Investors often react more favorably when a company directly works to mitigate greenhouse gas emissions directly through operational changes, like sourcing its electricity needs from renewable resources.
BLOOMINGTON, Ind. – When companies announce plans to use a certain percentage of renewable energy, address greenhouse gas emissions or other environmental, social, and governance initiatives, they presumably present a commitment to these issues and a desire to build trust with stakeholders.
But whether a firm is meeting ESG expectations of investors, clients, and other constituents often depends on how they act to mitigate the issue, whether it is doing so directly or by pursuing alternatives such as purchasing carbon offsets, according to research by Donald Young, assistant professor of accounting and a Blanche “Peg” Philpott Faculty Fellow at the Indiana University Kelley School of Business.
Donald Young
Since joining the Kelley School in 2017, Young has been an author of three journal articles about how companies’ ESG efforts and goals are viewed, and how they relate to market value.
“Commitment is a common theme in business and social psychology research, and it is typically characterized as an enduring and ongoing action for a cause, a relationship that exists over time or a desire to maintain a valued and stable relationship,” Young wrote in the journal Accounting, Organizations and Society. “A Google search for phrases like ‘our ESG commitments’ or ‘our ESG initiatives’ yields hundreds of corporate statements about ESG commitments and initiatives.
“The results of the query raise a valid question, do investors expect a perpetual commitment, finite initiatives, or both?”
In his research, Young generally has found the former to be the case. For example, investors often react more favorably if a company directly works to mitigate greenhouse gas emissions directly through operational changes, like sourcing its electricity needs from renewable resources such as wind turbines, rather than through an indirect means.
“When the firm’s strategy emphasizes purchasing offsets, participants view the firm as less socially and environmentally responsible and assign a lower value to the firm compared to when the firm’s strategy emphasizes making operational changes,” Young and his colleagues wrote in their paper, “The Influence of Firms’ Emissions Management Strategy Disclosures on Investors’ Valuation Judgements,” published in Contemporary Accounting Research.
“Both our theory and empirical findings suggest that investors expect that ‘dirtier’ firms should clean up their own operations before looking to invest in external sustainable activities,” they added.
But even setting goals to reduce emissions may fall short in terms of pleasing investors.
“Reducing direct emissions is perceived as more socially responsible. However, due to the diminishing marginal utility of ESG investment, investors only react this way when the firm’s prior ESG performance is poor versus good,” Young co-wrote in another paper, “Your emissions or mine? Examining how emissions management strategies, ESG performance and targets impact investor perceptions,” in the Journal of Sustainable Finance and Investment.
They also found that companies’ adopting an external emissions target as part of a management strategy – while seemingly positive – often is viewed as an insincere commitment to reducing emissions and thus negatively impacts investor relations.
Their findings suggest that companies should be cautious when adopting emissions targets. But they also should be of interest to policymakers as the consider emissions disclosure requirements.
“Even if companies’ management does not explicitly disclose their emissions management strategy, as was the case in our experiment, the strategy becomes evident when they follow the reporting guidelines outlined by various standard setters and disaggregate direct and indirect emissions across multiple reporting periods,” they wrote.
Young’s co-authors of both papers were Joseph Johnson, assistant professor of accounting at the University of Central Florida; Jochen Theis, interim head of cluster and associate professor at the University of Southern Denmark; and Adam Vitalis, associate professor of assurance at the University of Waterloo.