Is the Mandate Necessary?

• Author: Jennings, Robert

The Securities and Exchange Commission's new requirement that publicly traded firms report climate-related risks as part of their shareholder disclosures is ostensibly motivated by the desire for investors to have consistent, comparable, and reliable disclosures so they can better assess risks and make decisions consistent with their risk preferences. Mandating reporting assumes that these climate-related risks are of the same level of importance as financial and operational risks to investors, voluntary reporting is not adequate, and financial asset markets are incapable of addressing climate-related risk.

The academic literature calls each of these assumptions into question.

For instance, in a 2020 Review of Financial Studies article, Philipp Krueger, Zacharias Sautner, and Laura Starks conducted what is perhaps the most comprehensive survey of institutional investors' interest in climate-related risk disclosure. Their sampling is deliberately biased toward investors who care about climate risk and are pessimistic about the effect of climate change.

They ask respondents to rank six risks: financial risk, operating risk, governance risk, social risk, climate risk, and other environmental risks. Climate risk and environmental risks rank fifth and sixth, suggesting that these risks are not viewed by even climate-sensitive investors as on par with the more traditional information in mandated disclosures. Likewise, the most common reasons given for considering climate risk--reputation and moral/ethical--have little to do with the typical return-risk assessment entrusted to professional investors.

Several papers suggest that the capital markets already price in climate-related risks. A 2017 Contemporary Accounting Research article by Paul Griffin, David Lont, and Estelle Sun gathers information from voluntary disclosers' involvement with the Climate Disclosure Project to model the risk faced by non-disclosers. The authors find that the market discounts equity valuations of the non-disclosers slightly more than that of the disclosers, and that the non-discloser discount is only about 0.5% of market capitalization.

A 2021 Journal of Financial Economics article by Patrick Bolton and Marcin Kacperczyk finds that stocks of firms with higher emissions and higher changes in emissions earn higher returns than low-emission firms. They note that this "carbon premium" did not exist in the 1990s.

In a 2021 Review of Financial Studies article, Emirhan...