Institutional Investors, Climate Disclosure, and Carbon Emissions

Institutional Investors, climate disclosure, and carbon emissions

There is an ongoing debate over the role institutional investors play in the global effort to control climate risk. While some contend that asset managers can contribute significantly in pushing companies to reduce their carbon footprint, others are more skeptical and recommend that authorities focus on traditional regulatory tools. This skepticism is fueled by the perception that a substantial number of institutional investors engage in “greenwashing” (i.e., “window-dressing” actions that have little real impact on the reduction of actual emissions).

Our paper contributes to this debate by exploring two specific interrelated questions: Does institutional investor request for climate-related data pressure firms to disclose this information? And is such firm disclosure followed by a decrease in carbon emissions?

To address these questions, we exploit the unique features of the CDP, a global not-for profit network organization that maintains the world’s largest repository of (voluntary) climate risk disclosure. Often referred to as the “gold standard” of environmental reporting, the CDP is a uniquely suited setting for the purpose of this study. Unlike other institutional networks with an interest in climate change – notably the UN Principles for Responsible Investment (PRI) – the CDP focuses solely on environmental issues and offers its signatories private access to corporate climate risk disclosure, collected by the platform specifically on their behalf. Furthermore, the CDP publicly discloses the list of its signatories, and as such, becoming a CDP signatory can be interpreted as equivalent to publicly requesting climate-related information.

Our first hypothesis is that institutional investors’ demand for climate-related information (as reflected in an investor becoming a CDP signatory) induces firms to disclose information to the CDP. On the one hand, asset managers could demand climate-related information because they believe that climate-related performance affects prices and/or they believe that improving the environmental performance of their portfolio will help them attract or retain clients that are sensitive towards climate risk. As a result, firms disclose information to attract/retain institutional investors and/or to avoid investor actions that may be potentially costly for managers and/or directors (e.g., withheld votes at annual meetings). However, on the other hand, it is also possible that investor demand for climate-related information does not induce firms to disclose if such disclosures are costly for firms to complete. Moreover, investors could sign up to the CDP because they care more about the signaling value of being a signatory, rather than the information content itself (indeed, signatories often tout their signatory status on their annual CSR reports). In this case, it is unclear whether firms would feel pressured by institutional investors to disclose their climate information. This possibility is supported by anecdotal evidence and by recent empirical work looking at institutional investors that sign up as PRI signatories but do not exhibit superior environmental performance in their portfolios.

Our second hypothesis is that disclosure of corporate climate risk information is followed by relatively lower levels of carbon emissions. There are at least two plausible mechanisms through which this may occur. First, investors could use the CDP disclosures to engage with firms on environmental issues. For example, the disclosure data could be used to select engagement targets and/or to identify environmental issues in preparation for meetings with firm management. In fact, prior work shows that engagement activities often pressure firms to enhance their environmental performance. Second, investors could use the disclosed information for portfolio allocation decisions, which would pressure firms to decrease emissions to preempt potential divestment. That said, it is also plausible that investors use the disclosed information in ways that do not induce firms to improve environmental performance. For example, asset managers could use the CDP data to short stocks of pro-environmental firms. Or investors could use the CDP information in ways that induce only a relatively small decrease in emissions. As such, whether CDP disclosure contributes to a significant decrease in corporate carbon emissions is also an open empirical question.

Our tests are based on a sample of more than 7,000 public firms from 51 countries during the period from 2003 to 2020. We provide systematic international evidence that firms with a higher ownership stake of CDP signatories are more likely to disclose their climate risk information to the CDP. This result is robust to the use of demanding fixed effect structures as well as tests exploiting plausible exogeneous variation in institutional ownership. Consistent with our second hypothesis, we also find that disclosing information to the CDP is associated with a decrease in carbon emissions. This result, too, is robust to a number of robustness tests, including a matching analysis around the time firms start disclosing to the CDP.

We also explore the mechanisms explaining the association between CDP disclosure and carbon emissions and find evidence for both engagement and divestment. We document that investors are more likely to engage with top emitting firms after they disclose to the CDP. We also find lower investor holdings among top emitters after these firms disclose to the CDP. Taken together, our results suggest that institutional investor demand for climate-related information is associated with an increase in corporate climate disclosure and a reduction in carbon emissions. And finally, while the concern over the underlying motivation behind institutional investors’ public commitment to sustainability may be a valid one, in our setting we do not find evidence of greenwashing.