentialinstrumentsaretimeseriesdummyindicatorsontheusageofeachinstrumentforthesamplecountries.Theaggregatedmacroprudentialpolicyindex(MPI)takesthesumofpolicyactionindicatorsofall12individualinstruments.WeusethelaggedaggregatedMPIin2017tocapturepreviousexperiencewithconventionalmacroprudentialregulation.Allvariables,alongwiththeirrespectivedatasourcesandhypothesizedcausalimpactonthedependentvariable,aresummarizedinTable11.2.Table11.2:Variables,DataSources,andDirectionofImpactVariableSourceDirectionofImpactonDependentVariable(LikelihoodofImpositionofGreenMacroprudentialPolicies)ClimateRisksIndex(2017)NewaggregateindexdevelopedbasedontheHSBCClimateVulnerabilityIndex+Countriesmorevulnerabletoclimatechangearemorelikelytoimplementgreenmacroprudentialpolicies.Aggregatemacroprudentialindex(laggedby1year—2017)MacroprudentialIndexcompiledbyCerutti,Claessens,andLaeven(2017)basedontheInternationalMonetaryFundsurveyonGlobalMacroprudentialPolicyInstrumentsdatabase+Countrieswithpriorexperienceofmacroprudentialpoliciesaremorelikelytoalignthemwitha“green”objective.OverallinstitutionalcapacityPaun,Acton,andChan(2018)—subindexon“potentialtorespondtoclimaterisks”-Countrieswithhigherinstitutionalcapacityaremorelikelytohavetheresourcesandwherewithaltoimplementfiscalresponsestoclimatechange.Prudentialpolicies,consideredasasubstitutetofiscalpolicies,aremorelikelytobeimplementedinacountrywithlowerinstitutionalcapacity.HSBC=TheHongkongandShanghaiBankingCorporationLimited.Source:Authors.Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks19311.4.3ResultsTheanalysisestimatestheprobitmodelasdiscussed.ItstartswithabivariateregressionmodelestablishingtherelationshipbetweenGMIandtheindexcapturingphysicalimpactsofclimatechange.ResultsarepresentedinTable11.3,column(1).MPIisthenaddedtothemodelandresultsarereportedincolumn(2).Column(3)presentstheresultsoftheimpactofsensitivityofacountrytoextremeweathereventsonGMI.MPIisthenaddedtothemodelandresultsarereportedincolumn(4).Similarly,anaggregateindicator(consistingofanequallyweightedaverageofthefirsttwoindexes)isthencreatedandaddedtothemodelandresultsarereportedincolumn(5).MPIisthenincludedinthemodelandresultsarereportedincolumn(6).Robuststandarderrorsareusedtocorrectforpotentialheteroscedasticity.Table11.3:ClimateRisksandGreenPrudentialPolicies—ProbitModelVariables(1)GMPI(2)GMPI(3)GMPI(4)GMPI(5)GMPI(6)GMPIPhyrisk_rev0.4170.495(0.156)(0.184)Sensirisk_rev0.3270.327(0.0959)(0.101)Aggrisk_rev0.7880.803(0.192)(0.200)mpi_20170.2020.002850.103(0.128)(0.138)(0.135)Constant–2.076–3.425–1.838–1.849–4.080–4.652(0.748)(1.262)(0.546)(0.680)(0.989)(1.275)Observations414141414141GMPI=globalmacroprudentialpolicyindex.Notes:1.Phyrisk_revreferstophysicalriskscoresfromPaun,Acton,andChan(2018),whicharereversedforeaseofinterpretation.2.Sensirisk_revreferstosensitivityscoresfromPaun,Acton,andChan(2018),whicharereversedforeaseofinterpretation.3.Aggrisk_revreferstoanequallyweightedaverageofphysicalriskscoresandsensitivityscoresfromPaun,Acton,andChan(2018),whicharereversedforeaseofinterpretation.4.Mpi_2017referstotheaggregatemacroprudentialindexdevelopedbyCerutti,Claessens,andLaeven(2017).5.Probitcoefficientsarereported.Robuststandarderrorsareadopted.6.p<0.01,p<0.05,p<0.1.7.T-statisticsarereportedinparentheses.Source:Authors.ClimateChangeandClimateFinance194Resultsindicatethatallthreeclimateriskindicatorsarepositiveandhighlysignificant,evenaftercontrollingforpastrecordofimplementingmacroprudentialpolicies(capturedbympi_2017).Thisconfirmsourinitialhypothesis—countriesthataremorevulnerabletoclimaterisksaremorelikelytoimplementgreenprudentialpolicies.Next,weexaminewhethertheoverallinstitutionalcapacityofacountryisamechanismthatcanmediatetheimpactofhighervulnerabilitytoclimaterisksonthelikelihoodofimpositionofgreenprudentialpolicies.Wehypothesizethatacountrywithahigheroverallcapacity—capturedbythefourthsubindexinPaun,Acton,andChan(2018),whichincludesproxiesofbothacountry’sfinancialsoundnessandthestrengthofitsinstitutions—willbelesslikelytoimplementgreenprudentialpolicies,sincethesepoliciesareconsideredasecond-bestorsecond-orderresponsetocombatclimatechange(VilleroydeGalhau2020;Weidmann2020).Thefirst-bestresponsewouldbelevyofcarbontaxes,emissionstradingschemes,andgreeningofotherfiscalpolicies(Breman2020;Elderson2020).Toassessthishypothesis,weinteracttheproxyforinstitutionalcapacitywiththeaggregateclimateriskindicator.Table11.4showsthatforcountrieswithagivenlevelofclimaterisks(proxiedfirstbythetwosubindexesonphysicalimpactsofclimatechangeandsensitivitytoextreme-weatherevents,andthenanaggregateofthetwo),ahigherinstitutionalcapacityreducesthelikelihoodofimpositionofgreenprudentialpoliciesinallthreecases.Theresultsarehighlystatisticallysignificantatthe1%levelandremainrobusttotheinclusionofpastrecordofusingmacroprudentialpolicies.1414Institutionalcapacitybyitselfhasonlyaweakimpactonthelikelihoodofundertakinggreenprudentialpolicies.Onlyinthecaseofaggregaterisksastheindependentvariable,thecoefficientonoverallcapacityissignificantatthe5%levelbutwithapositivesign,indicatingthatahigherinstitutionalcapacityleadstoagreaterchanceofimplementinggreenprudentialpolicies,notwithstandingthedegreeofvulnerabilitytoclimatechange.Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks195Table11.4:InteractionEffectsofClimateRiskswithOverallCapacityDependentVariable:GMIDummy(1)(2)(3)Sensirisk_rev0.746(0.337)SensitivityscoreOverallcapacity–0.117(0.0538)Phyrisk_rev1.318(0.562)PhysicalimpactsOverallcapacity–0.176(0.0858)Aggrisk_rev2.587(0.804)AggregateOverallcapacity–0.355(0.110)Overallcapacity–0.01100.2191.200(0.311)(0.397)(0.552)mpi_20170.08160.2270.167(0.141)(0.165)(0.194)Constant–1.531–4.441–11.17(1.987)(3.192)(4.491)Observations414141GMI=greenmacroprudentialindex.p<0.01,p<0.05,p<0.1.Notes:SeeTable11.3.Source:Authors.11.5ConclusionIncreasingly,financialsupervisorsandcentralbanksarebeingcalledupontoundertakethetaskofmitigatingtheimpactofclimate-relatedfinancialrisksonfinancialstability.Accordingly,financialsupervisorsandcentralbanksmayneedtoembracegreenprudentialpoliciesaspartoftheirpolicytoolkitandusethemtofacilitatethetransitiontoamoresustainableeconomy.Sinceclimatechangeaffectsboththebalancesheetsofindividualfinancialentitiesandposessystem-widerisksaffectingtheentirefinancialsystem,bothmicro-andmacroprudentialpolicytoolsarebeingconsideredandimplementedindifferentcountriestomitigateitsimpact.Thepreliminaryempiricalevidenceinthischaptersuggeststhatcountriesthataremorevulnerabletoclimatechangetendtomorelikelybeadoptersofgreenprudentialpolicies.ClimateChangeandClimateFinance196Fromapolicyperspective,eventhoughdebateragesonregardingthedegreetowhichcentralbanksshouldincorporategreenobjectivesintheirmandatesandoverallregulatoryandmonetarypolicies,mostagreethatcentralbankscanplayavitalroleinfacilitatingthedevelopmentoftaxonomiesandclimate-relateddisclosures.Evenasmanycentralbanksareadoptingadegreeofgreenpolicyandregulationsatthedomesticlevel,internationalcoordinationandcollaborationisvitalinthisregard.Stepsareneededtoharmonizegreenstandardsinternationallytoensurecross-borderconsistencyofregulationsandtopreventgreenwashing.Atthegloballevel,severalstandard-settingbodieshavebeenestablishedwiththismandate,suchastheTaskforceonClimate-RelatedFinancialDisclosuresandtheTaskforceonClimate-RelatedFinancialRisksundertheBankforInternationalSettlements,theInternationalOrganizationforSecuritiesCommissionsSustainableFinanceTaskForce,theNetworkforGreeningtheFinancialSystem,andsoon.However,aninternationalglobalagreementontaxonomiesanddisclosuresremainselusive.SeveralAsianeconomieshaveemergedasglobalfrontrunnersinimplementingpoliciestoencouragegreenfinanceandtocreateaconduciveenvironmentforanorderlytransitiontoadecarbonizedeconomy.TheuptakeofgreenprudentialpoliciesofamandatorynatureisthehighestinAsiaascomparedwithotherregionsoftheworld,andthisisperhapspartlyduetothehighervulnerabilityofAsianeconomiestoextremeweather-relatedeventsandglobalwarming.The“greening”ofprudentialpolicies(bothmicroandmacro),undertakenparticularlybyAsiancentralbanks,areaimedbothatnudginginvestorstowardlow-carbon“green”sectors,aswellasmitigatingtheclimate-relatedriskstofinancialstability.Asiancentralbanksalsopromotegreenfinancethroughpreferentialallocationofcredittolow-carbonsectorsandawayfromhigh-carbonones,andarecalibrationofcentralbanks’ownbalancesheetsandreservestoreflectclimatepriorities.However,sincemostofthesepoliciesareimplementedindividuallybycountriesatthenationallevel,greaterdiscussionscouldalsobedoneonissuesrelatingtothegreeningofprudentialregulations,whichmayneedtobecoordinatedacrosscountriestopreventcross-borderregulatoryarbitragegivengreaterregionalizationoffinancialmarkets.TheAssociationofSoutheastAsianNations(ASEAN)TaskForceontheRolesofCentralBanksinManagingClimateandEnvironment-RelatedRiskssetupbyninecentralbanksofASEANcountriesin2019isanimportantinitiativeinthisregard.Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks197AnnexTableA.1:FourClimateRiskSubindexesfromtheHSBCFragilePlanetReport2018SubindexDescriptionPhysicalimpactsofclimatechangeCompositescoreisbasedon“temperaturelevels(35%ofthescore),wateravailability(50%),andextremeweatherevents(15%).”SensitivitytoextremeweathereventsExtremeweathereventsaredefinedasdroughts,floods,extremetemperatures,storms,andwildfires,normalizedbyadjustingforlandmass.Sensitivityismeasuredacrossthreedimensions—“costofdamage(40%weightage),numberofdeaths(30%),andnumberofpeopleaffected(30%).”EnergytransitionrisksMeasuredbyincluding“thelevelandchangeoverthepast10yearsforfossilrents(economicprofit)asapercentageofGDP(33.3%),shareoffossilfuelsinexports(33.3%),andshareoffossilfuelsinprimaryenergyuse(33.3%).”PotentialtorespondtoclimatechangeA50%weightageeachisassignedtofinancialcapacityandstrengthofinstitutions,orinstitutionalcapacity.MetricstocapturefinancialcapacityincludeGDPpercapitaatPPP,publicdebt,sovereignwealthfunds,andcostofcapital.Strengthofinstitutionsisproxiedusingmeasuresofruleoflaw,corruption,inequality,andtertiaryeducation.GDP=grossdomesticproduct,PPP=purchasingpowerparity.Source:Paun,Acton,andChan(2018).ClimateChangeandClimateFinance198ReferencesAglietta,M.andÉ.Espagne.2016.ClimateandFinanceSystemicRisks,MorethananAnalogy?TheClimateFragilityHypothesis.CEPIIWorkingPaper.No.2016-10.Paris:CEPII.Ameli,N.,P.Drummond,A.Bisaro,M.Grubb,andH.Chenet2020.ClimateFinanceandDisclosureforInstitutionalInvestors:WhyTransparencyIsNotEnough.ClimaticChange.160(4).pp.565–589.https://doi.org/10.1007/s10584-019-02542-2.Baer,M.,E.Campiglio,andJ.Deyris.2021.ItTakesTwotoDance:InstitutionalDynamicsAndClimate-RelatedFinancialPolicies.CentreforClimateChangeEconomicsandPolicyWorkingPaper.No.384/GranthamResearchInstituteonClimateChangeandtheEnvironmentWorkingPaper.No.356.https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2021/04/working-paper-356-Baer-et-al.pdf.Batten,S.,R.Sowerbutts,andM.Tanaka.2016.Let’sTalkabouttheWeather:theImpactofClimateChangeonCentralBanks.BankofEnglandStaffWorkingPaper.No.603.London:BankofEngland.Bolton,P.,M.Despres,L.A.P.daSilva,R.Svartzman,andF.Samama.2020.TheGreenSwan:CentralBankingandFinancialStabilityintheAgeofClimateChange.Basel:BankforInternationalSettlements.Breman,A.2020.HowtheRiksbankCanContributetoClimatePolicy.SpeechbytheDeputyGovernorofSverigesRiksbank.RoyalSwedishAcademyofEngineeringSciences,Stockholm.3March.https://www.bis.org/review/r200304g.pdf.Brunnermeier,M.K.andJ-P.Landau.2020.CentralBanksandClimateChange.VoxEU/CentreforEconomicPolicyResearch(CEPR).15January.https://voxeu.org/article/central-banks-and-climate-change.Campiglio,E.2016.BeyondCarbonPricing:TheRoleofBankingandMonetaryPolicyinFinancingtheTransitiontoaLow-CarbonEconomy.EcologicalEconomics.121.pp.220–230.https://doi.org/10.1016/j.ecolecon.2015.03.020.Climate-RelatedRiskstoFinancialStabilityandGreeningPoliciesbyCentralBanks199Carney,M.2015.BreakingtheTragedyoftheHorizon–ClimateChangeandFinancialStability.Speech.29September.https://www.bankofengland.co.uk/-/media/boe/files/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability.pdf?la=en&hash=7C67E785651862457D99511147C7424FF5EA0C1A.Cerutti,E.,S.Claessens,andL.Laeven.2017.TheUseandEffectivenessofMacroprudentialPolicies:NewEvidence.JournalofFinancialStability.28.pp.203–224.https://doi.org/10.1016/j.jfs.2015.10.004.Cevik,S.andJ.T.Jalles.2020a.AnApocalypseForetold:ClimateShocksandSovereignDefaults(20/231).InternationalMonetaryFund.https://www.elibrary.imf.org/doc/IMF001/29355-9781513560403/29355-9781513560403/Other_formats/Source_PDF/29355-9781513562285.pdf?redirect=true.Cevik,S.andJ.T.Jalles.2020b.FeelingtheHeat:ClimateShocksandCreditRatings.InternationalMonetaryFund.https://www.imf.org/en/Publications/WP/Issues/2020/12/18/Feeling-the-Heat-Climate-Shocks-and-Credit-Ratings-49945.Cevik,S.andJ.T.Jalles.2020c.ThisChangesEverything:ClimateShocksandSovereignBonds.InternationalMonetaryFund.https://www.imf.org/en/Publications/WP/Issues/2020/06/05/This-Changes-Everything-Climate-Shocks-and-Sovereign-Bonds-49476.Cheng,R.,B.Gupta,andR.S.Rajan.2022.WhyAreSomeCountriesGreeningMacroprudentialRegulationsFasterthanOthers?Mimeo.Cochrane,J.2020.CentralBanksandClimate:ACaseofMissionCreep.HooverInstitution.13November.https://www.hoover.org/research/central-banks-and-climate-case-mission-creep.D’Orazio,P.andL.Popoyan.2019.DatasetonGreenMacroprudentialRegulationsandInstruments:Objectives,ImplementationandGeographicalDiffusion.DatainBrief.24.103870–103870.https://doi.org/10.1016/j.dib.2019.103870.D’Orazio,P.andL.Popoyan.2019.FosteringGreenInvestmentsandTacklingClimate-RelatedFinancialRisks:WhichRoleforMacroprudentialPolicies?EcologicalEconomics.160.pp.25–37.https://doi.org/10.1016/j.ecolecon.2019.01.029.ClimateChangeandClimateFinance200Dafermos,Y.,M.Nikolaidi,andG.Galanis.2018.ClimateChange,FinancialStabilityandMonetaryPolicy.EcologicalEconomics.152.pp.219–234.Dikau,S.andJ.Ryan-Collins.2017.GreenCentralBankinginEmergingMarketandDevelopingCountryEconomies.London:NewEconomicsFoundation.https://neweconomics.org/uploads/files/Green-Central-Banking.pdf.Dikau,S.andU.Volz.2018.CentralBanking,ClimateChangeandGreenFinance.Tokyo:AsianDevelopmentBankInstitute.https://www.adb.org/publications/central-banking-climate-change-and-green-finance.Dikau,S.andU.Volz.2021.CentralBankMandates,SustainabilityObjectivesandthePromotionofGreenFinance.EcologicalEconomics.184.107022.https://doi.org/10.1016/j.ecolecon.2021.107022.Durrani,A.,M.Rosmin,andU.Volz.2020.TheRoleofCentralBanksinScalingUpSustainableFinance—WhatDoMonetar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lAssessments.SpeechattheEuropeanBankingCongress.20November.https://www.bis.org/review/r201120e.pdf.ChapterCentralBanksandClimateChange12JonathanKearns,AnnaPark,andSerenaAlim112.1IntroductionGiventhebroadandpervasiveeffectsofclimatechangeoneconomies,financialmarkets,andinvestortoleranceforrisk,centralbanksareincreasinglyturningtheirattentiontoclimatechange.Humanactivityissignificantlycontributingtoclimatechange.Globally,averagesurfaceairtemperatureshavewarmedbyover1oCsincethemid-1800sandaveragesealevelshaverisenabout25centimeterssince1880(CSIRO2002).Andthefrequencyandseverityofextremeweatherevents—heatwaves,storms,etc.—hasincreased.InAustralia,forexample,averagedayswithmeantemperatureabovethe99thpercentilerosefrom1dayevery3yearsin1920–1930to14dayseachyearin2010–2020(AustralianGovernment2021).Thebroadimpactonsocietyincludeseffectsoneconomicactivityandfinancialmarkets,boththroughtheimpactontheeconomyandmarketparticipants’risktolerance.Centralbankshavetakenaction,asnotedbyexpandinganalysisandresponsetothesedevelopments.1ThisworkwascompletedwhiletheauthorswereallworkingattheReserveBankofAustralia.TheauthorswouldliketothankAshviniRavimohanforassistanceonthiswork.CentralBanksandClimateChange205CategorizingtheeffectsofclimatechangeTheeffectsfallunderthreebroadcategories:Acutephysicalrisksaretheeffectsofextremeone-offevents—floods,cyclones,bushfires,etc.—thatdamageinfrastructure,harmlivestockandcrops,anddisrupttheeconomymorebroadlybyhamperingpeople’sabilitytoworkandhinderingtransportation.Chronicphysicalrisksaretheongoingeffectsofclimatechangefromrisingtemperatures,greaterfrequencyofveryhotdays,andchangesinrainfallpatternsthatreduceproductivityofsomeeconomicactivity,suchasbyloweringcropyieldsordiscouragingtouristsfromvisitingparticularareas.Transitionrisksarisefromchangesingovernmentpolicies,technology,andconsumerpreferencesinreactiontoclimatechangethatcan,forexample,reducetheincomegeneratedfromparticularactivitiesorassets,andsoerodetheirvalue.Becausecentralbanks’primaryobjectivesrelatetoeconomicandfinancialmarketoutcomes,theyneedtoaccountforclimatechangeintheirpolicydecisions.Somecentralbanksalsohavebroaderreasonsforrespondingtoclimatechange.Overall,fourissuesincentralbanks’objectivesandoperationswarrantaresponse.Theseincludetheir(i)inflationandemploymentmandates;(ii)financialstabilitymandates;(iii)ownoperationsincludingmanagementoftheirportfoliosofassets;and(iv)forsomecentralbanks,financialmarketdevelopmentandsupportinggovernmentpolicyobjectives.Centralbanksgenerallyassesstheimpactofclimatechangeonthefirsttwooftheseobjectivesinasimilarway.Onthethirdobjective—theirownoperations—somecentralbankshavebeenmoreactivethanothers.However,thegreatestdisparityincentralbanksclimatechangepositionsisonthefourthissue:whetherornottoactivelypromotefinancialmarketdevelopmentsthatwouldhelptheeconomybetterrespondtothethreatofclimatechangeandsupportassociatedgovernmentpolicies.InflationandemploymentmandatesAlmostallcentralbankshaveaninflationtarget(or,forafew,anothernominalanchorsuchasanexchangeratetarget).Inmostcases,thistargetisonepartofadualmandatethatalsofocusesonfullemploymentoreconomicsparecapacity.ClimateChangeandClimateFinance206Therealizationofacuterisksofclimatechangecanaffectthedynamicsofinflationandoutputand,atleastinthenearterm,thelevelofinflation.Climatechangecanresultinmorefrequentandextremesupplyshocks.SignificantfloodinginAustraliainrecentyears,forexample,hasreducedsupplyandincreasedpricesoffruitandvegetables.Beforethat,widespreaddroughtsraisedthepriceandreducedtheavailabilityofmeat.Supplyshockscanhavewide-rangingeffectsoneconomicoutput.Forexample,floodingandstormscanreduceminingoutputanddisruptshippingandothertransport,whichcaninturnreduceexportsormanufacturingoutputandretailsales.Short-termsupplyshockstendtohavelessimpactonemployment,asemployersgenerallydonotpermanentlyreduceemploymentinresponsetoatransientshock,butshort-termlayoffsmayresult.Centralbankswithflexibleinflationtargetscantypicallylookthroughtheeffectsofanysuchtransientsupplyshocks,includingthosefromextremeweather.However,ifincreasesininflationand,importantly,inflationexpectationsfromasupplyshockarepersistent(includingthoseatleastpartlyattributabletoclimatechange),thencentralbanksmayneedtotightenpolicy.Chronicphysicalrisksandtransitionrisksresultinstructuralchangeintheeconomyassomeeconomicactivitiesbecomeunprofitable,andothers(eventually)taketheirplace.Howdisruptivethisstructuralchangeiswilldependonwhetheritisanticipatedandhowrapidlyitoccurs.Ifstructuralchangeisabruptthentheproductivecapacity,andpotentialgrowthrate,oftheeconomywillbelower,atleastforaperiodoftime.Thiswouldmeanthatagivenlevelofoutput,orgrowth,wouldbemoreinflationarythanotherwise,andsorequireatightersettingofmonetarypolicy.Whensettingmonetarypolicy,centralbanksshouldaccountforanythingthatinfluencestheircoremandatesofinflationandemployment,includingtheimpactofweathereventsandtheclimate.Hence,analyzingtheeffectsofclimatechangeandrespondingtothoseeffectshasbecomeastandardapproachamongmostcentralbanks.Forexample,theBankofCanadastatesthat“tofulfilitsmonetarypolicymandateofkeepinginflationlowandstable,theBankneedstounderstandthepotentialimpactsofclimatechangeonthemacroeconomyandpricestability(BOC2021).”InthewordsoftheFederalReserve,“itisvitalformonetarypolicymakerstounderstandthenatureofclimatedisturbancestotheeconomy,aswellastheirlikelypersistenceandbreadth,inordertorespondeffectively”(Brainard2021).Table12.1providesexamplesofcentralbanks’climate-relatedobjectives.CentralBanksandClimateChange207Table12.1:ExamplesofCentralBankClimate-orSustainability-RelatedObjectivesBankofCanadaɂAssesstheeffectsofclimatechangeonthemacroeconomyandpricestabilityɂEvaluatetheCanadianfinancialsystem’sexposurestoclimate-relatedrisksandimproveassociatedriskmanagementcapacitiesɂMeasure,mitigate,andreportonthecentralbank’soperationalrisksrelatedtoclimatechangeɂEngageandcollaboratewithCanadianandinternationalpartnersBankofEnglandɂEnsuringthefinancialsystemisresilienttoclimate-relatedfinancialrisksɂSupportinganorderlyeconomy-widetransitiontonetzeroemissionsɂPromotingtheadoptionofeffectiveTCFD-alignedclimatedisclosureɂContributingtoacoordinatedinternationalapproachtoclimatechangeɂDemonstratingbestpracticethroughownoperationsBankofJapanɂSupporttheprivatesector’seffortsonclimatechangeɂSupportfinancialinstitutionsinidentifyingandmanagingtheirclimate-relatedfinancialrisksɂDeepenanalysisonhowclimatechangewouldaffectthemacroeconomy,includingeconomicactivityandprices,financialmarkets,andthefinancialsystemɂStrengtheneffortstopromoteinvestmentinclimate-relatedfinancialproducts,suchasgreenbondstofosterdevelopmentoffinancialmarketsEuropeanCentralBankɂManagingandmitigatingthefinancialrisksassociatedwithclimatechangeandassessingitseconomicimpactɂPromotingsustainablefinancetosupportanorderlytransitiontoalow-carboneconomyɂSharingexpertisetofosterwiderchangesinbehaviorMonetaryAuthorityofSingaporeɂStrengthentheSingaporefinancialsector’sresiliencetoenvironmentalrisksɂDevelopavibrantsustainablefinanceecosystemtosupportAsia’stransitiontoalow-carbonfutureɂIntegrateclimaterisksandopportunitiesintoourinvestmentframeworkɂReduceowncarbonandenvironmentalfootprinttosupportSingapore’sbroaderclimateambitionsandcommitmentReserveBankofNewZealandɂMonitorandmanageitsimpactonclimateɂUnderstandandincorporatetheimpactofclimatechangeinitscorefunctionsɂProvideleadershipasaninstitutionRiksbank(Swedishcentralbank)ɂWorktoensurethatitsownoperationsgraduallycomplywithinternationalagreementssuchastheParisAgreementɂHelptoincreaseknowledgeoftheeffectsofclimatechangeontheeconomybycontributingitsownresearchandanalysesɂTakeasustainabilityperspectiveinitsassetpurchasesandinthemanagementoftheforeignexchangereservesundertheframeworkoftheRiksbank’smandateɂPromoteincreasedtransparencyandreportingrelatedtoitsclimatefootprintɂPromoteregulationsinthefinancialmarketstoreducetherisksclimatechangemayentailforthefinancialsystemɂActivelyparticipateinvariousinternationalnetworksandpartnershipstohelpreducetherisksofclimatechangeatagloballevelTCFD=TaskForceonClimate-RelatedFinancialDisclosures.Source:Authors.ClimateChangeandClimateFinance208Somecentralbanksseeabroaderobjectivetosupportthetransitiontoalow-carboneconomyasflowingfromprimarymandates.TheBankofJapannotesthatsupportingtheprivatesector’seffortsonclimatechangewillhelpstabilizethemacroeconomyinthelongrun,whichisconsistentwithitsmandateofachievingpricestabilityandensuringthestabilityofthefinancialsystem(BOJ2021a).Similarly,somecentralbankshighlighttheirrole,drawingonresearchandanalysistoraiseawarenessoftheimpactsofclimatechange.Forexample,oneofthethreecoreclimateobjectivesfortheEuropeanCentralBank(ECB)is“sharingourexpertisetofosterwiderchangesinbehaviour”(ECB2022a).TheReserveBankofNewZealand’sclimatestrategyincludes“providingleadershipasaninstitution,”byhelpingsupportpolicydevelopmentandclosinginformationgaps(RBNZ2022).Manycentralbanksalsonotetheimportanceofcontributingtocollectiveeffortsonclimateandsustainabilityissues.TheBankofEngland,forexample,aimstocontributetoacoordinatedinternationalapproachtoclimatechange,includingthroughitsinvolvementwithinternationalgroups.FinancialstabilityMostcentralbankshavearesponsibilityforthestabilityofthefinancialsystem.Somearealsotheprudentialregulatorandsohaveadirectroleinoverseeingtherisksofindividualinstitutions.Climatechangehasthepotentialtoincreaseboththelikelihoodofborrowersdefaultingandthepotentialsizeofthelender’slossifborrowersdefault.Climatechangecanreducetheabilityofborrowerstomeettheirrepaymentsifitresultsinsustaineddeclineintheirincomeormakesitlessreliable.Climatechangecanalsoleadtolowerassetvaluationsifitreducestheassets’cashflowsormakesthemmorevolatile.Wherethoseassetshavebeenusedassecurityforloans,assetpricedeclinesincreasethepotentiallossesthatlendersfaceifborrowersdefault.Individualfinancialentitiescanalsobeexposedtoliabilityriskiftheymismanagetheirclimaterisks.Iftherisksfromclimatechangearenotwellmanagedbyfinancialinstitutions,andtheyresultinlargelossesforindividualinstitutionsorerodeconfidenceinpartsofthefinancialsystem,itcouldbedetrimentaltofinancialstability.Manycentralbankshighlighttheirroleinunderstandingandmanagingtherisksthatclimatechangeposestofinancialinstitutionsandfinancialstability.Forexample,theMonetaryAuthorityofSingaporeworksCentralBanksandClimateChange209to“strengthentheSingaporefinancialsector’sresiliencetoenvironmentalrisks”(MAS2022).TheBankofEnglandhascommittedto“ensuringthatthefinancialsystemisresilienttoclimate-relatedfinancialrisks”(BOE2022).Evenwherecentralbanksarenotprudentialregulators,aspartofaresponsibilitytosupportfinancialstability,theyidentifyaroleinimprovingtheabilityoffirmsandinvestorstounderstandandmanageclimate-relatedrisks.Forexample,theBankofCanadahascommittedto“evaluatetheCanadianfinancialsystem’sexposurestoclimate-relatedrisks”(BOC2021).TheReserveBankofAustralia,aspartoftheAustralianCouncilofFinancialRegulators,hasaroletoplayincreatingtheframeworkthatenablesparticipantstomanageclimatechangerisksandopportunities(Kearns2022).CentralbankoperationsandassetsManycentralbanksarealsoseekingtounderstandandmanagetheclimate-relatedrisksassociatedwiththeirownoperations.Centralbanksholdportfoliosofassetstoimplementmonetarypolicy,tofacilitateforeignexchangetransactionsforthegovernmentandincaseoftheneedforforeignexchangeintervention.Sinceclimatechangecouldresultindeclinesinassetprices,itisariskaffectingthevalueofthecentralbank’sportfolio.Howsignificantthisriskisforacentralbankdependsonthecompositionoftheirportfolio.Centralbanksthatholdonlysovereigndebtarelikelytobelessexposedthanthosethatalsoholddebtorequityissuedbyfirmswithsignificantexposuretoclimatechange.Somecentralbankshavealsoexaminedthegreenhousegasemissionsassociatedwiththeirholdingsoffinancialassets.TheBankofCanada,forexample,hascommittedto“measure,mitigateandreportontheBank’soperationalrisksrelatedtoclimatechange,”andto“reviewitsfinancialmarketoperationstoconsiderclimate-relatedfinancialrisksandopportunities”(BOC2021).Asdiscussedlater,centralbanks’actionsassociatedwithmeetingtheirownriskmanagementneedscanalsosupportotherobjectives,includingthedevelopmentofgreenfinancialmarketsortakingaleadershiprole.TheBankofEngland,forexample,aimsto“demonstratebestpracticethroughourownoperations”(BOE2022).FinancialmarketdevelopmentandsupportforgovernmentpoliciesSomecentralbanksalsohaveobjectivesfordevelopingtheirfinancialsystem—inparticular,greeningtheirfinancialsystem—orsupportingthegovernment’spolicyobjectives.Typically,theseadditionalobjectivesaredescribedassecondarytothecentralbank’sprimaryinflationandemploymentgoals.ClimateChangeandClimateFinance210Somecentralbanksidentifyasanobjectivesupportinganorderlyeconomy-widetransitiontonetzeroemissions,includingbypromotingsustainablefinance.Thisincludescentralbankswithexplicitsecondaryobjectivestosupportgovernmentpoliciesingeneral,orclimatepoliciesspecifically.Forexample,theBankofEnglandActstatesthatinrelationtomonetarypolicy,theobjectivesoftheBankofEnglandshallbe(i)tomaintainpricestability;and(ii)subjecttothat,tosupporttheeconomicpolicyofHerMajesty’sGovernment,includingitsobjectivesforgrowthandemployment.Andina2021lettertotheBankofEnglandgovernor,theUnitedKingdomtreasurerhasstatedthatthegovernment’seconomicstrategyincludes“transitiontoanenvironmentallysustainableandresilientnetzeroeconomy”(HMTreasury2021).Similarly,undertheEuropeanUnion(EU)Treaties,theECBhasasecondaryobjectivetosupportgeneraleconomicpolicieswhichhelpachieveEUobjectives,actingwithinitsmandateandwithoutprejudicingitsprimaryobjective.TheECBnotesthatthisincludesprotectingtheenvironment(ECB2021a).Aspartofsupportingthetransitiontoalow-carboneconomy,somecentralbanksidentifythedevelopmentofmarketsforsustainablefinanceasanobjective,whichstemsfromtheirroleinpromotingthedevelopmentoffinancialmarketsmorebroadly.Forexample,theMonetaryAuthorityofSingapore’smissionincludespromotingasoundandprogressivefinancialcenter,andaimsto“workwithfinancialinstitutionstodevelopavibrantsustainablefinanceecosystemstosupportAsia’stransitiontoalowcarbonfuture”(MAS2022).TheECBlists“promotingsustainablefinancetosupportanorderlytransitiontoalowcarboneconomy”asoneofitsthreecoreclimateobjectives(ECB2022a).Morebroadly,manycentralbankshavehistoricallyplayedaroleindevelopingmarketsandguidingcreditallocation.Othercentralbanks,incontrast,seetheirrolesasmorelimited.TheFederalReserve,forexample,hasnotedthatwhileithasaresponsibilitytooverseeclimate-relatedfinancialrisksasabankregulator,broaderpoliciesaddressingclimatechangewouldhavedistributionaleffectsacrossfirmsandregionsthatarebestmadebygovernments.Indeed,theFederalReservehasnotedthat“itwouldbeinappropriateforustouseourmonetarypolicyorsupervisorytoolstopromoteagreenereconomyortoachieveotherclimate-basedgoals”(Powell2023).Indeed,centralbanksoftenemphasizethatwhiletheiractionscansupportclimatemitigation,primaryresponsibilityforclimatechangepolicysitswithgovernment.Forexample,theECBstatesthat“governmentsshouldCentralBanksandClimateChange211taketheleadbecausetheyareprimarilyresponsibleforclimatepolicyandhavethemosteffectivetools”whilealsonotingthat“theECBalsohaveastronginterestinhelpingaddressclimatechange…becauseclimaterisksaffecthowwedoourjobofkeepingpricesstable”(ECB2021b).OrinthewordsoftheReserveBankofNewZealand,“Nosingleinstitutionworkingalonecanachievemeaningfulprogressonaglobalchallengesuchasclimatechange.Furthermore,itisnotforfinancialpolicymakerstodrivethetransitiontoalow-carboneconomy,norisitourroletoadvocateonepolicyresponseoveranother.Thatistheroleofgovernment”(RBNZ2022).12.2CentralBankActionsRelatedtoClimateObjectivesCentralbanks’climate-relatedactionsaresimilarinsomedimensionsbutvarywidelyacrossothers,reflectingdifferencesinmandatesandstatedclimateobjectives.Thissectionillustratestherangeofclimate-relatedactionsbydrawingoncentralbanks’ownstatements.Itisimportanttonotethatsomeactionsmayservemorethanoneofthefourclimate-relatedobjectivesnotedearlier.Givenclimaterisksarebecomingmuchmoreprominent,undertakingresearchandanalysishasbeenimportantforcentralbankstounderstandtheimplicationsofclimatechangefortheirmacroeconomicandfinancialstabilitymandates.Thisworkisalsoseenascontributingtoaleadershiprole.Thishasincludeddevelopinganalyticaltoolsandmodels,aswellascontributingtoworktoidentifyandaddressimportantgapsinthedata.Anumberofcentralbanksworkingwithfinancialinstitutionshaveundertakenclimatescenarioexercisestohelpmeasurethepotentialfinancialriskstobanksandunderstandhowbanksmayadjusttheirbusinessmodelsinresponse.Thosewithfinancialstabilitymandatesandprudentialresponsibilitiesarealsoprovidingguidanceanddevelopingframeworkstosupportthemanagementofclimate-relatedrisksbyfinancialentities.Whilethespecificactionsvaryconsiderablyinlinewithindividualcentralbanks’roleonfinancialstability,thiscanincludeprovidingsupervisoryguidance,improvingdisclosures,anddevelopingsustainablefinancetaxonomiesandframeworks(orsupportingthisworkwhereresponsibilitysitswithotherpolicymakers).Centralbanksmayalso,throughtheirownactions,modelgoodpracticeinthemanagementofclimate-relatedrisks.TheBankofEngland,forexample,inaimingtodemonstrate“bestpracticethoughourownoperations”ClimateChangeandClimateFinance212ispublishingtheTaskforceforClimate-RelatedDisclosures-alignedclimate-relatedfinancialdisclosures,settingouthowits2050netzeropledgewillbemetacrossallitsphysicaloperationsandisgreeningitscorporatebondportfolio(BOE2022).Somecentralbanksframetheirclimate-relatedmeasuresas“protective,”designedtoreducetheclimate-relatedrisksassociatedwiththeirfinancialportfoliosormarketoperations(NetworkforGreeningtheFinancialSystem2021).Sweden’sRiksbank,forexample,onlybuysbondsissuedbycompaniesdeemedtocomplywithsustainabilitystandardscoveringhumanrights,workingconditions,environment,andanti-corruption.TheRiksbankdescribesthisapproachasconsideringthefinancialrisksassociatedwiththepurchaseofthosebonds,as“itisriskiertopurchasebondsissuedbycompaniesthatareinbreachoftheseprinciples”(SverigesRiksbank2021).Othercentralbanksareimplementingorconsidering“proactive”measuresdesignedtopromoteatransitiontoaloweremissionseconomy.Oftenthesecentralbankshaveexplicitmandatestosupporttheirgovernment’snetzeroobjectivesortofosterfinancialmarketdevelopment.TheBankofEngland,forexample,hasintroducedclimate-relatedcriteriaforcorporatebondstobeeligibleforpurchasesinitsoperations,withpurchases“tilted”towardeligiblefirmswithstrongerclimatecredentials(BOE2021).Thisaimstoachievea25%reductioninthecarbonintensityoftheirportfolio,andisaimedatsupportinganorderlyeconomy-widetransitiontonetzero.Somecentralbanksalsoprovidelendingfacilitiesforgreenorsustainableactivitiestosupportanorderlytransitiontoalow-carboneconomy.TheBankofJapan,forexample,providesloansatalowerinterestratetobanksthatcontributetoJapan’sactionstoaddressclimatechange,notingthatthisis“withaviewtosupportingprivatesectoreffortsonclimatechange”(BOJ2021b).Thedistinctionbetweenprotectiveandproactiveactions,however,isnotalwaysclearcut.Protectivecentralbankactionsassociatedwithmeetingtheirownriskmanagementneeds,likerequiringclimate-relateddisclosuresincollateralframeworks,arealsoproactivebecausetheysupportthedevelopmentofgreenfinancialmarketsbyimprovingtheinformationavailabletopriceandmanagetheserisks.Inannouncingitsplantodecarbonizeitscorporatebondholdings,forexample,theECBsaidthat“thisaimstomitigateclimate-relatedfinancialriskstotheEurosystembalancesheet.Italsoprovidesincentivesforissuerstoimprovetheirdisclosuresandreducetheircarbonemissioninfuture”(ECB2022b).Table12.2providesmoreexamples.CentralBanksandClimateChange213Table12.2:ExamplesofChangestoMonetaryPolicyOperationsMonetaryPolicyPortfolioRiksbankOnlybuysbondsissuedbycompaniesdeemedtocomplywithsustainabilitystandardscoveringhumanrights,workingconditions,environment,andanti-corruption.EuropeanCentralBankTiltingcorporatebondholdingstowardissuerswithbetterclimateperformance.BankofEnglandClimate-relatedeligibilitycriteriaforcorporatebondpurchase,withpurchases“tilted”towardeligiblefirmsthatarestrongerclimateperformers,targetinga25%reductioninthecarbonintensityoftheportfolio.ForeignReservesPortfolioSverigesRiksbankA“sustainabilityperspective”isappliedintheselectionofassetsintheforeignexchangereservesportfolio.People’sBankofChinaWillfurtherincreasetheshareofgreenbonds,limitinvestmentincarbon-intensiveassets,andincorporateclimateriskfactorsintoourriskmanagementframework.ReserveBankofNewZealandPurchased$100millionofBISGreenBondInvestmentPool.Consideringtakingamore“holistic”approachwhenchoosingassetsforforeignreservesportfolio,byconsideringexpandinguniverseofsustainability-linkedinvestmentopportunities.Theywilllooktosupportthedevelopmentofsustainability-linkedmarkets.CollateralFrameworkEuropeanCentralBankWilllimitshareofassetsissuedbyentitieswithahighcarbonfootprintthatcanbepledgedascollateral.Thenewregimeaimstoreduceclimate-relatedfinancialrisksinECBcreditoperations.BankofEnglandCollectedclimate-relatedinformationinitsduediligencequestionnairessince2019andrecentlystartedaskingcounterpartiesprepositioningresidentialloancollateraltosubmitadditionalinformationonenergyefficiency.People’sBankofChinaExpandedcollateralformedium-termlendingfacilitytoincludeSMEsandgreenbonds.InvestmentorOtherPortfoliosNorgesBank(Norway)Managesthegovernment’ssovereignwealthfund(GovernmentPensionFundGlobal)andengagesin“responsibleinvestment”practices.NorgesBankhasdivestedfromassetsduetoconcernsaroundclimate-relatedrisks.MonetaryAuthorityofSingaporeTakingactionstoreducetheequitiesportfolioemissionsintensity,setexpectationsforexternalmanagersandexcludeinvestmentsinthermalcoalminingandoilsandsactivities.BankofCanadaDevelopingpracticalstepstointegrateESGconsiderationsintoinvestmentdecisionsandreporting.LendingFacilitiesPeople’sBankofChinaOfferinglowinterestloanstobanksthathelpfirmscutcarbonemissions.BankofJapanProvideloansatalowerinterestratetobanksthatusethefundstoinvestinclimate-friendlyprojectsinJapan.ReserveBankofIndiaAddedgreenprojectstoitsquotafor“prioritylending,”whichbanksmusthitwhentheymakeloans.BIS=BankforInternationalSettlements;ECB=EuropeanCentralBank,ESG=environmental,social,andgovernance;SMEs=smallandmedium-sizedenterprises.Source:Authors.ClimateChangeandClimateFinance214ChallengesforcentralbanksCentralbanksaremakingsignificantprogressinassessingtheimpactofclimatechangeandtailoringtheirresponse.Buttheeconomicandfinancialimpactsofclimatechangeraisechallengesforcentralbanks,justastheydoforfinancialinstitutions,businesses,households,andgovernmententities.Thereisagoodscientificunderstandingoftheimpactofclimatechangeonmeantemperatures;however,thereissignificantuncertaintyabouttheeffectonthefrequencyandseverityofextremeweatherevents.Morefrequentandsevereextremeweathereventsarelikelytoresultingreaterstructuralchangeandmorepersistentsupplyshocks,whichincreasestheuncertaintyforcentralbanksinhowtorespondtoclimatechange.Centralbanksareaccustomedtodealingwithuncertaintyaboutthefuturestateoftheeconomy,butwithclimatechangethereislessinformationtocharacterizethescaleoftheuncertainty.Asecondchallengeisthatthetimeframeoverwhichclimatechangeisplayingoutismuchlongerthanthehorizoncentralbankstypicallyconsider.Centralbanksgenerallyfocusonthenext2–3yearswhensettingmonetarypolicyandperhapsoutto10yearswhenconsideringthelongerdynamicsrelevantforfinancialstability.Incontrast,thehorizonoverwhichtheimpactsofclimatechangeareplayingoutismuchlonger;typicallyclimatechangeprojectionsaremadeformanydecades,oftenouttotheendofthecentury.Athirdchallengeforcentralbanksisthatclimatechangeislikelytoresultinmorefrequentandlargersupplyshocks.Butmonetarypolicyisbestabletorespondtochangesindemand,monetarypolicyusuallydoesnotrespondtosupplyshockssinceitcannotaddresstheirunderlyingcause.Largerandmorefrequentsupplyshockscouldthenmakeitharderforcentralbankstoachievetheirobjectives,forexample,ifclimatechangeinducedsupplyshocksweretomakeinflationexpectationslessstable.Afourthchallengeforcentralbanksisthatthedriversofclimatechange,andtheissuesthatarisefromit,areverydifferenttothosethatcentralbanksareusedtoanalyzing.Asaresult,centralbanksareneedingtoinvestinanewrangeofskills,newdata,anddifferentmodels(forexample,withlongerhorizonsandfinergranularityofindustriesorgeographicrepresentations)astheycontinuetoassesshowongoingclimatechangeaffectsallaspectsoftheirobjectivesandoperations.CentralBanksandClimateChange215ReferencesAustralianGovernment.2021.2021SoEClimateChangesinNumberofDaysWhentheAustralianArea-AveragedMeanTemperatureIsabovethe99thPercentile.Canberra.https://data.gov.au/data/dataset/2021-soe-cli-010.BankofCanada(BOC).2021.BankofCanadaAnnouncesClimateChangeCommitmentsforCOP26.Pressrelease.3November.https://www.bankofcanada.ca/2021/11/bank-canada-announces-climate-change-commitments-for-cop26/.BankofEngland(BOE).2021.GreeningOurCorporateBondPurchaseScheme.London.https://www.bankofengland.co.uk/markets/greening-the-corporate-bond-purchase-scheme._____.2022.Climate-RelatedFinancialDisclosure.London.https://www.bankofengland.co.uk/prudential-regulation/publication/2022/june/the-bank-of-englands-climate-related-financial-disclosure-2022.BankofJapan(BOJ).2021a.StrategyonClimateChange.TheBankofJapan’sStrategyonClimateChange.SpeechattheJapanNationalPressClub.27July.https://www.boj.or.jp/en/about/release_2021/rel210716b.pdf._____.2021b.OutlineofClimateResponseFinancingOptions.https://www.boj.or.jp/en/mopo/mpmdeci/mpr_2021/rel210922c.pdf.Brainard,L.2021.WhyClimateChangeMattersforMonetaryPolicyandFinancialStability.SpeechattheFederalReserveBankofSanFranciscoatTheEconomicsofClimateChangeConference.8November.CommonwealthScientificandIndustrialResearchOrganisation(CSIRO).2002.StateoftheClimate2022Report.Canberra.https://www.csiro.au/-/media/OnA/Files/SOTC22/22-00220_OA_REPORT_StateoftheClimate2022_WEB_221115.pdf.EuropeanCentralBank(ECB).2021a.ECBPresentsActionPlantoIncludeClimateChangeConsiderationsinitsMonetaryPolicyStrategy.Pressrelease.8July.https://www.ecb.europa.eu/press/pr/date/2021/html/ecb.pr210708_1~f104919225.en.html.ClimateChangeandClimateFinance216_____.2021b.ClimateChangeandtheStrategyReview.Frankfurt.https://www.ecb.europa.eu/home/search/review/html/climate-change.en.html._____.2022a.ECBClimateAgenda.Frankfurt.https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.pr220704_annex~cb39c2dcbb.en.pdf._____.2022b.ECBTakesFurtherStepstoIncorporateClimateChangeintoItsMonetaryPolicyOperations.Pressrelease.4July.Frankfurt.https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.pr220704~4f48a72462.en.html.HMTreasury.2021.RemitfortheMonetaryPolicyCommittee.LetterfromtheChancelloroftheExchequertotheBankofEngland.3March.London.https://www.bankofengland.co.uk/-/media/boe/files/letter/2021/march/2021-mpc-remit-letter.pdf?la=en&hash=C3A91905E1A58A3A98071B2DD41E65FAFD1CF03E.Kearns,J.2022.ClimateChangeRiskintheFinancialSystem.SpeechatCreditLawConference“ManagingFinancialServicesRisksinanAgeofUncertainty.”24August.Sydney.https://www.rba.gov.au/speeches/2022/sp-so-2022-08-24.html.MonetaryAuthorityofSingapore(MAS).2022.MASSustainabilityReport.Singapore.https://www.mas.gov.sg/-/media/MAS-Media-Library/publications/sustainability-report/2022/MAS-Sustainability-Report-2021_2022.pdf?la=en&hash=4B850000BE2CE8279A1913D29763C0370E3B8E70.NetworkforGreeningtheFinancialSystem.2021.AdaptingCentralBankOperationstoaHotterWorld–ReviewingSomeOptions.March.Paris.https://www.ngfs.net/sites/default/files/media/2021/06/17/ngfs_monetary_policy_operations_final.pdf.Powell,J.2023.CentralBankIndependenceandtheMandate–EvolvingViews.SpeechattheSverigesRiksbankSymposiumonCentralBankIndependence.10January.Stockholm.https://www.federalreserve.gov/newsevents/speech/powell20230110a.htm.CentralBanksandClimateChange217ReserveBankofNewZealand(RBNZ).2022.OurClimateChangeStrategy.Wellington.https://www.rbnz.govt.nz/about-us/how-we-work/our-climate-change-strategy#:~:text=The%20strategy%20focuses%20on%20ways,for%20New%20Zealand%27s%20financial%20system.&text=The%20Reserve%20Bank%20of%20New,sustainable%2C%20productive%20and%20inclusive%20economy.SverigesRiksbank.2021.ClimateReport–ClimateRisksinPolicyWork.Stockholm.https://www.riksbank.se/globalassets/media/rapporter/klimatrapport/2021/the-riksbanks-climate-report-december-2021.pdf.ChapterClimateRiskDisclosureandGreenTechnologyInnovation—ASurveyZijunZhao1313.1IntroductionUnderthethreatofclimaterisk,policymakers,standard-setters,andregulatorsneedtobemoreactiveineffortstocombatclimatechangeandstabilizethefinancialsystem,helpingtoleadthetransitiontoacleanereconomy,includingintheareaofinformationtransparency.Motivatedbythreatsofclimate-relatedriskonthefinancialmarket,andrecognizingtheroleofpolicytoolstocombatsuchrisk,thischaptersurveystheliteratureingreenfinance,environmentalaccounting,managementofclimateriskdisclosure,andgreentechnologyinnovationtoprovidemoreclarityaboutthepolicyimplicationsofenhancinginformationtransparencyandfacilitatinggreeninnovation.Insodoing,itcanshedmorelightontherolethatpolicymakersandregulatorscanplayintheseareas.Thesefactorshaveapivotalfunctioninmitigatingthedevastatingimpactofclimatechangeandinachievingnationaldecarbonizationtargets(e.g.,Christensen,Hail,andLeuz2021;Popp,Newell,andJaffe2010).Accurateandadequateinformationiscriticalforfinancialmarketefficiency,particularlyinrelationtoclimaterisks.1Investorsandstakeholdersinrecenttimesareincreasinglydemandingfirm-level,climate-relatedinformationtoassesswhetheracompanyisoperatingunderasustainable1Attentioninthechapterfocusesoncarbontransitionrisk,whichisaboutuncertaintyinpolicyortechnologicalinnovationaspectsgeneratedwhenreducingcarbondioxide(CO₂)emissionsandtransitioningtoacleanereconomy,sincethediscussionhereiscloselyrelatedtopolicyandtechnologyfactorsforrevealingandreducingemissions.ClimateRiskDisclosureandGreenTechnologyInnovation—ASurvey219model.Forexample,byfocusingontheUnitedStates(US)andglobalmarkets,BoltonandKacpercyk(2021a,2021b)confirmthatcarbonemissionrisk(orso-calledcarbontransitionrisk)—asasystematicrisk—ispricedintothefinancialmarket.Afollow-uppaperbyBoltonandKacpercyk(2021c)furtherillustratesthatcarbondisclosurereducesuncertaintyaboutemissionsandthusleadstoalowercostofcapitalforindividualfirms.Consistentwiththeimportanceofclimatedisclosure,debateisintenseabout“whethertostimulatevoluntarydisclosureorenforcemandatoryrequirementsbythegovernments.”Section13.2thereforeanalyzestheissuebyconsideringthebenefitsofbothdisclosureregimes(section13.2.1)andtheirpotentialcostsandpolicyimplications(section13.2.2).Governmentsandnongovernmentorganizationshaverecentlybeenstronglyencouraginggreentechnologyinnovation,recognizedasapivotalinstrumenttoreduceemissionsandacceleratethespeedofachievingnationaldecarbonizationgoals.TheUnitedNationsFrameworkConventiononClimateChange(UNFCCC)TechnologyExecutiveCommitteepointsoutthattechnologicalinnovationisacriticalacceleratorandenhancerofeffortstoimplementfederalclimateactionandachieveSustainableDevelopmentGoals.2Section13.3thereforeoutlinesthekeyfeaturesandroleofgreeninnovationintransitioningtocleanerenergy(section13.3.1).Moreover,asgreentechnologieshelpcurbcarbondioxide(CO₂)emissionsandimprovefirms’environmentalperformance,itwouldbeinterestingtoexplorewhethergreeninnovationcanbeextendedtoaffectcorporatedisclosuredecisions(section13.3.2),andwhatpolicytools(suchasregulation,taxation,andsubsidies)couldmotivategreeninnovation(section13.3.3).Christensen,Hail,andLeuz(2021)conductedacomprehensiveliteraturereviewofthedeterminantsandpotentialconsequencesofvoluntaryandmandatorydisclosureforcorporatesocialresponsibilitytopics.However,thischapterdiffersinitsfocusonlyonclimatedisclosure,acrucialcomponentofcorporatesocialresponsibilityreporting.Moreimportantly,corporatesocialresponsibilitydisclosureencompassesabroadrangeofenvironmental,social,andgovernancetopicsandthushasmorecomplexincentivestodisclose.Forexample,pollutingfirmsmightchooseinsteadtorevealbetterhumanrightsorsocialservicesbehaviorstooffsetanegativesocialimagerather2SeeUNFCCC(2017).ClimateChangeandClimateFinance220thanconcentratingonreducinggreenhousegas(GHG)emissions.Grewal,Hauptmann,andSerafeim(2021)noteforexamplethatExxonMobilhashighcorporatesocialresponsibilitydisclosurescoresbutpoorenvironmental,social,andgovernanceperformanceratingsinthesameyear.Therefore,apolicythatmotivatesfirmstoreportcorporatesocialresponsibilityinformationmightnotleadtobetterenvironmentalperformanceandtransparencywithkeyinformationaboutafirm’scarbonrisk.Consistentwiththisperspective,itwouldbenecessarytoanalyzeclimateriskdisclosuresolely,andthenconsiderthepolicyimplicationstoidentifywhichpoliciescouldleadtobetterdisclosureandsuperiorenvironmentalperformance.Thechapterextendstheanalysistodiscussthepoliticaldeterminantsofgreeninnovationandtheireffectsondisclosuredecisions,whicharenotcoveredinChristensen,Hail,andLeuz(2021).13.2ClimateRiskDisclosureResearchers,commentators,andgovernorssuggestthatinformationtransparencypromoteswell-functioningcapitalmarkets(e.g.,Ilhanetal.2021;Ross2021).Theviewisgrowingthatclimateriskissystematicwithadverseimpactsonthefinancialmarket(e.g.,In,Park,andMonk2019;BoltonandKacpercyk2021a).Inthissituation,robustdisclosureofclimate-relatedinformationisrequiredformultidimensionalaudiencestoassessfirms’climateriskandtopricetheriskintocapitalmarkets.Thissectiondiscussestheprosandconsofbothvoluntaryandmandatorydisclosure.13.2.1BenefitsofVoluntaryandMandatoryClimateDisclosureVoluntarydisclosureprovidesfirms(theboardandmanagers)todecidewhetherandwhatfactorstodisclose:disclosuredecisionsareatrade-offbetweentheircostsandbenefits(Leuz2010;GoldsteinandYang2017;Christensen,Hail,andLeuz2021).Inotherwords,firmshaveincentivestodisclosecorporateinformationwhenitcanbenefitthem.Thissectionsummarizestheprimarybenefitsofvoluntaryclimatedisclosureinfourareas.First,disclosureimprovesinformationtransparencyandreducesuncertaintyaboutemissionstohelpinvestorsassessfirm-levelclimaterisks,reducingfirms’costofcapital(BoltonandKacpercyk2021c;Matsumura,Prakash,andVera-Muñoz2022).Second,consistentwithasignalingtheory,voluntarydisclosureconveysapositivesignalthatthecompanyisengagingClimateRiskDisclosureandGreenTechnologyInnovation—ASurvey221(orgoingtoengage)indecarbonization,facilitatingefficientallocationofcapitaltothistypeoffirmbestpositionedtotransitiontolow-carbonbusinessmodels(Ross2021).Third,areportonfirm-levelenvironmentalperformance,especiallysuperiorperformance,couldreducethepenaltyforemissionsonthecapitalmarket(Matsumura,Prakash,andVera-Muñoz2014),ormitigateunwelcomepoliticalattention(e.g.,InnesandSam2008).Forexample,byfocusingonS&P500firms,Matsumura,Prakash,andVera-Muñoz(2014)findthatCO₂emissionsarepenalizedbythecapitalmarket,butfirmsthatvoluntarilydisclosesuchemissionsarepunishedlessthannon-disclosers.3Finally,asanonfinancialdisclosurewithmultidimensionalaudiences,climatedisclosurecouldbemotivatedbysocialresponsibility(BoltonandKacpercyk2021c).Inthissituation,disclosingGHGemissions(especiallypositivenewsonemissions)enhancesfirms’reputationandsocialtrust.Itthusincreasessalesandlong-termrelationshipswithstakeholders(Flammer,Toffel,andViswanathan2021).Despitethebenefitsofcorporateclimatedisclosure,itisstillinsufficienttojustifyamandatesincecorporateswouldhaveincentivestoprovideinformationvoluntarilywhenbenefitsexceedcosts(Leuz2010;LeuzandWysocki2016;Christensen,Hail,andLeuz2021).Sowhyexecutemandatorydisclosure?Toanswer,Leuz(2010)andChristensen,Hail,andLeuz(2021)analyzefinancialandnonfinancialcorporatesocialresponsibilityreporting.Firstandmostimportant,mandatoryreportingcreatesexternalities,whichmaynotbesufficientunderavoluntarycondition.Existingstudiessuggestthatvoluntaryclimateriskdisclosureismoreprevalentamonglargefirms(HahnandKühnen2013;Li,Lu,andNassar2021).However,smallfirmscouldalsocauseexcessivepollutionandadverseimpactsontheenvironment.Therefore,enforcingmandatorystandardshelpsmonitorandregulatecorporate-pollutingactivities.Meanwhile,firmsusuallyusedisclosureasatooltogainfinancialbenefits(suchasalowercostofcapital).Theyarethusnotresponsibleforprovidingpositiveexternalitiestosocietyunderavoluntaryregime.Inthiscase,governmentinterventionisrequiredtoaddressexternalities.Onecaninferfromthisperspectivethatamandatoryclimatereportisrequiredwhenthesocialvalueofdisclosedinformationexceedsitsprivatevaluetofirms,toincreasepositiveexternalities(i.e.,lowerGHGemissions).Forinstance,byexploitingauniquelawintheUnitedKingdomthatmandatesGHGemissions3TheempiricalevidenceinMatsumura,Prakash,andVera-Munoz(2014)illustratesthatthemedianvalueoffirmsthatdiscloseCO₂emissionsisabout$2.3billionhigherthannondisclosingfirms.ClimateChangeandClimateFinance222disclosure,JouvenotandKrueger(2021)andDownaretal.(2021)demonstratethatfirmsreducedemissionsafterthemandatorydisclosure.Tomar(2021)focusesontheUSGHGReportingProgram’simpact,whichmandatesthousandsofindustrialfacilitiestomeasureandreporttheirGHGemissions.Theempiricalevidenceillustratesa7.9%reductioninGHGemissionsfollowingthemandatoryrule.Tomar’sstudyalsofindsthatpeerbenchmarkingisthemechanismdrivingthisresult.Second,mandatesimprovestandardizationandcomparabilityofreportedclimateinformation.Bernowetal.(2019)arguethatinvestorscomplainaboutalackofcomparableinformation.EY(2021)demonstratesthatevenincreasingthenumberofcompaniesdisclosingundertheTaskForceonClimate-RelatedFinancialDisclosuresrecommendations,thecomplementofdisclosedelementsisstillinsufficient.Inthiscontext,mandatoryreportscreateastandardizedcorporatereportingregime,whichenhancestheaudience’sunderstandingandclarityaboutthedisclosedinformation.Consistentwiththisinsight,robustclimatedisclosureregulationsandclearpoliciesarerequiredtoimprovethequalityandcomparabilityofdisclosure.Third,mandatoryregulationsarelegislatedandthereforehavebetterinvestigationpowertodetectviolationsandamorepotentforcetoimposepenaltiesiftheirrulesareviolated.Morerobustfrauddetectionanduserinformationprotectionpreservethefinancialsystem’sstabilityandinvestors’confidenceinthefinancialmarket,allowingfirmstocommitmorecredibly.Itisthereforeconjecturedherethatamandatorystandardismorenecessaryincountrieswherethedisclosurequalityislowunderavoluntaryregime,orwithsalientindustrieswithhighCO₂emissions,sincetheyhaveahighprobabilityoffraudorviolationissues.13.2.2CostsandImplicationsofVoluntaryandMandatoryClimateDisclosureHowever,theimplicationofvoluntaryormandatoryclimatedisclosuremightnotmeanthata“one-size-fits-all”regimeissuitableforallcountriesandallfirms.Insomecases,voluntarydisclosurehasmorebenefitsthanmandatorydisclosureandviceversa.Ontheonehand,voluntarydisclosureprovidesmorediscretiontofirms,whichcouldbecost-saving,asitenablesmanagerstoconveyprivateinformationtomarketsatlesscost(Leuz2010).Discretionallowsmanagerstofine-tunetheneedsoffirmsandinvestors,avoidingtheproblemsofaone-size-fits-allapproach.Conversely,regulatorsClimateRiskDisclosureandGreenTechnologyInnovation—ASurvey223mightnotbeaswellinformedasthemanagersoffirmsaboutspecificcost–benefittrade-offs.Christensen,Liu,andMaffett(2020)pointoutthatbyincreasingtransparencybeyondthevalue-maximizinglevel,greaterfinancialreportingenforcementreducestheequityvalueoffirms.However,discretionisnotperfectasitcanbeusedopportunisticallytohidepoorfirmperformanceorrelatedagencyproblems.Next,thecostsofdisclosuremakevariouscompaniesreluctanttoprovideemissionsinformationvoluntarily,impedingmarketefficiencyandreallocationofcapitalinfinancialmarkets.Generally,thedirectcostsinvolvemeasuringandreportingemissions(BoltonandKacpercyk2021c),whichmightbemoreaffordableforlargecompanies.Ilhanetal.