Corporate Sustainability and Stock Returns

This paper examines the effects of corporate sustainability initiatives for climate change on stock returns and firm value. This research is motivated by the recent severe climate change events that led to devastating human and financial losses. Just at the beginning of this century, most investors would not have put climate change into their asset pricing equation. Over the last few years, however, we have witnessed drought, crop loss, wildfire, ice-melt, hurricanes, and severe climate change. Just in the dragon year of 2012, Hurricane Sandy brought New York City, the world's largest financial center and most of the east coast under water. Traditional asset pricing model focuses essentially on the market-risk premium factor. We can no longer assume that climate change topic does not belong to the research area of capital market and asset pricing. In this study, we measure the abnormal stock returns using a six-factor model that incorporates 1) market risk-premium, 2) small firm factor, 3) value stock factor, 4) momentum factor, 5) liquidity factor, and last, but certainly not the least 6) sustainability factor. By inserting this new factor into the traditional asset pricing model, we contribute to the financial literature as well as to corporate sustainability literature. The findings of this research may also shed light on investment strategies that could adapt to climate change. Our sample consists of 3000 publicly-traded companies in the KLD database matched with financial data from Compustat and CRSP files for the period of 1991-2012. We employ a combination of KLD data and ClimateCount scores to measure the performance of corporate sustainability initiatives. We hypothesize 1) climate change affects investor sentiment which in turn affects stock returns; 2) companies with commitment to sustainability and taking initiatives to address climate change may lead to better risk-adjusted stock returns and firm value; 3) corporate sustainability factor may have certain explanatory power for asset pricing.