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The Valuation Relevance of Greenhouse Gas Emissions under the European Union Carbon Emissions Trading Scheme

Abstract This study examines the valuation relevance of greenhouse gas emissions under the European Union Carbon Emissions Trading Scheme. We posit that carbon emissions affect firm valuation only to the extent that a firm's emissions exceed its carbon allowances under a cap-and-trade system and the extent of its inability to pass on carbon-related compliance costs to consumers and end-users. We measure a firm's ability to pass on the future costs by its market power and its carbon performance relative to its industry peers. The results show that firms' carbon allowances are not associated with firm valuation but the allocation shortfalls are negatively associated. We also find that the negative association between firm values and carbon emission shortfalls is mitigated for firms with better carbon performance relative to their industry peers and for firms in less competitive industry sectors. These findings, which suggest that the valuation impact of carbon emissions is unlikely to be homogenous across firms or industrial sectors, have important implications for future research design and for the disclosure and recognition of a firm's greenhouse gas liabilities.