(2021)statethatinstitutionalinvestors’demandforclimateinformationisgreaterforlargefirmswithrelativelylowerinformationproductioncosts.Thedisclosurecostmightcauseadramaticnegativeimpactonfirmvalueunderamandatoryregime—ifdisclosurebenefitedfirms,theywoulddisclosebeforethemandate.Chen,Hung,andWang(2018)examinetheimpactofmandatorycorporatesocialresponsibilitydisclosurerequirementsinthePeople’sRepublicofChinaandfindanegativeimpactonfirms’profitability.Besides,theindirectcostsofthedisclosureincluderevealingbusinesssecretstocompetitors—proprietarycosts(e.g.,Verrecchia1983;Breuer,Leuz,andVanhaverbeke2019),whichcouldbeamoresevereconcernunderamandatoryregime,sincealltargetedfirmsareforcedtodisclose.TheFinancialStabilityBoard(2019)pointsoutthatinaTaskForceonClimate-RelatedFinancialDisclosuressurvey,almosthalfofrespondentsindicatethatdisclosingscenarioanalysisassumptionsisdifficultbecauseoftheirinclusionofconfidentialbusinessinformation.Therefore,insomecases,eventhoughmandatoryclimatedisclosurecouldgenerateeconomicbenefitsandpositivesocialexternalitiesthatexceedthebenefitsofvoluntarydisclosure,mandatorydisclosurecouldstillbepoliticallyexpedient.Thisistrueeventhoughitmightleadtofarfrominnocuousunintendedconsequences(Christensen,Hail,andLeuz2021).Forinstance,publiclylistedfirmsareusuallytargetedfortheadoptionofmandatoryreporting.However,firmscouldavoidbeingregulatedandpenalizedbyshiftingtounregulated(private)firms(Leuz,Triantis,andWang2008;Kamar,Karaca-Mandic,andTalley2009;DeFondandLennox2011).Bynow,theempiricalevidenceoftheeconomicconsequencesofregulatoryavoidancestrategyisstillsparse.However,onecanconjecturethatitcouldunderminenationaldecarbonizationtargetsorevenhavenegativeeconomicimplicationsforcapitalmarkets.ClimateChangeandClimateFinance224Tosumup,howfirmsusediscretioninreportingshouldbeafirm-specificissue,andfirm-levelcharacteristics,suchascorporategovernance,mightshapeit.Inthebigpicture,policymakersandgovernorsneedtobetterunderstandandclarifywhichpolicytoolortoolsmaysuitdifferentcircumstancesandrealities,includingdifferentscenarioanalysesbasedonnationallegalenvironmentsandnationalculturalbackgrounds.Forexample,Djankovetal.(2003)suggestthatregulationisparticularlycompellingwhenthereisinequalityinthedistributionofresourcesor“weapons”amongtheprivateparties.Leuz(2010)suggestscreatinga“globalplayersegment”inwhichmemberfirmsplaybythesamereportingrulesandfacethesameenforcement.13.3GreenTechnologyInnovationPoliticalattentiontogreeninnovationisgrowingandseekingrenewablealternatives.TheUnitedKingdomannounced£16millioninnewgovernmentfundingin2021topromotegreeninnovationasitcontinueseffortstohelpbusinessesreducetheircarbonemissions.4Germanycommitted€2.5billionforinvestmentinelectricvehicleinfrastructureanda€9,000subsidypervehicletoencouragegreeninitiatives.5Thissectionreviewsthepotentialimpactofgreeninnovationonclimatedisclosuredecisionsandtheconsequencesofenvironmentalpolicytoolsoninnovationactivities.13.3.1RoleofGreenTechnologyInnovationGreentechnologyinnovationhasbeenrecognizedasapivotalinstrumenttoreduceemissionsandacceleratethespeedofachievingnationaldecarbonizationgoals.Forexample,innovationinrenewablesolarandwindenergyhelpsreduceenergy-relatedemissions;improvementinnewbiofuelorvehicleefficiencyhelpsdecreasemobility-relatedemissions(TobelmannandWendler2020).Asaresult,greeninventorscouldsuccessfullyreduceCO2emissions,emissionsintensity,ortherateofchangeinemissions.Recently,nationalandpan-nationalorganizationsarestronglyencouraginggreeninnovationactivitiesasanefforttocombatclimatechangeandtofulfill“netneutral”commitments.OECD(2010)explainsthattheabilityoffirmsto4SeetheUKGovernmentathttps://www.gov.uk/government/news/government-invests-over-116-million-to-drive-forward-green-innovation-in-the-uk.5SeeSixWaysthatGovernmentsCanDrivetheGreenTransitionatEY.https://www.ey.com/en_gl/government-public-sector/six-ways-that-governments-can-drive-the-green-transition.ClimateRiskDisclosureandGreenTechnologyInnovation—ASurvey225generatenewtechnologiestoreducepollutionanditseffects—candrasticallydecreasethecostsoffutureenvironmentalpolicy.TheUNFCCCTechnologyExecutiveCommitteealsopointsoutthattechnologicalinnovationisacriticalacceleratorandenhancerofeffortstoimplementnationalclimateactionandachieveglobalobjectives.613.3.2TheImpactofGreenTechnologiesonDisclosureGreeninnovationthathelpsreduceCO₂emissionsandmeetenvironmentaltargetsmightincreasethebenefitsofclimatedisclosure—andincentivizefirmstodisclosevoluntarily.Ifso,appropriatepoliciestomotivategreeninnovation,wouldleadthetransitiontoacleanerenergyandstabilizethefinancialmarket.Somestudiesagreethatsuperiorenvironmentalperformanceisadeterminantofcorporatedisclosure.Clarksonetal.(2008)explainthatfirmswithsuperiorenvironmentalactivitieswillconveytheir‘‘type’’bydemonstratingtheircompliancewithobjectivestandards,whicharedifficulttomimicbyinferiorfirms.Inotherwords,superiorperformershavestrongerincentivestodisclosetheiremissionsandsignaltheirtypetoattractinvestorsandpreservetheirreputation.Conversely,inferiorperformerswouldreveallessandhidetheirdisappointingcapacitytransfertoacleanereconomy.Drawingonthesestudies,anargumentisthatgreentechnologiesdrivefirms’incentivestodisclosethroughanimprovedenvironmentaloutcome,makingfirmsmoreconfidenttodemonstratetheirtype.Forexample,Clarksonetal.(2008,2011)findapositiveassociationbetweencorporateenvironmentalperformanceandthelevelofenvironmentaldisclosures.Lietal.(2018)suggestthatgreeninnovatingfirmshavemorepropensitytodisclosetheiremissionsfortheirconfidence,capability,andmotivation.However,legitimacytheorystandsforanalternativeassumptionthatbetterenvironmentalperformanceisnegativelyrelatedtoenvironmentaldisclosuredecisions.Inparticular,legitimacytheoryarguesthatfirmsreportenvironmentalperformanceundersocialpressureinanattempttolegitimizetheirlong-termoperation(SolomonandLewis2002;Mobus2005;ChoandPatten2007).Inthissituation,firmswithbetterenvironmentalperformancefacelesslegitimacypressureand,thus,lowerincentivesto6SeeUNFCCC(2017).ClimateChangeandClimateFinance226disclose(Lietal.2018).Fromtheperspectiveofgreeninnovationimpactontheenvironment,analternativeconjectureisthatnewtechnologiesreduceemissionsandthusmitigatelegitimacyconcernsforcorporations,whichmightreduceincentivestoreporttheirclimate-relatednewsvoluntarily.Inaddition,proprietarycostscouldimpedecorporatedisclosure,asmentionedinsection13.2.2;thismightbeparticularlytrueforinnovativefirmssincetechnologicalinnovationusuallyinvolvesprofessionalknowledgeorbusinesssecrets.Inthiscontext,greeninnovationwouldweakenfirms’incentivetodisclose,duetoconcernaboutdivulgingtechnicalinformationtocompetitors.13.3.3WhatAretheDeterminantsofGreenInnovationInkeepingwiththeirpivotalcapacityinreducingemissions,policymakersandstandard-settersneedtounderstandwhatdeterminesgreeninnovationanddevelopgranularpoliciesastoolstostimulateinnovationanddecarbonization.Basedonthediscussioninsection13.3.2,ifgreeninnovationisadeterminantofclimatedisclosure,theneffectivepolicieswouldbetomotivatefirmstoseekandutilizerenewabletechnologies,whichinturncouldenhancevoluntarydisclosureforcorporates(i.e.,twobirdswithonestone).Ontheotherhand,ifgreeninnovationwouldunderminedisclosuredecisions,thenmoreprogressivepoliciesarerequiredtofacilitateinnovationwithoutimpedingcorporatedisclosure.Forexample,moreappropriateprotectionforintellectualpropertymightmitigateconcernsaboutproprietarycostsofdisclosure,whichinturnimprovegreeninnovationandclimatedisclosure.Therestofthischapterreviewsandsummarizesexistingstudiesontheimpactoflawsandregulationsoninnovation,whichmightshedmorelightonthisareaandassistpolicymakersandstandard-settersintheirdecision-making.TheOECD(2010)reporthighlightstheimportanceofutilizingenvironmentalpolicytoolstopromotegreeninnovation.Thereportemphasizesthatwithoutpricinginthecostofpollution,companiesmaylackmotivationtopursuesustainableandenvironmentallyresponsiblepractices.Inordertoaddressthisissue,governmentscanapplyarangeofpolicytools,includingregulatorymechanismssuchascarbontaxes,aswellasmarket-basedtoolsliketradablepermits.Furthermore,governmentscanoffersubsidiestosupportresearchanddevelopmentinthefieldofcleanertechnologies,providinganadditionalboosttogreeninnovation.ClimateRiskDisclosureandGreenTechnologyInnovation—ASurvey227First,OECD(2010)highlightedtheeffectivenessofmarket-basedtools,suchascarbontaxes,inprovidingincentivesforinnovation.7Itisbecausethecostsofemissionsmotivatepolluterstoseekandutilizecleaneralternatives.Moreover,Deloitte’s(2015)researchdelvesintotheimpactoftheUSFederalsolarinvestmenttaxcredits,whichprovidea30%taxcreditforsolarenergysystemsinstalledonresidentialorcommercialproperties.Theirfindingsrevealthatsincethesolarinvestmenttaxcreditwaspassedin2006,$66billionhasbeeninvestedinsolarinstallationsnationwide.However,theincreaseincorporatetaxationmightleadtooppositeresults.Mukherjee,Singh,andŽaldokas(2017)findthatanincreaseinstate-levelcorporatetaxintheUSleadstofewerpatentsandlessinvestmentinresearchanddevelopment(R&D),indicatingthathighercorporatetaxesreduceinnovationincentives.Theauthorsalsofindthatinnovationincreaseslessfollowingtaxcuts.Second,testsoftheimpactofregulatorytoolshavemixedresults.Lerner(2009)usesglobaldataandfindsthatpoliciesonpatentprotectionarepositivelyrelatedtotheinnovationrate.However,Mezzanotti(2021)illustratesthatstrictpatentlawraisespatentlitigationrisksandimpedesinnovationactivitiesforfirmsintheUS.Third,Howell(2017)investigatestheimpactofUSgovernmentR&Dsubsidiesoninnovationandfindsapositiveresult,indicatingthatearly-stagegrantsmitigatefinancialconstraintsfirmsfaceandenablefirmstoinvestinreducingtechnologicaluncertainty.However,Kong(2020)illustratesthatgovernmentspendingreducescorporateinnovationduetoresourcediversion.Tosumup,themixedresultsidentifiedinpriorstudiessuggestthatthisareaisalsolesslikelytohavea“one-size-fits-all”approachthatpositivelyaffectsgreeninnovationinallsituationsandallcountries.Thissupportstheneedforamorecomprehensiveanalysisbypolicymakers.Forexample,policiesshouldbemoregranulartosuitdifferentcircumstancesbyusingvariousscenarioanalysesbasedonnationallegalenvironments,nationalculturalbackgrounds,differencesbetweengeographicregions,andlevelsofnationalfinancialwealth.7ThecasestudiesexaminingtheinnovationimpactsoftheUnitedKingdom’sClimateChangeLevyonfossilfuelsandelectricityfoundthatfirmssubjecttothefullrateofthelevypatentedmorethanfirmssubjecttoareducedrate,onlyone-fifthofthefullrate.ClimateChangeandClimateFinance22813.4ConclusionsTomitigatetheadverseimpactsofclimateriskonthefinancialmarketandfacilitatethetransfertoamoreenvironmentallysustainableeconomy,governmentscanplayacriticalroleinincreasinginformationtransparencyinrelationtothefirm-level,climate-relatedperformanceandactionsandincentivizefirmstoseekandusecleanertechnologies.Drawingonexistingliterature,thischapterdiscussestherelativemeritsofincentivizingvoluntaryclimatedisclosureorenforcingmandatoryregulations.Tosumup,theimplicationsofvoluntaryandmandatoryclimatedisclosuresuggestthata“one-size-fits-allregime”isnotsuitableforallcountriesandallfirms.Forexample,insomecases,discretionallowsmanagerstofine-tunetheneedsoftheirfirms.However,standardizedinformationprovidedunderamandatoryregimehelpsinvestorscompareandassessfirms’sustainablemodels.Inaddition,mandatoryenforcementhelpspromotesocialexternalities,whichmightbeinadequateunderavoluntaryregime,butthecostsofmandatorydisclosuremighterodefirmvalue.Becausegreentechnologyinnovationcanenhanceandaccelerateeffortstofulfil“net-neutral”commitments,thechapteralsodiscusseswhethergreeninnovationcouldaffectclimatedisclosuredecisions.Oneargumentisthatcleanertechnologiesreduceemissionsandthusincreasefirms’incentivestodisclosepositivenewstothepublic.Anotheristhattheremightbeconcernsthatbetterenvironmentalperformancereducesfirms’legitimacypressureand,thus,theirincentivestodisclose.Finally,thechapterconsidersdifferentenvironmentalpolicytools(suchasregulation,tax,andsubsidies)tomotivatecorporategreeninnovation.Again,themixedresultsinpriorresearchimplythatthereisnoperfectpolicytooltofitallsituations.Inall,thesemixedresultsarepartofaninitialattempttoshedmorelightonthisareatoassistpolicymakersandstandard-settersindecision-making.Furtherworktoenhanceunderstandingandclarityaboutwhichpolicytoolortoolsmaysuitdifferentcircumstancesandrealitiescouldincludedifferentscenarioanalysesbasedonnationallegalenvironments,nationalculturalbackgrounds,differencesbetweengeographicregions,andlevelsofnationalfinancialwealth.ClimateRiskDisclosureandGreenTechnologyInnovation—ASurvey229ReferencesBernow,S.,J.Godsall,B.Klempner,andC.Merten.2019.MorethanValues:TheValue-BasedSustainabilityReportingthatInvestorsWant.McKinseyandCompany.7August.Bolton,P.andM.Kacperczyk.2021a.DoInvestorsCareaboutCarbonRisk?JournalofFinancialEconomics.142(2).pp.517–549._____.2021b.GlobalPricingofCarbon-TransitionRisk.NBERWorkingPaperSeries.No.28510.Cambridge,MA:NationalBureauofEconomicResearch._____.2021c.CarbonDisclosureandtheCostofCapital.https://ssrn.com/abstract=3755613.Breuer,M.,C.Leuz,andS.Vanhaverbeke.2019.ReportingRegulationandCorporateInnovation.NBERWorkingPaperSeries.No.26291.Cambridge,MA:NationalBureauofEconomicResearch.Chen,Y.C.,M.Hung,andY.Wang.2018.TheEffectofMandatoryCorporateSocialResponsibilityDisclosureonFirmProfitabilityandSocialExternalities:EvidencefromChina.JournalofAccountingandEconomics.65(1).pp.169–190.Cho,C.H.andD.M.Patten.2007.TheRoleofEnvironmentalDisclosuresasToolsofLegitimacy:AResearchNote.Accounting,OrganizationsandSociety.32(7–8).pp.639–647.Christensen,H.B.,L.L.Hail,andC.Leuz.2021.MandatoryCorporateSocialResponsibilityandSustainabilityReporting:EconomicAnalysisandLiteratureReview.ReviewofAccountingStudies.26(3).pp.1176–1248.Christensen,H.B.,L.Y.Liu,andM.Maffett.2020.ProactiveFinancialReportingEnforcementandShareholderWealth.JournalofAccountingandEconomics.69(2).101267.Clarkson,P.M.,Y.Li,G.D.Richardson,andF.P.Vasvari.2008.RevisitingtheRelationbetweenEnvironmentalPerformanceandEnvironmentalDisclosure:AnEmpiricalAnalysis.Accounting,OrganizationsandSociety.33(4–5).pp.303–327.ClimateChangeandClimateFinance230_____.2011.DoesItReallyPaytoBeGreen?DeterminantsandConsequencesofProactiveEnvironmentalStrategies.JournalofAccountingandPublicPolicy.30(2).pp.122–144.DeFond,M.L.andC.S.Lennox.2011.TheEffectofSOXonSmallAuditorExitsandAuditQuality.JournalofAccountingandEconomics.52(1).pp.21–40.Deloitte.2015.CreditsandIncentivesProvideGreenforGoingGreen.https://www2.deloitte.com/us/en/pages/tax/articles/credits-and-incentives-provide-green-for-going-green.html.Djankov,S.,E.Glaeser,R.LaPorta,F.Lopez-de-Silanes,andA.Shleifer.2003.TheNewComparativeEconomics.JournalofComparativeEconomics.31(4).pp.595–619.Downar,B.,J.Ernstberger,S.Reichelstein,S.Schwenen,andA.Zaklan.2021.TheImpactofCarbonDisclosureMandatesonEmissionsandFinancialOperatingPerformance.ReviewofAccountingStudies.26(3).EY.2021.IfClimateDisclosuresAreImproving,WhyIsn’tDecarbonizationAccelerating?https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/assurance/ey-if-the-climate-disclosures-are-improving-why-isnt-decarbonization-accerlerating.pdf.FinancialStabilityBoard.2019.TaskForceonClimate-RelatedFinancialDisclosures:StatusReport.https://www.fsb.org/wp-content/uploads/P050619.pdf.Flammer,C.,M.W.Toffel,andK.Viswanathan.2021.ShareholderActivismandFirms’VoluntaryDisclosureofClimateChangeRisks.StrategicManagementJournal.42(10).pp.1850–1879.Goldstein,I.andL.Yang.2017.InformationDisclosureinFinancialMarkets.AnnualReviewofFinancialEconomics.9.pp.101–125.Grewal,J.,C.Hauptmann,andG.Serafeim.2021.MaterialSustainabilityInformationandStockPriceInformativeness.JournalofBusinessEthics.171.pp.513–544.https://doi.org/10.1007/s10551-020-04451-2.ClimateRiskDi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keprogresstowardstacklingclimatechange.AbouttheAsianDevelopmentBankADBiscommittedtoachievingaprosperous,inclusive,resilient,andsustainableAsiaandthePacific,whilesustainingitseffortstoeradicateextremepoverty.Establishedin1966,itisownedby68members—49fromtheregion.Itsmaininstrumentsforhelpingitsdevelopingmembercountriesarepolicydialogue,loans,equityinvestments,guarantees,grants,andtechnicalassistance.AbouttheInstituteofGlobalFinanceTheInstituteofGlobalFinance(IGF)isaleadingpolicyresearchinstitutethatfocusesonissuesrelatedtoglobalfinancialstability,globalgovernance,climatechangeandclimatefinance,multilateralism,andglobalprosperity.Itscollaboratorsandresearchassociatesareamongstthemosteminentscholarsandinfluentialpolicymakersaroundtheworld.TheIGFalsoengagesincollaborativeworkwithboththebusinesscommunityandnongovernmentorganizations.