Hartzmark and Shue (2023)

Hartzmark, Samuel, and Kelly Shue. “Counterproductive Sustainable Investing: The Impact Elasticity of Brown and Green Firms.”  Working Paper (University of Chicago, Yale University), August 2023.   

From the authors’ abstract: “We develop a new measure of impact elasticity, defined as a firm's change in environmental impact due to a change in its cost of capital. We show empirically that a reduction in financing costs for firms that are already green leads to small improvements in impact at best. In contrast, increasing financing costs for brown firms leads to large negative changes in firm impact… Due to a mistaken focus on percentage reductions in emissions, the sustainable investing movement primarily rewards green firms for economically trivial reductions in their already low levels of emissions.”

Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4359282

 

lk notes from Kelly Shue presentation at PRI in Person Academic Network Conference (Tokyo), October 2023.

 There is significant heterogeneity across sustainable investment strategies.  But “the dominant strategy” seeks a green transition, and does so by …

  • Reducing portfolio exposure to firm-lever greenhouse gas emission intensity,

  • While minimizing disruption to global impact

     

Mechanism – the hope is to make firms more green by changing their cost of capital.  Success of this depends on Impact Elasticity of green and brown firms. 

Examples:

1) Green firm - Traveler Insurance, extremely low emissions intensity, ambitious Net Zero goals.

  • Cannot get much greener.

  • Reduce cost of capital – invest in what?

  • Green firms have low impact elasticity – an insurance firm won’t pollute much more or less if we increase(decrease) its cost of capital.

2) Brown firm - Martin Marietta Materials, very high intensity, but has cut emissions 12% (2019-2021).  Big absolute reduction.  More modest long-term goals, reductions costly.

  • Lower cost of capital would allow firm to invest in green technologies.

  • Higher cost of capital an incentive to cut corners.

  • Brown firms (highest emission quintile) dominate all emissions.  The other four quintiles are small by comparison.

  • “Raising their cost of capital also raises their carbon transition risk.”

  • Brown firms have high impact elasticity.   Raising cost of capital makes short-term cash flows more attractive, makes them care less about future.

What if brown firms become green to get cheaper access to capital?  Promising in theory, but sustainable investors tend to reward firms that are already green for large improvements off small bases.  Some industry adjustment is needed, e.g., we can’t consumer less agriculture and consumer more insurance as a substitute.

Hao Liang (discussant) comments –

  • Impact elasticity an important concept

  • Most investors employing ‘ESG integration’ and ‘active ownership’.  These strategies can be productive.

  • Transition finance – promotes long-term strategic GHG emission reduction initiatives (transition or sustainability-linked bonds).

  • Would argue that issues are being addressed by policymakers in Japan and China, as well as in markets to some extent.

  • Open issue – green firms most likely to be in insurance, healthcare, and financial services.  But these have a ‘huge proportion’ of Scope 3 emissions.  Institutional investors increasingly focusing on Scope 3.